2.5 Economic Growth Flashcards
Actual vs Potential Economic Growth
Actual Economic Growth is a growth in real GDP / real output
Potential Economic Growth is a growth in the productive capacity of an economy, an outward shift in LRAS / the PPF
Trend Rate
The average sustainable rate of economic growth that can be maintained without inflationary pressures.
It is based on the current level of full employment as well as projected changes in spare capacity and full employment.
Causes of Actual Economic Growth
- Any change in any factor increasing a component of AD causing an increase in real output.
- A fall in the cost of production / a change in the quantity or quality of the factors of production causing an increase in Aggregate Supply.
- However, if the economy has no spare capacity, an increase in AD would only result in price level rises without a change in output.
Causes of Potential Economic Growth
Potential Economic Growth can only occur when YFE shifts to the right, increasing the level of full employment and spare capacity in the economy.
Caused by an increase in the quality/ quantity of factors of production available in the economy (e.g. increased labour force / increased productivity)
The importance of international trade for export led growth
Export led growth is where an increase in net trade is the main driver of growth in an economy.
In China, exports account for more than 50% of AD.
This means that the balance of payments on the current account will improve as exports rise.
Main issue is that export demand can be volatile, making exporters vulnerable to changes in global demand / exchange rates.
This is why some export led economies such as China have government intervention in place to prevent currency appreciation.
Constraints on Economic Growth
- Labour Market Imbalances. A shortage in skilled labour constrains the productive potential of the economy. Developing countries are also vulnerable to brain drains and emigration.
- Credit Availability. Banks unwilling to lend money and high interest rates would restrict consumption and investment.
- Infrastructure Deficiencies. If a country has poor infrastructure, this limits its productive potential and could limit potential output.
- External Changes. External changes such as falls in global confidence / security concerns would slow down trade. Another example would be volatility in the Forex markets as well as trade restrictions.
Output Gap
An output gap is the difference between actual output and the trend / potential output.
A positive output gap is unsustainable in the long run and indicates that resources are being used unsustainably and will prompt rises in interest rates.
A negative output gap is where there is spare capacity in the economy and could prompt a fall in interest rates.
However, output gaps are hard to estimate as resources have different effects on the economy when they are fully employed.
Furthermore, long-term productive potential tends to fall when there are high levels of long term unemployment.
Trade (Business Cycle)
A model demonstrating recurring trends in economic growth rates.
Booms tend to be followed by economic slumps or slowdowns which then tend to be followed by a recession and a consequent recovery back to a boom.
This can be partly explained by animal spirits where individuals over exaggerate the state of the economy.
Definition: Hysterisis
The effect where the economy is unable to return to its long term trend rate of growth following a severe recession.
This is attributed to the loss of productive potential and a decline in the level of full employment.
Characteristics of a Boom
- Rising real incomes and consumption
- Falling unemployment
- Higher tax revenue
- Higher levels of inflation
- Shortages of labour and raw materials
- Strong business investment
- High Profits
- Current Account Deficit
- Budget Surplus
- Positive Output Gap
Characteristics of a Recession
- Falling real incomes and consumption
- Rising unemployment
- Lower tax revenue
- Low levels of inflation
- Surpluses of labour and raw materials
- Low business investment
- Low Profits
- Current Account Surplus
- Budget Deficit
- Negative Output Gap
Benefits of Economic Growth: Consumers
- Rising incomes as a result of higher output creating more derived demand for labour.
- Higher asset prices as a result of more demand for high value assets e.g houses
- Increased financial security as consumers can save more of their higher income for future consumption.
- Increased variety as consumers can import higher quality items from abroad and growth leads to more competition.
- Better Quality of Life as workers can work less for their same wage, or spend money on more wants, increasing satisfaction and subjective happiness.
Benefits of Economic Growth: Firms
- Higher Profits as consumer spending rises, meaning that firms sell more, increasing revenue.
- Economies of Scale as profits and revenue rise, firms can reinvest / take on more workers to grow in the future. This allows them to lower average costs and improve efficiency.
Benefits of Economic Growth: Government
- Increased Tax revenue when incomes, consumption, asset value and profits rise, people are forced to pay more in the form of taxes such as corporation tax, VAT, income tax and capital gains tax.
- Lower Benefit spending as unemployment falls and quality of life improves, governments have to pay less in the form of benefits, allowing them to reallocate that money elsewhere.
Benefits of Economic Growth: Current and Future Living Standards
- Increased Govt Spending as the government gains tax revenue and has to spend less on benefits, they can reallocate this to other areas such as healthcare and education, improving living standards
- Rising incomes as incomes rise, consumers are able to satisfy more of their needs and wants, increasing their satisfaction and living standards.
- Fall in Poverty Rates as wages and employment rises, there would be less impoverished people.
Note: Standards of living will typically rise as long as the costs of living rise at a lower rate.
