2.5 Economic growth Flashcards
What is an output gap and how do positive and negative occur
It is the difference between the actual level of output (real GDP) and the maximum potential level of output
+ Occurs when real GDP is greater than the potential real GDP. This happens during periods of high economic growth and is associated with inflationary pressure and low unemployment.
The current account deficit will worsen because increased incomes and less unemployment means an increase in demand for imports.
- Occurs when the real GDP is less than the potential real GDP. This happens during periods of low or negative economic growth and is associated with deflationary pressure and high unemployment.
The current account deficit will improve becasue reduced incomes and higher unemployment means a decrease in demand for imports.
Why is it difficult to measure output gaps accurately
Because it is hard to know exactly what the maximum productive potential of an economy is.
Rapidly rising prices can indicate a positive gap is developing
Rising unemployment and a slowdown in economic growth can indicate that a negative is increasing
What is actual growth vs long-term growth
Actual: Can be differentiated from the idea of long-term trends in growth rates
Long-term: The underlying trend rate of economic growth over a longer period of time. This is determined by the constant increases in the productive capacity of the economy (AS)
When does potential output occur
When the economy is working at full capacity over the long-term. This occurs when all factors of production are working efficiently.
The economy can operate above potential output in the short-run but pressure on factors of production such as labour means that it is unsustainable in the long-term
Evaluate economic growth
It is important that the government find a balance between short-run and long-run economic growth policies as stimulating the demand-side of the economy is vital but if supply-side of the economy remains constrained, high levels of inflation are likely to occur.
Equally, focusing on improving the supply-side of the economy will have limited effect if the demand-side of the economy is suppressed. There will likely be significant spare capacity and unused resources.
However, the enhancement of the supply-side of the economy has significant time-lags attached and not all capital investment yields the desired improvements in productive efficiency.
Explain how LR growth (potential growth) and SR growth (actual growth) happen and their causes
SR Growth: The primary cause of an increase in economic growth is an increase in AD (using spare capacity to increase real GDP). This leads to actual economic growth. This can also occur if there is an increase in short-run AS. Possible reasons AD could increase:
- Lower IR
- Lower income / corporation tax
- Higher consumer / business confidence
- Higher government spending
- Weaker exchange rate
LR Growth: There must be an increase in the productive capacity of the economy, meaning an increase in the long-run AS. This leads to potential economic growth. Increases in LRAS can occur if there is a change in the quantity or quality of factors of factors of production or increased efficiency.
Factors that can shift the curve:
- Increase in labour productivity
- Increase in workforce size
- Investment
- Infrastructure improvements
- Increase in competition
What is the significance of factors causing economic growth
- Migration: The movement of people from one country to another, this will impact on labour as a factor of production.
Immigration: Will lead to greater productive capacity and a shift right in the LRAS curve.
Emigration: Will have the opposite effect.
- Changes in birth rates: Will have the same impact, with increased birth rates leading to a rightward shift in the LRAS curve
- Increases in productivity: Will mean that capital and labor are being used more effectively with increased output for the same input.
- Exports led growth: Will lead to greater productive capacity.
What are the 4 benefits of growth
- Higher disposable income: Households will be earning more disposable income because firms are making higher profits so will possibly be translating some of that into higher wages and salaries.
- Higher employment: With higher growth there is no more demand for a countries goods and services so for firms to produce that output they need to employ workers.
- Higher profits for firms: If households are earning and spending this means higher profits so firms can invest in things such as capital which is good for them as it means a continuing profit over time whilst also being very good for the economy.
- Fiscal dividend for government (increase in tax revenue): income tax revenues will rise as households are earning more income, VAT revenues will rise as these incomes are spent on goods and services, corporation tax revenues will rise because firms are making more profit, tariff revenues will rise as households are spending more on imports from abroad.
Meaning that the government can now fund there spending in the economy more easily so there spending on: housing, education, infrastructure, welfare, public sector wages.
Factors of a Boom, Recession and Recovery
Boom
- Growth beyond and faster than trend
- Firms producing a lot so high profits (selling easily)
- Employment goes up as workers will be needed so a decrease in unemployment
- High consumer and business confidence
- High demand for imports
- Rising tax revenues
- Inflation (Demand-pull)
Recession
- Declining AD
- High unemployment (businesses getting rid of workers)
- Fall in business and consumer confidence (decrease in: consumer spending, investment, manufacturing and house prices)
- Lower inflation
- Loose policies
- Low demand for imports
Recovery
- Rising consumer confidence (Willingness to spend, increase in house prices as a result)
- Rising business confidence (More investment, increase in construction / manufacturing)
- Loose policy’s trying to prevent going back into the economy
- Unemployment falls
- Increase in inflation
What are 4 costs of growth
- Inflation (higher demand-pull): It will erode purchasing power and therefore the higher the living standards improvements may not occur to the right level.
- Environmental costs: The destruction to the environment comes in so many different ways such as air pollution, deforestation, desertification, soil erosion, resource depletion, resource degradation. So environmental costs cause negative externalities in production and with that our welfare loss.
- Current account deficit: When incomes rise household incomes rise theres going to be the sucking in of imports effect as these households spend on goods and services from abroad and we lose a Macro objective in the process as increased imports lead to a balance of payments deficit on the current account.
- Higher income inequality: Which can be due to one dominant sector, capital intensive production, poor quality jobs
Evaluate costs and benefits of growth
We want sustainable growth as thats our key objectives of growth meaning:
- Growth without inflation
- Without the destruction of the environment
- Inclusive growth where everybody benefits not just a few people
- Balanced growth so that it can be continuous and sustained over time
