2.5 - Economic Growth

Question 1

Actual vs economic growth

Answer 1

Actual: an increase in real GDP
Potential: an increase in the productive capacity in the economy

Question 2

Causes of actual economic growth

Answer 2

• there is an increase in a component of AD. Consumption, investment, government expenditure, or net exports.
• in increase in costs of production as a result of costs of production falling
• if AD increases on the vertical part of AS, there won’t be an increase in output
• if AS increases but AD is on horizontal, then equilibrium will remain in the same place

Question 3

Causes of potential growth

Answer 3

It can only increase when the vertical paper of the AS curve shifts to the right, indicating that the amount an economy could produce has increased.
On a PPF, potential economic growth is shown as an outward shift.
-discovery of her new natural resources
-inc I by private or public sector
-increase in size of the labour force
-increase in productivity

Question 4

The importance of international trade for export led growth

Answer 4

It is a main driver of economic growth in many economies. It means that the balance of payments on the current account will improve as more goods and services are sold abroad. It makes exporters vulnerable to changes in demand in other countries in demand in other countries, or exchange rates, both are uncontrollable. In 2008, China’s growth slowed significantly and to maintain its exports the government decided to intervene to keep the currency rising against other countries. Currency market interventions aren’t popular in terms of the world trade climate.

Question 5

Constraints on economic growth

Answer 5

• labour market problems: shortages of skilled labour is a major constraint of growth. As a country gets richer, birth rates falls, so in LR there is a smaller labour force. An effective policy is to allow more immigration but this could lead to shortages of labour in low income countries.
• costs of and access to credit: if interest rates are high then investment and consumption decrease, so AD decreases.
• deficiencies in infrastructure: a country may have poor networks for water, energy, transport, and communications.
• external factors: global recessions, terrorism, volatility in exchange rate markets, changes in policies of major economies.

Question 6

What’s an output gap?

Answer 6

The difference between actual output and wither the trend or potential output.

Question 7

Positive output gap

Answer 7

The economy is growing faster than the the trend. Pressures will grow in an economy, such as tight labour markets, wage pressures and shortages of raw materials. It may be a sign that the economy is overheating and the inflationary pressures are likely to be evident. Interest rates may be raised by the MPC.

Question 8

Negative output gap

Answer 8

The economy is growing below the trend so there is likely to be spare capacity in the economy. MPC may cut interest rates.

Question 9

How do you estimate the side of an output gap?

Answer 9

Many organisations estimate the the UK’s output gap. The B of E inflation report or the data from the IMF, OECD or the office of budget responsibility. It’s difficult to estimate as not all unemployed resources would have the same impact if employed. The non-use of resources make them less useable in the long run and productive potential of the economy tends to fall when there is long-tern unemployment.

Question 10

What is the trade cycle?

Answer 10

They can be explained by animal spirits. This is Keynes’ term got the speculative action that results from any rise or fall in output and prices. Other reasons can explain the trend, the effects of changes in investment which magnify changes in output and the role of expectations in the decision-making of businesses.

Question 11

Charecteristics of a boom

Answer 11

In a boom real GDP is rising at a faster rate than the long run trend rate of economic growth.
Its likely to be associated with 
-rising real incomes
-rising consumption
-falling unemployment
-higher tax revenues
-higher rate of inflation if the boom is caused by excessive AD
-shortages of labour and raw materials

Question 12

Characteristics of a recession

Answer 12

It’s two successive quarters of negative economic growth.
It’s associated with following characteristics:
-falling real incomes and consumption
-an improvement in the balance of trade
-rising unemployment
-decrease in the rate of inflation
-lower tax revenues, causing an increasing budget deficit

Question 13

Benefits of economic growth

Answer 13

• consumers: incomes and wealth rise. People can save for future consumption. Confidence increases so are more willing to spend on consumer durables such as cars or gadgets. There are likely to be more employment opportunities. Increases wages so fewer hours and holidays.
• firms: make more profit when there is growth. Consumer spending rises which means firms sell more. Firms can take on more workers and are more likely to invest. Increases future growth prospects.
• governments: people pay more income tax, VAT and capital gains tax. More corporation tax as profits increase. Have to pay less unemployment and social benefits. A healthier fiscal position.
• current and future living standards: people feel better off, poverty rates fall as wages and unemployment rise. Govt may spend more of its income on areas that will increase s.o.l like health or education. Firms use cleaner technology. Standards of living increase as long as the costs of living don’t increase at the same rate

Question 14

Costs of economic growth

Answer 14

• opportunity cost: living standards could fall in production is directed to capital goods. Only in the long run would PPF shift
• income inequality: the unwaged and unskilled are less likely to benefit from increased incomes. There may be a two-speed economy where the incomes of some people accelerate but others only increase slowly. Likely to be unemployment for people who do not have labour market flexibility
• environmental problems: depletion of natural resources and external costs such as carbon emissions are likely to increase with growth. Govt can use the increased tax revenues to clean up economic growth
• balance of payments on the current account: domestic consumers are likely to spend more on imports and firms have incentives to reduce exports. If growth was export led then current account would improve
• inflation: when there is little spare capacity in the economy, there is likely to base shortages of factors of production, which is likely to increase inflation.
• monopoly: increase as large firms take over smaller firms. Crease barriers of entry of new firms
• increased stress and social dislocation: longer hours that increase stress, expectations increase and social life decreases