CH32 Causes of economic growth and the trade cycle

Question 1

What is economic growth?

Answer 1

it is the change in potential output of the economy shown by a shift of the PPF to the right

Question 2

What is economic growth usually measured by?

Answer 2

it is usually measured by the change in real national income

Question 3

what is the trade cycle?

Answer 3

the trade cycle is the fluctuations of economic activity around the trend rate of growth.

Question 4

When does a positive output gap exist?

Answer 4

a positive output gap exists when the economy is in boom and GDP is below its long-term trend value

Question 5

when does a negative output gap exist?

Answer 5

a negative output gap exists when the economy is in recession and GDP is below its long-term trend value

Question 6

what is economic growth caused by?

Answer 6

economic growth is caused by increases in the quantity or quality of land, labour, and capital, and by technological progress which lead to a rise in long run aggregate supply

Question 7

What is potential growth?

Answer 7

potential growth is the change in the productive potential of the economy over time.
-It is shown on a diagram by the shift to the right in the LRAS curve or the PPF

Question 8

What can the phrase ‘economic growth’ either mean?

Answer 8

it can either mean actual growth (change in GDP) or potential growth

Question 9

what is the problem with using real GDP to measure the productive potential of an economy?

Answer 9

the problem with using real GDP is that, in the short term, GDP fluctuates around the long-term trend growth path of output.

Question 10

what are the 4 main phases that every trade cycle has?

Answer 10

1) Peak or boom
2) Downturn
3) Recession or depression or trough or slump
4) Recovery or expansion

Question 11

What does it mean when the economy is at peak or is in a boom?

Answer 11

it means that national income is high.
-it is likely that the economy will be working at beyond full employment.
-Consumption and investment expenditure will be high. Tax revenues will be high. Wages will be rising and profits increasing.
-there will also be inflationary pressures in the economy

Question 12

what is present in an economy if it is in a boom? and why?

Answer 12

overheating is present, due to the economy most likely working at beyond full employment. (However, this is not always the case, an economy could be at less than full employment, according to Keynesians, if there are bottlenecks in certain industries in the economy)

Question 13

what does it mean when an economy moves into a downturn?

Answer 13

it means that output and income fall, leading to a fall in consumption and investment.
-tax revenues begin to fall and government expenditure on benefits begins to rise. Imports decline and inflationary pressures ease

Question 14

What is the economy like during a recession?

Answer 14

-economic activity is at a low in comparison with surrounding years.
-high unemployment exists, so consumption, investment and imports will be low.
-there will be few inflationary pressures in the economy and prices may be falling (i.e. there will be deflation)

Question 15

what is the economy like during recover?

Answer 15

-as the economy moves into a recovery or expansion phase, national income and output begin to increase. Unemployment falls. Consumption, investment and imports begin to rise. Workers feel more confident about demanding wage increases and inflationary pressures begin to mount.

Question 16

in the UK, when does the gov define a recession?

Answer 16

when real GDP falls in at least two successive quarters

Question 17

Does GDP always actually fall in the recession phase?

Answer 17

no. There are milder trade cycles where GDP does not fall. Instead, the economy fluctuates around its long-run real GDP growth path but real GDP continues to rise even in a downturn even if the rise is relatively small.

Question 18

what are the two main types into which the different reasons why the short run rate of growth of real GDP may fluctuate around its long-term trend?

Answer 18

the two main types are:
1) Demand-side shocks
2) Supply-side shocks

Question 19

what are demand-side shocks? and what are examples of them?

Answer 19

demand-side shocks are shocks which affect aggregate demand. Examples include:
- a housing market bubble may burst. This occurs when house prices rise to too high a level and suddenly there is a collapse in demand for housing and a sharp fall in house prices.
- the stock market may crash. This reduces the wealth of individuals, so they are likely to then cut back on their spending. This reduces AD causing the recession
- the central bank may sharply raise interest rates perhaps to combat rising inflation. This reduces consumer spending on durables and investment spending, causing a recession.
- the gov may sharply raise taxes or cut gov spending. This leads to lower AD

Question 20

What are supply-side shocks? and what are examples of them?

Answer 20

supply-side shocks are shocks which affect aggregate supply. Examples are:
- a large rise in world commodity prices could both raise the price level in the UK and lead to a rise in import values if demand for the commodity is price inelastic. The rise in import costs will reduce aggregate supply leading to lower output.
- an outbreak of trade union militancy could see large wage increases which will raise the price level sustainably and reduce aggregate supply leading to recession.

Question 21

What is meant by the output gap?

Answer 21

it is the difference between the actual level of GDP and the productive potential of the economy.

Question 22

When is a negative output gap said to exist?

Answer 22

a negative output gap is when actual GDP is below the productive potential of the economy.
-this means there is spare capacity in the economy, with factories, offices and workers lying idle when they could be producing goods and services.

Question 23

when is a positive output gap said to exist?

Answer 23

a positive output gap is said to exist when actual GDP is above the productive potential of the economy and it is in boom

Question 24

can output gaps also be illustrated using an aggregate demand and aggregate supply curve?

Answer 24

yes

Question 25

is it difficult to estimate the size of an output gap? and why?

Answer 25

yes it is difficult to estimate. This is mainly because economists do not know exactly the position of the long run aggregate supply curve. -the other problem in estimating the output gap is that initial estimates of GDP, showing where short run aggregate supply and demand are equal, are almost always inaccurate.

Question 26

what happens to the output post in a recession during a boom?

Answer 26

output lost in a recession is regained during a boom, leaving the economy no better or worse off in the long term.

Question 27

what are the costs when an economy enters a boom after having been in a recession?

Answer 27

-those made unemployed during a recession, however mild, suffer a loss in their income even if the majority of workers are unaffected. -those on fixed incomes suffer in a boom if inflation rises. Their spending power is eroded because of higher prices.

Question 28

what do some economists argue about deep recessions? and what is this an example of?

Answer 28

-some economists argue that in a deep recession, economies do not bounce back to their previous trend level of growth. This is an example of hysteresis. -instead, the economy remains at a lower level of output, albeit still growing at its previous trend rate.

Question 29

what are two reason why an economy may fail to recover fully from a deep recession?

Answer 29

-because there is a permanent loss of human capital. In a recession, millions can lose their jobs. Some take early retirement, with a consequent loss of output for the economy. Others suffer long periods of unemployment and become deskilled. They are therefore less productive than before. -also because there can be a permanent loss of physical capital. In a recession, firms cut back on their investment. If they fail to make this up in the next boom, there is less physical capital in the economy than would otherwise have been the case. Potential output must then fall.

Question 30

what are the two things which cause fluctuations in the level of real GDP around the trend rate of growth?

Answer 30

demand and supply side shocks

Question 31

what are the 2 ways in which technological progress increases economic growth?

Answer 31

-it cuts the average cost of production of a product -it creates new products for the market

Question 32

what does becoming more export orientated therefore force firms to become?

Answer 32

it forces firms to become more efficient

Question 33

When measuring GDP, what are the 4 important distinctions which should be made?

Answer 33

-economic growth is typically measured by the rise in the output of goods and services over time. Economic growth is changes in real GDP and not changes in nominal GDP which also includes increases in real prices. -real GDP is a proxy measure of the volume of goods and services produced. The value of goods and services is produced is volume times the average price. -total GDP is the total amount of GDP produced in an economy. However, when comparing living standards, it is often more important to compare GDP per capita -falling economic growth does not mean that the level of real GDP itself is falling.

Question 33

When measuring GDP, what are the 4 important distinctions which should be made?

Answer 33

-economic growth is typically measured by the rise in the output of goods and services over time. Economic growth is changes in real GDP and not changes in nominal GDP which also includes increases in real prices. -real GDP is a proxy measure of the volume of goods and services produced. The value of goods and services is produced is volume times the average price. -total GDP is the total amount of GDP produced in an economy. However, when comparing living standards, it is often more important to compare GDP per capita -falling economic growth does not mean that the level of real GDP itself is falling.