9.2 Economic growth and sustainability

Question 1

What is economic growth?

Answer 1

Economic growth is the increase in a country’s real national output. This is caused by increases in the quality or quantity of factors of production, which cause an outward shift in the PPF.

Question 2

What is economic development?

Answer 2

The process of improving peoples wellbeing and quality of life, involving improvement in standards of lving, reduction in poverty, improved health and education along with increased freedom and economic choice.

It covers a more moral side to economic growth

Question 3

What is sustainability?

Answer 3

Sustainability is a concept that suggests resources, such as the environment, have to be used effectively and efficiently, so they can be maintained for future generations.

Question 4

When is growth sustainable?

Answer 4

Growth is sustainable when the rate of economic growth can be maintained in the long run, so future generations can enjoy the same rate of growth. Fast economic growth today could mean that natural resources, such as oil, might deplete, which would create environmental problems for future generations, and mean the future rate of growth might be weak. Unsustainable growth occurs around the boom and
bust sections of the business cycle. These are essentially deviations from the trend rate of growth. If growth is excessive, there could be inflation in the average price level, wages and assets. There could be excessive credit, which is unsustainable in the long run, and the savings rate might be low and falling.

Question 5

What is actual growth?

Answer 5

Short run growth is the percentage increase in a country’s real GDP and it is usually measured annually. It is caused by increases in AD.

Question 6

What is potential growth?

Answer 6

Long run economic growth occurs when the productive capacity of the economy is increasing and it refers to the trend rate of growth of real national output in an economy over time. It is caused by increases in AS.
The potential output of an economy is what the economy could produce if resources were fully employed.

Question 7

What is a positive output gap?

Answer 7

A positive output gap occurs when the actual level of output is greater than the potential level of output.
It could be due to resources being used beyond the normal capacity, such as if labour works overtime. If productivity is growing, the output gap becomes positive. It puts upwards pressure on inflation.
Countries, such as China and India, which have high rates of inflation due to fast and increasing demand, are associated with positive output gaps.

Question 8

What is a negative output gap?

Answer 8

A negative output gap occurs when the actual level of output is less than the potential level of output.
This puts downward pressure on inflation. It usually means there is the unemployment of resources in an economy, so labour and capital are not used to their full productive potential. This means there is a lot of spare capacity in the economy.

Question 9

What is an economic cycle?

Answer 9

This refers to the stage of economic growth that the economy is in.
The economy goes through periods of booms and busts

Question 10

What are the characteristics of a boom?

Answer 10

High rates of economic growth
Lots of investment
High demand pull inflation
Near full capacity or positive output gaps
(Near) full employment
Consumers and firms have a lot of confidence, which leads to high rates of investment
Government budgets improve, due to higher tax revenues and less spending on welfare payments

Question 11

What are the characteristics of a recession?

Answer 11

In the UK, a recession is defined as negative economic growth over two consecutive quarters. The characteristics are:

Negative economic growth
Lots of spare capacity and negative output gaps
Demand-deficient unemployment
Low inflation rates
Lots of destocking and discounts
Government budgets worsen due to more spending on welfare payments and lower tax revenues
Lower AD as lower consumer confidence

Question 12

What are the characteristics of a recovery?

Answer 12

Increasing house prices so increasing consumer confidence
Increase in investment which increases business confidence
Increasing consumption
Loose macro policy which allows sustained growth
Increasing construction and manufacturing
Increased growth and lower unemployment

Question 13

Causes of recession?

Answer 13

Demand:
Banking/housing/currency crisis

Supply:
Increase in oil or commodity prices
Increase in business taxes
Decrease in exchange rates so imports dearer

Question 14

What factors contributing to economic growth?

Answer 14

Trade liberalisation
Promotion of FDI
Microfinance schemes
Privatisation
Development of human capital
Development of tourism
Development of primary industries
Fairtrade schemes
Aid
Debt relief

Question 15

Trade liberalisation

Answer 15

Free trade is the act of trading between nations without protectionist barriers, such as tariffs, quotas or regulations. World GDP can be increased using free trade, since output increases when countries specialise. Therefore, living standards might increase and there could be more economic growth.

Question 16

Promotion of FDI

Answer 16

FDI is the flow of capital from one country to another, in order to gain a lasting interest in an enterprise in the foreign country.
FDI can help create employment, encourage the innovation of technology and help promote long term sustainable growth. It provides Low Economically Developed Countries with funds to invest and develop.

Question 17

Microfinance schemes

Answer 17

Microfinance involves borrowing small amounts of money from lenders to finance enterprises. It increases the incomes of those who borrow, and can reduce their dependency on primary products. There could be a multiplier effect from the investment of the loan.
They are small loans for usually unbankable people. It allows them to break away from aid and gives borrowers financial independence.
Microfinance loans detach the poor from high interest, exploitative loan sharks. They could help businesses to be set up, although the money could also be spent on immediate consumption, rather than investment. Since the money goes directly to Small and Medium Enterprises, it can stimulate employment.

Question 18

Privatisation

Answer 18

This means that assets are transferred from the public sector to the private sector. In other words, the government sells a firm so that it is no longer in their control. The firm is left to the free market and private individuals.
Free market economists will argue that the private sector gives firms incentives to operate efficiently, which increases economic welfare. This is because firms operating on the free market have a profit incentive, which firms which are nationalised do not.
Since they are operating on the free market, firms also have to produces the goods and services consumers want. This increases allocative efficiency and might mean goods and services are of a higher quality.
By selling the asset, revenue is raised for the government. However, this is only a one-off payment.

Question 19

Development of human capital

Answer 19

By developing human capital, the skills base in the economy would improve.
This would improve productivity and allow more advanced technology to be used, since workers will have the necessary skills.
Businesses struggle to expand where there are skills shortages. It also limits innovation.
By developing human capital, the country can move their production up the supply chain from primary products, to manufactured goods and to services, which can earn them more.

Question 20

Infrastructure development

Answer 20

Examples of physical infrastructure include transport, energy, water and telecommunications.

Question 21

Development of tourism

Answer 21

Tourism can create thousands of jobs and help shift a developing country away from dependency on primary products. Developing countries tend to have a marginal propensity to consume, which could create a multiplier effect.
It helps to diversify the economy and it could make the country more attractive to FDI, as well as developing their infrastructure.
Tourism can also be a way of earning foreign currency for developing countries.
However, little revenue is retained in the country, since travel agents and hotel owners are likely to repatriate their profits. Moreover, there is the issue of overcrowding and the loss of habitats.
Income from tourism is likely to be unstable, since it relies heavily on the business cycle in developed countries.
Locals could feel stigmatised by tourism, especially if they cannot afford the luxuries that the tourists have. There could also be some environmental damage, such as pollution.

Question 22

Development of primary industries

Answer 22

Some developing countries have an abundance of raw materials, so some governments might choose to exploit this advantage and develop the industry so the country can have a comparative advantage in its production.
Moreover, primary industries, especially those allied to farming, form the livelihoods of the bulk of the population. It is sometimes the only source of income for most families. Therefore, it is important that the industry is supported.

Question 23

Fairtrade schemes

Answer 23

Fairtrade schemes ensure that farmers can receive a fair price for their goods. Supermarkets buy a guaranteed quantity at a price above the market equilibrium. This helps farmers since they have a guaranteed income and certainty about their sales, so they can plan for the future.
Fairtrade can help support community development and social projects, as well as ensuring working conditions meet a minimum standard.
It encourages sustainable production, promotes environmental protection, and stops the use of child labour.
Critics say the impact of Fairtrade schemes is insignificant. They argue that
Fairtrade is simply a psychological influence on consumers in developed countries, who believe they are helping by buying Fairtrade goods. Fairtrade could distract from other policies and development, and it could make producers not part of Fairtrade worse off. This is since it divides the market into Fairtrade and non-Fairtrade markets. It could be argued that by distorting price signals, Fairtrade is less efficient.

Question 24

Aid

Answer 24

Consumers in LEDCs have a higher propensity to consume than save, due to their limited incomes. Capital inflows, including those in the form of aid, can help fill this savings gap.
Aid provides temporary assistance to a country, such as humanitarian aid offered to countries after conflicts or natural disasters. Aid could also be a grant for a project that a country might not have the funds for.
Aid could be used to reduce human capital inadequacies or to pay off debt. It can improve infrastructure, which can help make the country more productive.
However, the benefits of aid are limited by corrupt leaders, the size of the aid payment and the potential for the recipient country to become dependent on aid.

Question 25

Debt relief

Answer 25

Debt relief is the partial or total forgiveness of debt.
In developing countries, debt is considered to be a principal cause of poverty, since it causes human suffering and misery, and it hampers development.
With high levels of debt, financial resources are diverted from infrastructure, education and healthcare. The country’s ability to pay the debt, not the size, is most important. If a country defaults on its debt, it can make it hard to borrow more money in the future.
Debt forgiveness can allow a country to import more and increase the population’s standard of living. It improves government finances, so public services could be funded instead.
However, if debt is forgiven, it could encourage more borrowing in the future. Moreover, there could be corruption.

Question 26

Costs of economic growth on consumers

Answer 26

Economic growth does not benefit everyone equally. Those on low and fixed incomes might feel worse off if there is high inflation and inequality could increase.
There is likely to be higher demand-pull inflation, due to higher levels of consumer spending.
Consumers could face more shoe leather costs, which means they have to spend more time and effort finding the best deal while prices are rising.
The benefits of more consumption might not last after the first few units, due to the law of diminishing returns, which states that the utility consumers derive from consuming a good diminishes as more of the good is consumed.

Question 27

Benefits of economic growth on consumers

Answer 27

The average consumer income increases as more people are in employment and wages increase.
Consumers feel more confident in the economy, which increases consumption and leads to higher living standards.

Question 28

Costs of economic growth on firms

Answer 28

Firms could face more menu costs as a result of higher inflation. This means they have to keep changing their prices to meet inflation

Question 29

Benefits of economic growth on firms

Answer 29

Firms might make more profits, which might in turn increase investment.
This is also driven by higher levels of business confidence.
Higher levels of investment could develop new technologies to improve productivity and lower average costs in the long run.
As firms grow, they can take advantages of the benefits of economies of scale.
If there is more economic growth in export markets, firms might face more competition, which will make them more productive and efficient, but it will also give them more sales opportunities

Question 30

Costs of economic growth on the gov

Answer 30

Governments might increase their spending on healthcare if the consumption of demerit goods increases.

Question 31

Benefits of economic growth on the gov

Answer 31

The government budget might improve, since fewer people require welfare payments and more people will be paying tax.

Question 32

Costs of economic growth on current and future living standards

Answer 32

High levels of growth could lead to damage to the environment in the long run, due to increased negative externalities from the consumption and production of some goods and services.

Question 33

Benefits of economic growth on current and future living standards

Answer 33

As consumer incomes increase, some people might show more concern about the environment.
Also, economic growth could lead to the development of technology to produce goods and services more greenly.
Higher average wages mean consumers can enjoy more goods and services of a higher quality.
Public services improve, since governments have higher tax revenues, so they can afford to spend on improving services.
This could increase life expectancy and education levels.

Question 34

What are the types of aid?

Answer 34

Humanitarian aid is provided after disasters. It aims to save lives and reduce suffering.
Tied aid is when aid is donated with conditions. For example, a developed country might donate aid in return for a trade deal.
Charitable aid is given from organisations, such as OXFAM and it is funded by donations from the public.
Development or long term aid aims to provide education to local communities to enhance their skills and aim for sustainable development.
Multilateral aid is provided by international organisations rather than individual countries. For example, it could be aid from the World Bank.

One of the main problems of aid is that countries can become dependent on it. It is particularly a problem if the aid is a loan and not a grant, since the recipient might struggle to pay it back.

Question 35

What are the costs and benefits of free trade?

Answer 35

Free trade is the act of trading between nations without protectionist barriers, such as tariffs, quotas or regulations.

Free trade provides the following benefits:
- Countries can exploit their comparative advantage, which leads to a higher output using fewer resources and increases world GDP. This improves living standards.
- Free trade increases economic efficiency by establishing a competitive market. This lowers the cost of production and increases output.
- By freely trading goods, there is trade creation because there are fewer barriers. This means there is more consumption and large increases in economic welfare.
- More exports could lead to higher rates of economic growth.
- Specialising means countries can exploit economies of scale, which will lower their average costs.

The following costs could be considered:
- Free trade has resulted in some job losses since countries with lower labour costs have entered the market.
- Free trade might have contributed to some environmental damage. This is especially from the increase in manufacturing.

Question 36

What is FDI and MNCs?

Answer 36

FDI is the flow of capital from one country to another, in order to gain a lasting interest in an enterprise in the foreign country.

FDI can help create employment, encourage the innovation of technology and help promote long term sustainable growth. It provides LEDCs with funds to invest and develop.

Multinational companies (MNCs) are organisations that own or control the production of goods and services in multiple countries. They have used marketing to become global, and by growing, they have been able to take advantage of economies of scale, such as risk bearing economies of scale. The spread of technological knowledge and economies of scale has resulted in lower costs of production.

Question 37

What is the role of the IMF and the world bank?

Answer 37

The World Bank mainly focuses on development. The IMF tries to keep payments and receipts between countries logical and ordered.

World Bank
The World Bank can loan funds to member countries, and its aim is to promote economic and social progress by raising productivity and reducing poverty.
The World Bank is involved in several projects globally, such as providing microcredit, supporting education, and helping the rebuilding of countries after earthquakes.

International Monetary Fund (IMF)
The IMF aims to promote monetary cooperation between nations, and monetary problems can be consulted in the institution.
It also aims to help free trade globally, so jobs are supported. The IMF promotes exchange rate stability, and tries to avoid competitive depreciations in the currency.
Members can also borrow from the IMF, such as if they need to correct an imbalance in the balance of payments.
External debt is the amount of money owed to foreign lenders. Governments, firms and consumers could be borrowing money. Money is owed to commercial banks, governments and international institutions, such as the IMF and World Bank

Question 38

What are the indicators of living standards and economic development?

Answer 38

HDI
MEW - measurement of economic welfare
HPI - human poverty index
MPI - Multidimensional poverty index
GDI - gender related development index
Kuznets curve

The three dimensions of the Human Development Index (HDI)
The components of HDI are education, life expectancy and standard of living, measured by real GNI at purchasing power parity
(PPP) per capita.
It measures economic and social welfare of countries over time.
The education component combines the statistics of the mean number of years of schooling and the expected years of schooling.
The lift expectancy component uses a life expectancy range of 25 to 85 years.
The standard of living component measures GNI adjusted to PPP per capita. GDP was used instead of GNI, but to account for remittances and foreign aid, GNI is now used, since it reflects average income per person.
A value close to 1 is indicative of a high level of economic development. A value close to 0 suggests a low level of development.

Question 39

HDI

Answer 39

The three dimensions of the Human Development Index (HDI)
The components of HDI are education, life expectancy and standard of living, measured by real GNI at purchasing power parity
(PPP) per capita.
It measures economic and social welfare of countries over time.
The education component combines the statistics of the mean number of years of schooling and the expected years of schooling.
The lift expectancy component uses a life expectancy range of 25 to 85 years.
The standard of living component measures GNI adjusted to PPP per capita. GDP was used instead of GNI, but to account for remittances and foreign aid, GNI is now used, since it reflects average income per person.
A value close to 1 is indicative of a high level of economic development. A value close to 0 suggests a low level of development.

Question 40

The advantages and limitations of using the HDI to compare levels of development between countries and over time

Answer 40

HDI does not consider how free people are politically, their human rights, gender equality or people’s cultural identity.
HDI does not take the environment into account. It could be argued that this should be included to focus on human development more.
HDI does not consider the distribution of income. A country could have a high HDI but be very unequal. This can mean many people might still be in poverty.
HDI does allow for comparisons between countries to be made, based upon which countries are generally more developed than other countries.
It provides a much broader comparison between countries than GDP does.
Education and health are important development factors to consider, and it can provide information about the country’s infrastructure and opportunities. It also shows how successful government policies have been.

Question 41

Measure of Economic Welfare (MEW):

Answer 41

This is an alternative to GDP. It takes national output, and then adjusts it to include a value for leisure time and unpaid work. This
increases the welfare value of GDP. The value of environmental damage caused by industrial production and consumption is also considered.

Question 42

Human Poverty Index (HPI):

Answer 42

measures life expectancy, education and the ability of citizens to meet basic needs. There are two types: HPI-1 and HPI-2. The former measures poverty in developing countries and the latter measures poverty in developed countries.

In HPI-1, the longevity part of the index measures the probability of living to the age of 40. The education component considers the adult literacy rate. The ability of citizens to meet basic needs is measured by the percentage of underweight children
and the percentage of people not using improved water sources.

For HPI-2, the probability of not surviving to at least the age of 60 is used. The percentage of adults which do not have literacy skills is calculated, and poverty is calculated by those living below the poverty line. This is below 50% of median income.

Question 43

Multidimensional Poverty Index (MPI):

Answer 43

measures poverty in over 100 developing countries. It works with income based measures, and it considers the lack of
education, poor health and low living standards that people face. This means that poverty can be assessed on an individual level, and the intensity of poverty can be measured by considering what is deprived.

Question 44

Gender-related Development Index (GDI):

Answer 44

measures the relative inequality between men and women. It combines HDI with a consideration of gender. For example, it will consider differences in life expectancies, income and education between genders.

Question 45

Kuznets curve

Answer 45

Kuznets hypothesis states that as society moves from agriculture to industry, so it develops, inequality within society increases, since the wages of industrial workers rises faster than farmers.
Then, wealth is redistributed through government transfers and education. He essentially argued that inequality in poor countries is just a transitional phase, and once nations become economically developed, inequality reduces.
Thomas Piketty famously discredited this theory in 2014 by arguing that the capitalist free market system inevitably leads to continued inequality. The rate of return on capital increases, so as the rich get richer with higher returns on their investments, inequality increases

Question 46

What are the characteristics of Less economically developed countries?

Answer 46

Less economically developed countries (LEDCs) tend to be characterised by thefollowing features:
- Low life expectancies
- High mortality rates
- High dependency ratio
- Low GDP
- Fast population growth
- Low levels of education
- Poor standard of living
- Poor nutrition, lack of access to clean, safe drinking water and a lack of sanitation
- Poor or absent health care provision

Question 47

What are the characteristics of more economically developed countries?

Answer 47

More economically developed countries (MEDCs) are characterised by:
- Long life expectancies
- High income per capitas
- High levels of education
- Slow population growth per year
- Low mortality rates
- Urban and city populations are large

Question 48

GDP as a measure of economic growth

Answer 48

Economic growth occurs when there is a rise in the value of Gross Domestic Product (GDP).
GDP measures the quantity of goods and services produced in an economy. In other words, a rise in economic growth means there has been an increase in national output.
Economic growth leads to higher living standards and more employment opportunities.
Real GDP is the value of GDP adjusted for inflation. For example, if the economy grew by 4% since last year, but inflation was 2%, real economic growth was 2%.
Nominal GDP is the value of GDP without being adjusted for inflation. In the above example, nominal economic growth is 4%. This is misleading because it can make GDP appear higher than it really is.
Total GDP is the combined monetary value of all goods and services produced within a country’s borders during a specific time period.
GDP per capita is the value of total GDP divided by the population of the country.
Capita is another word for ‘head’, so it essentially measures the average output per person in an economy. This is useful for comparing the relative performance of countries.

Question 49

What can national income be measured by?

Answer 49

Gross National Product (GNP) is the market value of all products produced in an annum by the labour and property supplied by the citizens of one country.
It includes GDP plus income earned from overseas assets minus income earned by overseas residents. GDP is within a country’s borders, whilst GNP includes products produced by citizens of a country, whether inside the border or not.

Gross National Income (GNI) is the sum of value added by all producers who reside in a nation, plus product taxes (subtract subsidies) not included in the value of output, plus receipts of primary income from abroad (this is the compensation of employees and property income).

Question 50

Limitations of using GDP

Answer 50

GDP does not give any indication of the distribution of income. Therefore, two countries with similar GDPs per capita may have different distributions which lead to different living standards in the country.
GDP may need to be recalculated in terms of purchasing power, so that it can account for international price differences. The purchasing power is determined by the cost of living in each country, and the inflation rate.
There are also large hidden economies, such as the black market, which are not accounted for in GDP. This can make GDP comparisons misleading and difficult to compare.
GDP gives no indication of welfare. Other measures, such as the happiness index, might be used to compare living standards instead or in conjunction with GDP.

Question 51

What is national debt and what factors affect it?

Answer 51

The national debt is the amount of money the government has borrowed at one time through issuing securities by the Treasury.

Factors influencing the size of national debts
The national debt is the accumulation of the government deficit over time. It is the total amount the government owes.
If the government is continuously running a deficit, the size of the debt increases.
If the government reduces the size of their deficit, the rate of increase of the total debt is slower, but the debt is still increasing.
It is only when the government runs a budget surplus that the size of the national debt decreases. Currently, the UK government is trying to reduce the size of the deficit and eventually run a budget surplus by 2019-2020, at which point they will
start paying off the debt.

The significance of the size of national debts
The cost of borrowing could increase, since by borrowing money, the government is increasing demand for credit in the economy.
If confidence is lost in the government’s ability to repay the debt, governments might have to raise interest rates to encourage investors to buy bonds, so that they can finance the debt.
It could lead to higher taxes and austerity measures, especially if the debt becomes uncontrollable.
A fiscal deficit could be inflationary if it increases AD.
More government spending could lead to crowding out of the private sector. This leaves fewer funds in the private sector for firms to use, since the government is borrowing money, which crowds them out of the market.

Question 52

Different theoretical approaches to how the macro economy functions

Answer 52

-Keynesian economics is a view that believes AD (spending) influences economic output in the short run. Keynesians also believe that the private sector sometimes leads to inefficiency, so the public sector has to intervene in order to stabilise the business cycle. This refers to monetary policy and fiscal policy in particular.
-Keynesians prefer mixed economies, where the private sector is dominant, but the
government intervenes during recessions.
-Keynes shifted macroeconomic thought from a focus on AS to AD. Keynesian economists emphasise the use of demand-side policies, fiscal and monetary, to close gaps between actual and potential output.
- Keynesians believe that as long as firms have confidence about the future, they will invest. Investment is independent of the price level or interest rates

-Monetarism emphasises government control over the money supply. This view believes that changes in the money supply influence national output in the short run, and influences the price level in the long run.
-Rather than how confident firms feel, monetarists believe that interest rates have a greater influence over investment decisions.
-Monetarists believe that inflation is caused by excessive quantities of money flowing in the system. If production increases at a slower rate to the money supply, monetarists argue that there will be inflation. The money supply increases when more money is printed or there are several loans and credit.