LS10

Question 1

State the factors which can cause fluctuations in the productive potential of an economy

Answer 1

• land
• labour: changes in demography, changes in participation rates, immigration
• capital
• technological progress
• efficiency

Question 2

What could change long run economic growth

Answer 2

Economists agree that changes in long run aggregate supply can increase the potential output of an economy. LRAS can increase with if existing inputs are used more effectively or increased

Question 3

Explain the impact of land as a cause of long run economic growth

Answer 3

• land is defined as the land itself as well as any natural resources that come of it.
• Some countries experience high rates of economic growth because they are richly endowed e.g. Saudi Arabia and its oil
• economists argue that exploitation of natural resources is an insignificant source of growth in developed countries but can be in developing countries

Question 4

Explain the impact of labour as a cause of long run economic growth
Describe some changes in labour (7)

Answer 4

• this can be considered a change in the number of workers or a change in the quality of labour. this can result from changes in the birth rate, increases in participation rates and increases in immigration.
• changes in participation rates: this is the proportion of the population of a certain age who are either in/ seeking work. think about: proportion of young people staying on in education, the state pension age, more and more women have entered the labour force in the UK (encouraged by higher wages, better childcare arrangements and labour saving devices in the home.)
• changes in demography: Think about birth rate (knock-on effect upon labour force in 20yrs later). an increase in labour can increase output but not necessarily economic welfare. Also if women come back to work they give up their spare time, lessens the increase in economics welfare
• immigration: this increases output but not quality of work which is more important in the long run
• Labour can also be made more productive through education. It is especially important because it allows workers to cope with the demands of their job (e.g. lorry drivers who can read signs), it allows workers to be flexible and change jobs (requires a broad educations), and it allows workers to contribute to change (new ideas +improvements + techniques in production, new products/inventions)
• capital: capital stock needs to grow to sustain economic growth= need for sustained investment into the economy. Investment doesn’t necessarily cause increase in gdp though
• technological progress: cuts the average cost of production of a product, creates new products for the market = more spending = Econ growth
• efficiency: increases in efficiency = increase in LREG

Question 5

Explain why it’s not possible to measure the productive potential of an economy directly
What do we use instead?

Answer 5

There is no way of producing a single monetary figure for the value of variables like machinery, workers and technology. Instead we use changes in GBP as a proxy measure. The problem with this is that it fluctuates too much in the long-term these fluctuations are known as the trade cycle.

Question 6

State the 4 main phases in the trade cycle

Answer 6

• Peak or boom
• Downturn
• Recession/depression/trough/slump
• Recovery/expansion

Question 7

Describe the peak/boom phase of the traditional business/trade cycle

Answer 7

• National income is high
• The economy is working at beyond full employment, although Keynesian theory says that if there are bottlenecks in certain industries economy, could be at less than full employment
• Consumption and investment expenditure will be high, the country will be importing a lot
• Tax revenues will be high
• Wages and profit both will be increasing
• There will be inflationary pressures
• High rate of economic growth
• Increased consumer + business confidence
• Improving the government budget balance as tax revenue increases and government spending on benefits decreases.

Question 8

Describe the downturn phase of the traditional business/trade cycle

Answer 8

• output and income falls this leads to a fall in consumption and investment
• Tax revenues, begin to fall and government expenditure on benefits begins to rise
• Wage demands, begin to moderate as unemployment rises
• Imports decline
• Inflationary pressures ease

Question 9

Describe the recession/depression/trough/slump phase of the traditional business/trade cycle

Answer 9

• this is the bottom of the cycle where economic activity is at the lowest in comparison with surrounding years
• High unemployment exists and consumption + investment + imports will be low
• Very few inflationary pressures
• Prices may be falling (definition)
• negative rates of economic growth
• Worsening government, budget balance

Question 10

Describe the recovery/expansion phase of the traditional business/trade cycle

Answer 10

• this is the expansion phase
• National income and output begin to increase
• Unemployment, falls and workers feel more confident about demanding wage increases
• Consumption+ investment+ imports begin to rise
• Inflationary pressures begin to arise

Question 11

Describe GDP in a mild business/trade cycle

Answer 11

GDP doesn’t fall in milder trade cycles and the cycle don’t demonstrate recession phases
- The economy fluctuates around it’s a long run, real GDP growth
- Real GDP continues to rise, even in a downturn
- The trend level of real GDP to be gently curving upwards

Question 12

What are the causes of the trade cycle?

Answer 12

• There are two main types: demand-side shocks and supply-side shocks
• Demand-side shocks affect aggregate demand
• Supply-side shocks affect aggregate supply

Question 13

As a cause of the trade cycle, give some examples of (negative) demand-side shocks

Answer 13

• housing market bubble might burst: house prices could be too high, and there is a sudden collapse in demand for housing and a sharp fall in house prices. This erodes consumer confidence, so less consumer spending. Impacts output unemployment
• Stock market might crash: stock market prices could be too high. A crush reduces the wealth of individuals who will cut back on spending which would reduce A.D.
• Sharp rise in interest rates: reduces consumer spending on durables as well as investment spending
• Sharp, raising taxes, or cuts in government spending: lead to lower A D
• the world economy might go into recession: UK exports sharply decline
• Sharp rise in value of the pound: reduces the competitiveness of the UK economies exports reduces AD

Question 14

As a cause of the trade cycle, give some examples of (negative) supply-side shocks

Answer 14

• A large rise in the world, commodity prices: causes a rise in the price level leading to an increase in import values if demand is price inelastic. This will reduce AD
• an outbreak of trade union militancy: this could cause large wage increases which would increase the price level substantially reducing AD

Question 15

As a cause of the trade cycle, give one example of a positive supply-side shock

Answer 15

A sharp fall in oil and other commodity prices could cause the UK economy to boom because the UK is a net importer of oil and other commodities

Question 16

Define an output gap

Answer 16

This is the difference between the actual level of real GDP and its estimated long-term value at a point in time

Question 17

Can you draw the output gap diagram?

Answer 17

It looks like a straight line with a wavy line over it

Question 18

Describe output gaps
Both negative and positive

Answer 18

• The straight line is the trend rate of growth in real GDP, this shows the level of real GDP associated with the productive potential of the economy
• The actual level of real GDP varies around this line. This fluctuation is the trade cycle.
• A negative output gap exists when the economy is in recession (high unemployment/deflation/spare capacity in the economy )
• A positive output gap exists when the economy is in an inflationary boom and the actual level of real GDP is above the trend line.

Question 19

Can you draw a positive and negative output gap?

Question 20

Describe and explain the positive output gap graph
How can it be filled?

Answer 20

• The SRAS and AD curves intersect at a point on the right of the LRAS curve
• The space in between this intersection (short-run output), and the LRAS curve is the positive output gap
• This gap can be filled either through long-run economic growth, which would move the LRAS curve to the right, or through a recession, which shifts AD down, and the SRAS curve up

Question 21

Describe and explain the negative output gap

Answer 21

• The SRAS and AD curves intersect at a point on the left of the LRAS curve
• The space in between this intersection (short-run output), and the LRAS curve is the negative output gap
• This gap can be filled if aggregate demand is likely to rise faster than the long run growth in the economy

Question 22

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

Answer 22

• economists do not know the exact position of the LRAS curve
• Estimating the output gap is difficult because initial estimates of GDP showing where SRAS and AD are equal are almost always inaccurate. This is because GDP figures are constantly revised.
• Some economists believe that output gaps are difficult to measure and are not a valid concept to use for the purpose of economic policy

Question 23

What are the benefits of economic growth?

Answer 23

• for individuals as consumers, it allows them to buy more goods and services
• Life expectancy tends to be associated with income
• Housing standards can become higher
• people will have enough to eat and drink, food safety will also improve
• Literacy rates will increase
• The health of the population will improve - this impacts quality of life

Question 24

Define growth
Give an example of antigrowth arguments

Answer 24

• growth can be defined as an increase in the productive potential of the economy which does not lead to fall in the productive potential of the economy for future generations
• It is unrealistic to assume that growth can not be sustained because of many reasons such as: extra percentage increases in income are likely to use up nonrenewable resources. The world will soon run out of these and there will be an economic collapse. Increases in income also associated with greater pollution, leading to an uninhabitable Earth.
• Other economic theories suggest that the future may not be as bleak because scarcity of resources, especially nonrenewable ones will lead to tools in consumption and demand because of the rationing function. There will also be a growing economy of substitute products and new supplies.
• Governments also have to respond to pressures from scientists and the public. Industries are far more regulated today than they were 30 years ago and pollution emissions are also strictly controlled.
• However, market mechanisms and government are very slow to act. They are not good at responding to pressures and therefore global warming and the other consequences of economic growth may be irreversible. This may lead to economic collapse.

Question 25

Describe the impact of economic growth in regards to growth and happiness

Answer 25

• economists argue that higher average incomes do not necessarily mean increases in happiness
• Cross-sectional surveys have found happiness and income of positivity related at lower levels of income, but this relationship dissolves as income increases
• This is known as the Easterlin paradox: Richard Easterlin identified this problem in a 1974, research paper: an increase in consumption of material goods can improve well-being when basic needs are not met, but once these needs are met, the increasing quantity of consumption will not increase well-being in a long-term
• Instead of concentrating on increasing GDP, the governments of high income countries should concentrate on factors which contribute to happiness: minimum income, adequate healthcare, work-life balance

Question 26

Describe the impact of economic growth on a different groups

Answer 26

• consumers: economic growth causes an increase in household income, this will result in an increase in consumption, but in terms of well-being, the average household will see no gain. This is related to the Easterlin paradox.
• Firms: economic growth provides opportunities to increase sales, but economic growth can change the structure of the economy and technologies within the economy, which means some firms may become obsolete. There is also an opportunity for new firms to establish themselves.
• ## The government: rising incomes equals rise in government tax revenue. An increase in consumption. Usually does mean that tax revenues rise, but the response to this rise can depend upon the parties in power. Right-wing governments will be more likely to reduce rates of tax and reduce government services then left-wing governments.

Question 27

Describe the impact of economic growth on a different issues

Answer 27

• The environment: in which developed countries, economic growth can lead to less pollution and cleaner environment. This is because technologies and project will be created to improve the environment. In developing countries, however, growth in primary and secondary industries will likely increase pollution and degrade the environment. China, for example has experienced growth of heavy industries, but this has led to a large pollution problem.
• The economy: growth in GDP result in a larger economy. This will impact consumers/firms/the government, and in terms of jobs there will be less unemployment. Also an increase in productivity.
• Current, and future living standards: this depends on who received the benefit of economic growth. It’s only the rich profit. Then the majority of households will feel no different. However, in developing countries, everybody is more likely to benefit from economic growth.

Question 28

Give two reasons why we cannot be sure that GDP per capita/GNI per capita indicates standard of living

Answer 28

• National income statistics do not accurately measure the true value of output produced
• Standards of living are closely related to a variety of factors that GDP and GNI are unable to account for so these figures can be misleading.

Question 29

Why do national income statistics (GDP/GNI) not accurately measure the true value of output (3)

Answer 29

• GDP and GNI do not include non-marketed output: some output of goods and services do not generate any income. An example would be repairing and improving one’s own home. If the work was carried out by hired workers, GDP would increase, but in less developed countries, households are self-sufficient therefore, the nonmarketed output would be far greater and less developed countries.
• GDP and GNI do not include output, sold in underground (parallel,) markets: these are all the unrecorded transactions in an economy. This may be the reselling of a good at a higher price. Or when income is not reported in order to avoid taxation.
• GDP and GNI and differing domestic price levels: goods and services sell very different prices in different countries. Good X may cost £100 in one country and £200 in another but if 10 units are sold in both countries the latter country will have a greater increase in GDP. Purchasing power parity is can help to convert values of GDP and GNI into one common currency.

Question 30

Why do national income statistics (GDP/GNI) not accurately measure the true value of standard of living

Answer 30

• GDP and GNI make no distinctions about the composition of output: does the economy produce military weapons or merit goods (education/healthcare/Cleanwater)? GDP and GNI Include the value of all goods, without any distinctions about their impact on the standard of living.
• GDP and GNI Cannot reflect achievements in the levels of education, health and life expectancy: these factors will contribute significantly to standards of living. An alternative and broader measure (human development index) has been developed to reflect societies achievements in these areas.
• GDP and GNI Provide no information on the distribution of income and output: how equally the income and output are distributed is another factor of standard of living, because if wealth is highly concentrated in a few households, while the larger portion of the population are unable to satisfy their basic needs, this means the standard of living in that country is overall quite poor. GDP and GNI Only provide an indication of average output/income.
• GDP and GNI Do not take into account increased leisure: in many countries, the number of hours work per week has declined, but this has not been accounted for in GDP and GNI
• GDP and GNI do not account for quality of life factors: standard of living also depends on non-economic factors, like the crime rate, stress levels, political freedom, which GDP and GNI cannot account for
• GDP and GNI Do you not account for the value of negative externalities such as pollution, toxic waste and other undesirable by-products of production: all countries contribute to environmental degradation, but this is not reflected in GDP and GNI
• GDP and GNI Do not take into account the depletion of natural resources: this reduces societies, well-being
• GDP and GNI Do you not take into account quality improvements in goods and services: the quality of products can improve over time due to technological advances. This will offer benefits to consumers because product will be sold at lower prices.. GDP and GNI does not reflect this

Question 31

Describe national income measures and standard of living comparisons over time

Answer 31

• to make comparisons over time, we must use the real values of income and output measures as these account for changes in the price level
• Even using real values, the comparisons of GDP and GNI may be misleading
• an increase in real GDP for one country may overestimate/underestimate the true change in standard of living because of factors, such as product, quality/improvements in health and education/increased leisure/changes in quality of life, factors etc

Question 32

Discuss national income measures and standard of living comparisons between countries

Answer 32

• Because GDP and GNI are unable to measure the true value of output, and because of the exclusion of many standard of living factors it is difficult to compare between countries.
• There may be a high levels of inequality, so even though the GDP is larger in one country, the standard of living may be poorer for the majority population. Domestic price levels are also an important issue

Question 33

Describe national income measures and standard of living comparisons to measure income and wealth

Answer 33

• National income tend to be correlated with a national wealth
• Wealth is the stock of assets, which produce a flow of income over time
• Countries with high will produce higher levels of income in countries with low levels of wealth
• However, wealth can be mismanaged and used poorly, so there is not a perfect correlation between wealth and income

Question 34

Describe national income measures and standard of living comparisons to measure national income/economic welfare/happiness

Answer 34

• National income is used to measure economic welfare/the standard of living
• Income is used as a measure of happiness, but there are other factors which contribute to standard of living
• Easterlin paradox is concerned with this
• Some economists have disputed the paradox, and instead suggest a correlation between income and happiness, even if it is weak
• Some surveys show that those with above average incomes tend to have higher levels of happiness. Therefore, if income is increased for every individual, there would be no increase in happiness, but if an individual worker had an increase in their income, they would be happier because their relative income has increased.
• There are two explanations for the correlation between income and happiness. One explanation is that income is a symbol of social status and psychologically we feel happier if we feel that we are of a higher status. This is a competitive streak and has biological roots. The second explanation is that above average incomes are correlated with other factors which are associated with happiness, for example, better health and long life expectancy. they have more control over their environment and are less likely to be unemployed.