Economic Growth

Question 1

What causes economic growth?

Answer 1

Growth occurs when there is an increase in aggregate demand or aggregate supply, and there is a new equilibrium level at which there is greater output and more is produced.

Question 2

What may cause a shift in aggregate demand?

Answer 2

A shift in aggregate demand, importantly and increase, may occur when there is an increase in one of the components of aggregate demand:

1) Consumption (C)
2) Investment (I)
3) Government spending (G)
4) Net exports (X-M)

Question 3

Give three reasons for an increase in consumption.

Answer 3

1) A cut in the interest rate, meaning that the opportunity cost of saving falls, and the cost of borrowing to invest falls. It can also lead to falls in the cost of mortgage repayments meaning that people have more money to spend in the economy.
2) Increase in confidence.
3) Wealth effects from rising house or share prices.

Question 4

Give two reasons why investment may increase.

Answer 4

1) Firms are able to invest more when the cost of borrowing falls, i.e. interest rates are cut.
2) Increase in confidence - if firms think there will be growth in the future, they are more likely to invest which in itself stimulates growth.

Question 5

How can government stimulate growth through government spending?

Answer 5

Governments can use fiscal policy to stimulate the economy, this means spending on government projects such as road building and education when the rest of the economy is lacking in aggregate demand.

Question 6

What may cause an increase in net exports?

Answer 6

Economies can be stimulated through export-led growth. China and Germany were able to sail through the last recession by maintaining spending through exports.

Question 7

Give three policies which may be employed to stimulate exports.

Answer 7

1) Hold the exchange rate down, this makes exports cheap compared to imports, however this is not possible in the UK because we have a fully floating exchange rate.
2) Reduce tariffs and quotas - despite an initial increase in imports, encouraging trade will lead to an increase in exports in the long run.
3) Encouraging the efficiency and productivity in export markets - this has an impact on AD despite being a supply side policy.

Question 8

What may cause a shift of aggregate supply?

Answer 8

Shifting AS to the right is a supply side policy, they tend to be long-run and involve making firms’ costs of production cheaper.

Question 9

What is actual economic growth?

Answer 9

Actual economic growth is the measure of the increase in real GDP, which is found by adding up all the spending in the economy, all the incomes or all the output. None of which are alone completely reliable, but between them it is possible to get a good indication of changes in activity in the economy.

Question 10

What is potential economic growth?

Answer 10

This shows how much the country could produce if all resources were fully and efficiently employed. It is useful for measuring the success of governments and assessing the likelihood of changes in living standards over time.

Question 11

What is the output gap?

Answer 11

The output gap is the difference between actual growth and potential growth. The bigger the output gap, the bigger the difference. A persistent output gap is likely to lead to fall in potential growth.

Question 12

What is sustainable growth?

Answer 12

Sustainable growth is the highest rate of growth that does not compromise the welfare of suture generations. If an economy were to grow by mining all of its resources, it may find it difficult to grow in the future.

Question 13

What are output gaps a sign of?

Answer 13

Output gaps are a sing that an economy is not using its resources efficiently, or at their maximum potential.

Question 14

Give five reasons why an output gap may exist.

Answer 14

1) Resources available are not suited to the needs of the economy.
2) The welfare system pays generously for some people not to work.
3) The effects of relocation of production to other countries.
4) Increased competitiveness of other countries.
5) Structural changes meaning the economy no longer produces output that is tailored to the market.

Question 15

What is a positive output gap?

How can this be shown?

Answer 15

A positive output gap is when actual growth rates are higher than the economy can sustain.
This can be shown on a classical AS curve as a temporary situation where the economy can produce more, but this cannot be sustained in the long run. In the long run the AS curve is vertical and the positive output gap will disappear.

Question 16

Why is it difficult to measure the size of output gaps?

Answer 16

Output gaps are difficult to measure because the level of potential output depends on the spare capacity, and without trying to use the spare capacity, it is difficult to know how much the economy van produce.

Question 17

What is an economic boom?
What is a slump?
What is a recession?

Answer 17

Boom - rapid economic growth.
Slump - very slow economic growth.
Recession - two consecutive quarters of negative economic growth.

Question 18

Give five characteristics of a boom.

Answer 18

1) High employment
2) Increased living standards
3) Increased investment
4) Inflation
5) Widening inequality and increased negative externalities.

Question 19

Give four characteristics of a recession.

Answer 19

1) High unemployment or underemployment.
2) Lower or no increase in living standards
3) Lower inflation
4) Narrowing inequality

Question 20

Give five reasons for a recession.

Answer 20

1) Lack of investment
2) Weak or obstructive government
3) Currency instability or a fixed exchange rate, where exchange rates are too high.
4) Lack of human capital
5) Lack of access to international trade.

Question 21

Give four benefits of growth.

Answer 21

1) As long as inflation does not rise with it, incomes and living standards will increase.
2) Greater profits for firms and increased returns for share holders.
3) Greater number of people in work and paying tax which means less people claiming benefits.
4) Reduction in poverty, developing countries can gain foreign investment which may lead to improvement in infrastructure.

Question 22

Give five possible costs of economic growth.

Answer 22

1) Damage to the environment.
2) Widening income inequality.
3) Worsening balance of payments because higher incomes means that people are able to buy more imports.
4) In choosing to achieve economic growth, the economy has to forgo other objectives.
5) While people may have increased wealth and income, their happiness may deteriorate.