2.5 - Economic Growth

Question 1

What is actual Economic growth?

Answer 1

It is the increase in real GDP.

Question 2

What is Real GDP?

Answer 2

It is GDP adjusted for inflation.

Question 3

What is potential economic growth?

Answer 3

It is the level of output an economy could produce if there was full employment of all the resources in in the economy

Question 4

What is potential economic growth reflected by?

Answer 4

Changes in LRAS

Question 5

What is potential output determined by?

Answer 5

1- Size of the labour force
2- Capital stock
3- Productivity
4 - Natural resources.

Question 6

What is an output gap?

Answer 6

The output gap is the difference between actual GDP (or growth) and potential GDP (or growth)

Question 7

When does economic growth occur? (2 reasons)

Answer 7

When there is an increase in AD or in LRAS.

Question 8

What factors can cause economic growth due to changes in AD or LRAS?

Answer 8

Changes in AD:

1 - Increase in consumption: Effected by disposable income, consumer confidence, wealth effect and interest rates.

2 - Increase in Investment: Effected by: business expectations, animal spirits, interest rates, access to credit, government influence and demand for exports.

3- Increase in government expenditure: Effected by: the trade cycle and fiscal policy.

4- Net exports: Effected by: real foreign income, real domestic income, exchange rate, protectionism and non price factors.

Changes in LRAS:

1- Increase in investment

2- New technology

3- Increase in net migration

4- Supply side policies.

Question 9

Illustrate economic growth due to an increase in AD.

Answer 9

Right shift of AD1 to AD2 resulting in a shift from Y1 to Y2.

Question 10

Illustrate economic growth due to an increase in LRAS.

Answer 10

Right shift of LRAS resulting in Y1 increasing to Y2

Question 11

What factors may restrict economic growth?

Answer 11

1- Lack of access to funds for investment
2- Corrupt governments
3- Currency instability or an overvalued exchange rate.
4- Poor quality human capital
5- Protectionism by other countries

Question 12

How does international trade result in economic growth?

Answer 12

An increase in exports causes the AD curve to shift to the right, with multiplier effects.

Question 13

How might a country stimulate exports?

Answer 13

1- Engineer a depreciation of the exchange rate (by cutting interest rates). This makes exports relatively cheap and imports relatively expensive.

2- Adopt policies to improve productivity and efficiency in export markets.

Question 14

What is the actual rate of economic growth?

Answer 14

It is the rate at which real GDP changes from one year to another.

Question 15

When does a negative output gap exist?

Answer 15

When actual growth rates are below potential growth rates. When Y is less than YFE.

Question 16

Illustrate a negative output gap

Answer 16

AS / AD graph, the output gap is the distance between YFE and Y1

Question 17

When does a positive output gap exist?

Answer 17

When actual GDP is greater than potential GDP. It is a sign of excess demand.

Question 18

Illustrate a positive output gap

Answer 18

Classical LRAS curve. see textbook pg. 110.

Question 19

What is a problem with measuring an output gap?

Answer 19

It is difficult to measure output gaps due to the difficulty of measuring the level of potential output.

Question 20

Illustrate the Trade Cycle

Answer 20

Output against time. Straight line sloping upwards showing growth/ Curved line going up and down with peaks and toughs representing growth and recession. The curved line is in trend with the straight line.

Question 21

What are the characteristics of a boom?

Answer 21

1- Low unemployment
2- Less underemployment
3- Increased living standards
4- Increased levels of investment
5- Increasing rate of inflation (if caused by rising AD)
6- Increasing income inequality

Question 22

What are the characteristics of a recession?

Answer 22

1- Rising unemployment rates
2-More underemployment
3- Falling living standards
4- Falling levels of investment
5- Falling rate of inflation (AD is falling)
6- Increasing income inequality

Question 23

What is the benefit of economic growth on consumers?

Answer 23

1- Rise in real incomes
2- Consumers have higher standards of living as they can afford more goods and services.
3- Reduction in unemployment
4- Higher incomes may lead to an increase in subjective happiness.
5- Increase in life expectancy as higher real incomes allow people to eat healthier

Question 24

What is the benefit of economic growth on firms?

Answer 24

1- Increased demand for goods and services
2- Increased profits
3- Increased investment
4- Shareholders are likely to enjoy increased returns

Question 25

What is the benefit of economic growth on the government?

Answer 25

1- Increased tax revenue via income tax, as real incomes rise. 2- Increased tax revenue via VAT, as people are spending more. 3- Increased tax revenue via corporation tax, as businesses are earning more. 4- Decrease in spending on welfare payments related to unemployment. 5- It can help to reduce the budget deficit, perhaps even bringing about a budget surplus which would allow money to be saved for future recessions.

Question 26

What are the benefits of economic growth on current and future living standards?

Answer 26

1- Lower poverty levels 2- Increased number of goods and services 3- Economic growth can help developing countries gain foreign investment. This can improve infrastructure.

Question 27

What are the costs of economic growth on consumers?

Answer 27

1- Rapid growth can lead to inflation 2- If inflation is higher than the increase in wages, then real income will fall. 3- An increase in growth may lead to inequalities. 4- Economic growth may mean longer working hours and thus increased stress

Question 28

What are the costs of economic growth on firms?

Answer 28

1- An increase in growth would cause an increase in demand for workers and raw materials. This means they will increase in cost. As a result firms costs increase and potentially decrease their profit. 2- Firms who sell inferior goods with negative income elasticities may loose out. 3- Changing technologies may result in some markets disappearing e.g. DVD rentals.

Question 29

What is a cost of economic growth on the government

Answer 29

1- Economic growth tends to mean people expect more from the government i.e. better education, better roads etc.

Question 30

What is a cost and a benefit of economic growth on the enviroment?

Answer 30

1- Cost: With increased economic growth there is damage to the environment. For instance deforestation may occur to clear land for factories or for more resources. Large scales of production may result in both air and noise pollution. Furthermore an increase in waste may occur 2- Benefit: The government may have more income to clear up environmental damage. Subsidies may be given to companies in 'green' technology.

Question 31

What are the positive and negative effects of economic growth on the balance of trade?

Answer 31

Positive impacts: 1- Increased exports: Economic growth can lead to increased production, some of which may be exported, improving the trade balance. 2- Attracting Foreign Investment: Growing economies often attract foreign direct investment (FDI), which can improve the financial account of the balance of payments. Negative impacts: 1- Rising Imports: As income levels rise, consumers often demand more imported goods, which can lead to a worsening current account deficit if imports exceed exports. 2- Exchange Rate Appreciation: Economic growth can lead to currency appreciation, making exports more expensive and imports cheaper, potentially worsening the trade balance.