4.2.3.1 economic growth and the economic cycle

Question 1

what is short-run growth?

Answer 1

the actual annual % change in a country’s real GDP
- caused by increases in AD or SRAS

Question 2

what is long run economic growth?

Answer 2

• increase in productive capacity of the economy
• it refers to the trend rate of growth of real national output in an economy over time
• caused by increases in AS
• change in the quantity / quality of factors of production

Question 3

what is the potential output of an economy?

Answer 3

economy working at full capacity over the long-term
- all factors of production working efficiently

Question 4

when does an output gap occur?
and how’s it measured?

Answer 4

when there’s a difference between the actual level of output/growth and the potential level of output/growth

• it’s measured as a % of national output

Question 5

when does a negative output gap occur?

Answer 5

• when the actual level of output is less than the potential level of output
• puts downward pressure on inflation
• usually means there’s unemployment of resources in an economy, so labour + capital aren’t used to their full productive potential
• meaning there’s a lot of spare capacity in the economy
• associated with deflationary pressure and high unemployment
• current account deficit improves (decrease D for M)

Question 6

when does a positive output gap occur?

Answer 6

• when the actual level of output is greater than the potential level of output
• if productivity is growing, the output gap becomes positive
• puts upward pressure on inflation
• countries like China and India have high rates of inflation due to fast and increasing demand
  -> they’re associated with positive output gaps
• current account deficit worsens (demand for M increases)

Question 7

how do classical economists illustrate an output gap?

Answer 7

• they believe markets clear in the long run, so there’s full employment
• believe there are output gaps in the short run
• a -ve output gap is between Ye and Y1
• a +ve ouput gap is between Ye and Y2

Question 8

what are some characteristics of an economic boom?

Answer 8

• high rates of economic growth
• high demand
• low unemployment
• inflationary pressure
• skills shortage
• high confidence
• high capital investment
• gov budget improves due to high tax revenues and less spending on welfare payments

Question 9

what is an economic recession?

Answer 9

rate of economic growth starts to fall in a downturn
-> if real GDP falls for 6 months (2 quarters)
this = a recession

Question 10

what are the characteristics of a recession?

Answer 10

• demand falls
• falling inflation
• some firms will go out of business
• confidence is low
• firms will reduce investment
• unemployment begins to rise (with demand pull inflation)
• gov budget worsens

Question 11

what are the characteristics of economic recovery?

Answer 11

• business confidence is very important
• economic growth starting to rise
• demand increases
• unemployment falls
• inflation starts to rise
• confidence in the economy increases
• capital investment increases

Question 12

the housing market is frequently quoted as a ‘key indicator of economic activity’
what are the characteristics?

Answer 12

• sustained low or negative growth
• low demand and inflation
• high unemployment
• low confidence
• high levels of business failure

Question 13

what are the determinants of long run growth?

Answer 13

• I in capital goods
• innovation - products and processes
• migration
  -> immigration leads to greater productive capacity
  -> emigration has opposite effect
• changes in birth rates
• increase in productivity
• export-led growth
  -> leads to greater I in capital goods

Question 14

what are the 3 costs to consumers of economic growth?

Answer 14

1) doesn’t benefit everyone equally
- those on low and fixed incomes might feel worse off if there’s high inflation
- inequality could increase

2) likely to be higher demand-pull inflation
- due to higher levels of consumer spending

3) benefits of more consumption might not last after first few units
- due to law of diminishing returns
- states that the utility consumers derive from consuming a good diminishes as more of the good is consumed

Question 15

what are 2 benefits of economic growth to consumers?

Answer 15

1) average consumer income increases as more ppl are in employment and wages increase

2) consumers feel more confident in the economy
- increases consumption and leads to higher living standards

Question 16

what is 1 cost to firms and 1 cost to the government of economic growth?

Answer 16

FIRMS
1) could face more menu costs as a result of higher inflation
- this means they have to keep changing their prices to meet inflation

GOV
1) might increase their spending on healthcare if the consumption of demerit goods increase

Question 17

what are 4 benefits of economic growth to firms?

Answer 17

1) might make more profits, which might increase investment
- also driven by higher levels of business confidence

2) higher levels of I could develop new technologies to improve productivity and low average costs in the long run

3) as firms grow, they can take advantages of the benefits of economies of scale

4) if there’s more economic growth in export markets
- firms may face more competition which will make them more productive and effevient
- also give them more sales opportunities

Question 18

what’s 1 benefit of economic growth for the government?

Answer 18

1) government budget might improve
- fewer ppl require welfare payments and more ppl will be paying tax

Question 19

what’s a cost of economic growth to current and future living standards?

Answer 19

1) higher levels of growth could lead to damage to the environment in the long run
- due to increase negative externalities from the consumption and production of some goods and services

Question 20

what are 4 benefits of economic growth for current and future living standards?

Answer 20

1) as consumer incomes increase
- some ppl might show more concern about the environment

2) economic growth could lead to the development of technology to produce goods and services more greenly

3) higher average wages mean consumers can enjoy more goods and services of a higher quality

4) public services improve
- governments have higher tax revenues so can afford to spend on improving services
- could increase life expectancy + education levels

Question 21

why is a balance between short-run and long-run growth policies needed?

Answer 21

• stimulating demand-side is vital but if supply-side is constrained, inflation will occur
• focusing on supply-side is limited if demand-side is suppressed
  -> there will be spare capacity
• enhancement of the supply-side of the economy has significant time-lags

Question 22

why can you only operate above the productive output in the short-run?

Answer 22

• because pressure on factors of production makes this unsustainable

Question 23

when is economic growth sustainable?

Answer 23

when the rate of economic growth can be maintained in the long run, so future generations can enjoy the same rate of growth

Question 24

what does fast economic growth pose issues of?

Answer 24

• could mean that natural resources, like oil, might deplete
• would create environmental problems for future generations
• mean the future rate of growth might be weak

Question 25

when does unsustainable growth occur?

Answer 25

around the boom and bust sections of the economic cycle
- these are essentially deviations from the trend rate of growth

Question 26

what are the issues of excessive growth?

Answer 26

• there could be inflation in the average price level, wages and assets
• could be excessive credit
  -> which is unsustainable in the long run and the savings rate might be low and falling

Question 27

what are the issues of excessive growth in credit and levels of debt?

Answer 27

• growth financed by public debt (gov borrowing) or excessive levels of credit (consumer borrowing) might not be sustainable
• may be difficult to pay it back in the future, and doesn’t contribute to improvements in productivity

eg) sub-prime mortgage lending and the financial crisis

Question 28

when do asset price bubbles occur?

Answer 28

• when the price of an asset is predicted to rise causing it to be traded more
• demand is more than supply to prices rise beyond the intrinsic value

Question 29

when do asset bubbles ‘burst’?
and what does this cause?

Answer 29

when the price steeply and suddenly falls to its ordinary level
- causes panic and investors try to sell their assets

-> results in loss of confidence and it can lead to economic decline or depression

Question 30

what does destabilising speculation lead to?

Answer 30

changes in the price level in a market, as a result of speculation

Question 31

Keynes formed the term animal spirits what are these?

Answer 31

describe instincts and emotions of human behaviour, which drives the level of confidence in an economy

• if firms expect a high rate of return they’ll invest more, if firms are uncertain about the future they’ll postpone investments
• expectations about society and politics therefore affect investment

Question 32

what is herding?
why does it happen?
what can it cause?

Answer 32

the act of reacting to the behaviour of other economic agents rather than the market
- might be because some investors think their economic agents are better informed about the market, so they follow their actions

• can cause instability in the market

Question 33

how do you show short run growth on an AD/AS diagram?

Answer 33

Question 34

how do you show long-run growth on a diagram
1) if there is SRAS
2) if there isn’t SRAS

Answer 34

Question 35

label:
- boom
- recession
- recovery
- depression

Answer 35