Economic Growth

Question 1

What is actual economic growth

Answer 1

An increase in real GDP

Question 2

What’s potential economic growth

Answer 2

Is an increase in the productive capacity in the economy.

Question 3

Are actual and potential economic growth the same

Answer 3

NO

actual economic growth is a increase in real GDP, and potential economic growth is an increase in the productive capacity of the economy.

Question 4

How does real GDP fluctuate over the course of an economic cycle

Answer 4

Real GDP tends to fluctuate over the course of an economic cycle. During a boom, real GDP rises fast. During a recession, it falls for at least 2 consecutive quarters. During a slowdown, the level of GDP may be rising, but rising below the trend, or GDP might be falling.

Question 5

Define actual economic growth

Answer 5

An increase in real GDP

Question 6

Define potential economic growth

Answer 6

An increase in the productive capacity of an economy.

Question 7

List to me the causes of ‘actual economic growth’

Answer 7

Increase in components of AD eg. Increased consumption, increased investment, increased government spending, export led growth

Can also occur because of an increase in AS

Question 8

Tell me how the following factor causes actual economic growth: increased consumption

Answer 8

Actual economic growth can occur because there is an increase in one of the components of AD

Increased consumption. This might occur because of a cut in interest rates, an increase in real wages, a rise in consumer confidence or an increase in the availability of credit.

Question 9

Tell me how the following factor causes actual economic growth: increased investment

Answer 9

Investment not only increases the level of growth but is itself dependant on the level of growth (I.e has an accelerating effect on growth rates)

Question 10

Tell me how the following factor causes actual economic growth: increased government spending

Answer 10

For example, an increase in government expenditure on major infrastructure projects would have a multiplier effect on GDP

Question 11

Tell me how the following factor causes actual economic growth: export-led growth

Answer 11

This occurs when the country’s rate of economic growth is increased as a result of an expansion of its exports. This may be part of the governments overall economic policy.

Question 12

Tell me how the following factor causes actual economic growth: an increase in aggregate supply

Answer 12

Actual economic growth can also occur because of an increase in aggregate supply (AS). This might happen because costs of production fall (eg as a result of a fall in energy prices)

Question 13

If AD increases and the AD curve is crossing the vertical part of the AS curve, what’s the effect on actual economic growth

Answer 13

The only effect will be an increase in the price level and not an increase in real GDP. Similarly, if AS increases and the AD curve is crossing the AS curve on the horizontal part, there will be no change in the equilibrium and there will be no change in the price level or real output.

A shift in the AD or AS curve to the right should cause an increase in actual growth.

Question 14

When can potential economic growth only occur

Answer 14

When the vertical part of the AS curve shifts to the right, increasing the amount that the economy could produce.

Using another model, potential economic growth increases when the production possibility curve shifts to the right.

Question 15

What are the possible causes of potential economic growth

Answer 15

Possible causes of the AS shift include:

Discovery of new natural resources

Increased investment by either the public sector or private sector

Increase in the size of the labour force (eg. As a result of immigration or a higher birth rate)

Increased productivity (eg as a result of new technology or a more highly skilled workforce.

Question 16

If you are given nominal or current values of economic growth what should you say?

Answer 16

Comment that the figures are distorted by inflation

Question 17

What’s the main cause of actual economic growth usually

Answer 17

Export led growth - where the driver of growth is an increase in the export component of AD - is a main driver of growth for many economies.

International trade for (export led) economic growth is very important. For countries that have been rapidly emerging into industrialised states, such as China, exports can often account for more than 50% of AD. Export led growth means that the balance of payments on current account will improve as more goods and services are sold abroad.

Question 18

What’s the main problem with export led growth

Answer 18

The main problem is that it makes the exporters vulnerable to changes in demand in other countries, or exchange rates, both of which are often outside their control. China’s growth slowed significantly as a result of the global financial crisis in 2008, and in order to maintain its exports the government decided to intervene to keep the currency, the renminbi, from rising against other countries. Currency market interventions are not popular in terms of the world trade climate.

Question 19

For developed countries, list the factors that constrain economic growth

Answer 19

Labour market problems

Cost of and access to credit

Deficiencies in infrastructure

External factors

Question 20

How is labour market problems a constraint on economic growth in developed economies

Answer 20

A shortage of skilled labour is a major constraint on growth. As countries get richer, birth rates tend to fall dramatically; in the long run this means that the labour supply will fall. One of the most effective policies to increase labour supply in high income countries is to allow a higher level of immigration, although in low income countries the exit of skilled workers (known as the ‘brain drain’) might increase their shortage of skilled labour.

Question 21

How is the cost of and access to credit a constraint on economic growth in developed economies

Answer 21

If interest rates are high then this will raise the cost of borrowing money for investment and consumption. Similarly, if banks are unwilling to lend money, then investment and consumption are likely to be subdued. Consequently, both these factors could act as constraints on growth.

Question 22

How are deficiencies in infrastructure a constraint on economic growth in developed economies

Answer 22

If a country has poor networks for energy, water, transport and digital communications, then this is likely to limit its economic growth rate. For example, if electricity supplies are frequently interrupted then manufacturing output will be lower than potential output.

Question 23

How are external factors a constraint on economic growth in developed economies

Answer 23

Global recession or fears of terrorism also slow down trade, as does volatility in exchange rate markets. A change in the policy of major economics may also be significant. For example, following Donald Trump’s election of president of the USA in 2016, there has been an increase in tariff and non tariff barriers to trade. Figures suggest that for every 3% growth in world trade there is s 1% increase in world GDP, and therefore anything that restricts international trade is likely to act as a constraint on growth.

Question 24

What is the output gap

Answer 24

The difference between actual output and either the trend or potential output is called the output gap.

If there is an output gap, the country is not growing at the trend rate of economic growth or the potential output.

Question 25

Tell me about a positive output gap

Answer 25

If the economy is growing faster than the trend, pressures will grow in the economy, such as tight labour markets, wage pressures and shortages of raw materials. This is referred to as a positive output gap. It may be a sign that the economy is overheating and the inflationary pressures are likely to be evident. These might persuade the Bank of England’s monetary policy committee to raise interest rates.

Question 26

Tell me about a negative output gap

Answer 26

If the economy is growing below trend, there is likely to be spare capacity in the economy. This situation is known as a negative output gap. It means there is scope for a cut in interest rates, which are designed to boost economic growth.

Question 27

Where can you find estimates of the UKs output gap and other countries output gap

Answer 27

By looking at the bank of England’s inflation report or the data from the IMF, the OECD or the office of budget responsibility (OBR).

Estimates of The UKs output gap from various organisations may be found in the office for budget responsibility’s economic and fiscal outlook which is published in the spring and autumn of each year.

Question 28

Is it difficult to estimate the size of the output gap? Why?

Answer 28

It is difficult to estimate the size of the output gap because not all unemployed resources would have the same impact on the economy if they were eventually employed. To make the situation more complicated, the non use of resources makes them less useable in the future and the productive potential of the economy tends to fall when there are high levels of long term unemployment.

This can be shown on a diagram with a straight line looking like the AS curve being broken where there’s an output gap and the later bit being shifted down. This whole line is the path of potential or trend growth.

Question 29

How do Keynesian economists illustrate the output gap

Answer 29

The output gap is a measure of the difference between actual and potential growth in the economy. It is based on estimates of what the production possibility of the country is relative to the actual GDP. One way in which Keynesian economists illustrate the output gap is as follows.

To illustrate the country production possibility, draw a level of output through the vertical part of the AS curve. For Keynesians, the AS curve is a curve that is not vertical but upward sloping (where is goes horizontal and starts going vertical) . To plot the output gap, we can show the difference between actual output (where AD equals AS) and the full capacity potential (where the AS curve just turns vertical)

Question 30

What are the different views of the existence of output gaps

Answer 30

Keynesians believe that a negative output gap can exist in the long run as well as the short run, but classical economists believe that output gaps do not exist in the long run because the LRAS is vertical through full employment output.

Question 31

What’s the trade cycle also known as

Answer 31

The economic or business cycle

Question 32

What does the trade cycle demonstrate

Answer 32

Demonstrates recurring trends in economic growth rates. Booms tends to be followed by economic slumps or slowdowns, which tend to be followed by recession, before the economy moves into the recovery phase, and then back into a boom.

Question 33

How can the trade cycle be shown by output gaps

Answer 33

When output is above trend of potential output, it’s a boom, when the output is moving back to the potential output, its a slowdown, and then when its below its a recession and then a recovery when it moves back to potential output and so on

The book calls this a stylised diagram of the trade cycle

Question 34

How can trade cycles be explained

Answer 34

May be explained in part by animal spirits - Keynes term for the speculative action that results from any rise or fall in output or asset prices. However, other reasons can explain the trend, such as the effects of changes in investment which magnify changes in output and the role of expectations in the decision making of business.

Question 35

Tell me the characteristics of a boom

Answer 35

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

Question 36

Tell me the characteristics of a recession

Answer 36

A recession is usually defined as two successive quarters of negative economic growth. Such a fall in real GDP is usually associated with the following characteristics:

Falling real incomes and consumption

An improvement in the balance of trade (because lower consumption is likely to lead to a decrease in imports)

Rising unemployment

A decrease in the rate of inflation

Lower tax revenues for the government, causing an increasing budget deficit.

Question 37

List to me the benefits of economic growth

Answer 37

Growth benefits:
consumers, 
firms, 
governments, 
current and future living standards.

Question 38

Tell me how economic growth benefits consumers

Answer 38

Incomes and wealth rise when there is economic growth. It also means that people can afford to save money for their future consumption. People feel more confident about their jobs when growth is high, so they are more willing to spend on consumer durables such as cars or gadgets. There are likely to be more employment opportunities so that people can progress in their careers, either within their own company or in another. Wages might rise as firms try to keep hold of their workers. With higher incomes people can afford to work fewer hours, go on more luxurious holidays, pay for their children’s education or retire early.

Question 39

Tell me how economic growth benefits firms

Answer 39

Firms tend to make more profit when there is economic growth. In times of growth, consumer spending usually rises, which means that firms sell more. As revenues and profits rise, firms can take on more workers and are more likely to invest. This increases future growth prospects.

Question 40

Tell me how economic growth benefits governments

Answer 40

When incomes and assets rise in price, people pay more income tax, VAT and capital gains tax. Firms will pay more corporation tax on their profits. Governments also have fewer demands to pay unemployment and social benefits. So in times of economic growth the government is likely to enjoy a healthier fiscal position.

Question 41

Tell me how economic growth benefits current and future living standards

Answer 41

Growth means that total incomes are rising in an economy, so this is likely to make people feel better off. Poverty rates are likely to fall as wages and employment rise. The government may decide to spend more of its income on areas that will increase living standards for all, such as improvements in healthcare or making town centres more pleasant. Firms might use cleaner technology because they can afford to, possibly motivated by improving their image for corporate social responsibility, thereby possibly increasing benefits to themselves and living standards more widely. Standards of living rise as long as the costs of living do not increase at the same rate. In other words, real growth means real incomes rise. Increased in growth mean that wealth in the form of assets such as shares and houses increases.

Question 42

List the costs of economic growth

Answer 42

Opportunity cost

Income inequality

Environmental problems

Balance of payments problems on the current account

Inflation

Monopoly power

Increased stress and social dislocation.

Question 43

Tell me how opportunity cost is a cost of economic growth

Answer 43

In the short term, living standards could fall if resources are diverted from the production of consumer goods to the production of capital goods. It would only be in the long run that living standards increase when the production frontier shifts outwards.

Question 44

Tell me how income inequality is a cost of economic growth

Answer 44

The unwaged and unskilled are less likely to benefit from increased incomes. Although money might eventually trickle down to lower income groups, there might equally be a two speed economy where the incomes of some people accelerate but others increase only slowly. The type of production tends to change during periods of economic growth, so there is likely to be short term unemployment for people who do not have labour market flexibility.

Question 45

Tell me how environmental problems are a cost of economic growth

Answer 45

Depletion of natural resources and external costs such as carbon emissions and other forms of pollution are likely to increase with economic growth. However, governments can use their increased tax revenues to clean up the environment.

Question 46

Tell me how balance of payment problems on the current account is a cost of economic growth

Answer 46

With higher incomes, domestic consumers are likely to spend more on imports. In addition, domestic firms have less incentive to export because domestic demand is strong. However, if growth were export led, the current account would improve.

Question 47

Tell me how inflation is a cost of economic growth

Answer 47

When there is little spare capacity in the economy, there are likely to be shortages of factors of production such as skilled labour. This is likely to result in an increase in the rate of inflation.

Question 48

Tell me how monopoly power is a cost of economic growth

Answer 48

This might increase if large firms take over smaller firms. These firms might create barriers to the entry of new firms. This can be shown using an increasingly inelastic AS curve.

Question 49

Tell me how increased stress and social dislocation is a cost of economic growth

Answer 49

Economic growth might be achieved with longer working hours which could increase stress. Furthermore, higher incomes will be earned by some, but not all. With increased earnings, expectations increase - for example, that the extra income will be spent on items such as mobile phone contracts for children. There may be more travel for employment and the need to move further afield as firms grow. So social life may or may not improve as the economy grows.

Question 50

How can economic growth be explained

Answer 50

Can be explained in terms of actual GDP or increases in potential GDP. When AD increases, actual GDP increases, as long as the AS curve is not vertical. When AS increases, actual GDP increases, as long as the AD curve does not cross the AS curve on a horizontal part of the curve. Only a shift in the AS curve to the right causes an increase in potential economic growth.

Question 51

Are the benefits and costs of economic growth easy to measure

Answer 51

No, they change over time. These benefits and costs also vary between countries at different stages of economic development. It is therefore, difficult but important to assess whether the benefits outweigh the costs.

Question 52

What is the difference between actual and potential economic growth

Answer 52

Actual economic growth is an increase in real GDP and potential economic growth is an increase in capacity in the economy.

Question 53

What economic characteristics are likely to be associated with a positive output gap

Answer 53

A positive output gap is likely to be associated with falling unemployment, an increasing rate of inflation and an increase in imports - because the economy is growing faster than its trend rate of growth.

Question 54

Is there any validity in saying “if there is increased growth, there will be inflation”

Answer 54

This is not true if the increase is in potential economic growth and not necessarily true of the increase is in actual growth. It depends on the availability of spare resources, ie the output gap.