Economic Growth and the Economic Cycle

Question 1

What is short run growth?

Answer 1

The percentage increase in a country’s real GDP, usually measured annually.

Question 2

What causes short run growth?

Answer 2

An increase in aggregate demand

Question 3

What is long run economic growth?

Answer 3

Where the productive capacity of the economy is increasing, referring to the trend rate of growth of real national output in an economy over time.

Question 4

What causes long run economic growth?

Answer 4

An increase in aggregate supply

Question 5

What is the potential output of an economy?

Answer 5

What the economy could produce if resources were fully employed

Question 6

When does an output gap occur?

Answer 6

Where there is a difference between the actual level of output and the potential level of output

Question 7

How are output gaps measured?

Answer 7

As a percentage of national income

Question 8

What is a negative output gap?

Answer 8

Where the actual level of output is less than the potential level of output

Question 9

What are the effects of a negative output gap?

Answer 9

A downwards pressure on inflation, meaning the economy’s resources are not being used to their full productive potential, i.e there is still spare capacity in the economy

Question 10

What is a positive output gap?

Answer 10

When the actual level of output is greater than the potential level

Question 11

Why does a positive output gap occur?

Answer 11

Resources are being used beyond their normal capacity, e.g if labour works overtime

Question 12

What are the effects of a positive output gap?

Answer 12

Upwards pressure on inflation and high rates of economic growth

Question 13

What is the business cycle?

Answer 13

The stage of economic growth that an economy is in. It consists of periods of booms and busts.

Question 14

When is there a recovery stage?

Answer 14

When there are periods of economic growth so real output increases

Question 15

When is there an economic boom?

Answer 15

When there are fast rates of economic growth, usually inflationary or unsustainable

Question 16

When is there a recession?

Answer 16

When the real output in the economy falls so there is negative economic growth

Question 17

What can governments do during a recession?

Answer 17

Increase spending to try and stimulate the economy. This could be through increasing spending on welfare payments or cutting taxes

Question 18

What happens during periods of economic growth?

Answer 18

Governments will receive more tax revenue as consumers are spending and earning more. Furthermore, the government will not need to spend as much as the economy does not need stimulating

Question 19

What are the characteristics of a boom?

Answer 19

High rates of economic growth
Near full capacity or positive output gaps
(Near) full employment
Demand-pull inflation
High levels of confidence, leading to increased inflation
Improved government budgets

Question 20

What is demand-pull inflation?

Answer 20

A period of inflation which occurs when economic growth is too fast

Question 21

What is a recession?

Answer 21

2 consecutive quarters of negative economic growth

Question 22

What are the characteristics of a recession?

Answer 22

• Negative economic growth
• Negative output gaps/lots of spare capacity
• Demand-deficient unemployment
• Low inflation rates
• Worsened government budgets with higher spending on welfare payments
• Less confidence amongst consumers and firms

Question 23

What is the cost of economic growth for consumers?

Answer 23

• It does not benefit everyone equally, for example those on low incomes will feel worse off when there is high inflation and therefore inequality will increase
• There will be higher demand-pull inflation due to the higher levels of consumer spending
• Consumers could face more shoe leather costs
• The benefits of higher consumption may not last long term due to the law of diminishing returns

Question 24

What is the law of diminishing returns?

Answer 24

The utility that consumers derive from consuming a good diminishes as more of the good is consumed

Question 25

What is the benefit of economic growth for consumers?

Answer 25

- The average consumer income increases as more people are in employment - Consumers feel more confident in the economy, increasing consumption and leading to higher living standards

Question 26

What are shoe leather costs?

Answer 26

Having to spend more time and effort finding the best deal as prices rise

Question 27

What is the cost of economic growth for firms?

Answer 27

They may face more menu costs as a result of rising inflation

Question 28

What are menu costs?

Answer 28

The cost that a firm will endure due to changing its prices

Question 29

What are the benefits of economic growth for firms?

Answer 29

- They may make more profit, increasing investment. Better technology could lead to increased production and lower costs in the long run - As they grow they can take advantage of the benefits of economies of scale - If there is growth in export markets the firms will face more competition, making them more productive and efficient. Also, it will give them more sales opportunities

Question 30

What are the costs of economic growth for the government?

Answer 30

The government may have to increase their spending on healthcare if the consumption of demerit goods increase

Question 31

What are the benefits of economic growth for the government?

Answer 31

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

Question 32

What are the costs of economic growth for living standards?

Answer 32

High levels of economic growth could damage the environment in the long run due to an increase in negative externalities from the consumption of some goods and services

Question 33

What are the benefits of economic growth for living standards?

Answer 33

- As consumer incomes increase people are more able to show concern for the environment - Economic growth may lead to the development of technology that allows the production of goods and services in greener ways - Higher average wages result in consumers enjoying goods and services of a higher quality - Public services can be improved, increasing life expectancy + education levels

Question 34

What are the causes of cyclical instability?

Answer 34

- The sustainability of economic growth - Excessive growth in credit and levels of debt - Asset price bubbles - Destabilising speculation and animal spirits

Question 35

How can the sustainability of economic growth affect cyclical instability?

Answer 35

- Growth is sustainable when the rate of economic growth can be maintained in the long run. - Fast economic growth today could mean that natural resources are depleted, causing environmental problems for future generations and reducing the potential rate of growth

Question 36

When does unsustainable growth occur?

Answer 36

During the boom and bust sections of the business cycle (deviations from the trend rate of growth)

Question 37

How can excessive growth in credit and levels of debt affect cyclical instability?

Answer 37

Growth financed by public debt does not contribute to higher productivity and is unsustainable, making it hard to pay back in the future. By being more productive, economic growth is more sustainable as it also increases the economy's productive capacity and therefore there is more room for the economy to grow.

Question 38

How can asset price bubbles affect cyclical instability?

Answer 38

When a market price bubble occurs the asset is traded more, causing demand to exceed supply and the price to rise above its intrinsic value. The bubble will then burst, causing the price to suddenly drop to its ordinary level and a loss of confidence in the asset.

Question 39

When does an asset price bubble occur?

Answer 39

When the price of an asset is predicted to rise significantly.

Question 40

What are animal spirits?

Answer 40

Instincts and emotions of human behaviour, driving the level of confidence in an economy.

Question 41

What is destabilising speculation?

Answer 41

Speculations that lead to changes in the price level in a market. For example, speculators purchase assets that they believe will rise in price. This can cause shifts in the actual price of assets in an economy.

Question 42

How can destabilising speculation and animal spirits cause cyclical instability?

Answer 42

Expectations about the economy have major impacts on rates of investment and economic performance as a whole.