MACRO - LS10 - Economic Growth (Part 1)

Question 1

Economic Growth

Answer 1

• increase in the real value of goods and services produced as measured by the annual percentage change in GDP
• also defined as a long-run increase in a country’s productive capacity/potential output

Question 2

sustainable growth

Answer 2

growth in the productive potential of an economy today which doesn’t lead to a fall in the productive potential of an economy for future generations

Question 3

what can cause economic growth

Answer 3

• increase in any component of AD
• increase in LRAS - considers the following factors:
• land
• labour
• capital
• technical process
• efficiency

Question 4

Land

Answer 4

• defined as all natural resources
• countries like Saudi Arabia experience large growth rates due to it
• UK only started to exploit oil & gas resources in the mid 1970’s
• it’s unlikely to be a significant source of growth for developed economies, although more vital for developing economies

Question 5

Labour

Answer 5

• increase in quantity of workers or increase in quality of labours
  factors incl.:
• changes in demography
• changes in participation rates
• immigration

Question 6

changes in demography

Answer 6

• today’s birth rate will effect economy in 20 yrs time
• high birth rate –> increasing no. of workers e.g. African countries
• relatively low in recent decades in Europe

Question 7

Change in participation rates

Answer 7

• it’s proportion of population in or seeking work
• increase of people staying on in education decrease workforce
• more workers can afford early retirement
• but increase in state pension age is seeing men working past 65 & women 60
• more women working due to higher wages & better childcare

Question 8

immigration

Answer 8

• large inflows of migrant labour from Eastern Europe in UK
• may increase output but not economic welfare as work shared among more people so less income change

Question 9

why is increase in human capital important?

Answer 9

• need to be educated to cope with demands of the exisiting stock
• workers need to be flexible - may have to change jobs/roles
• need to be able to contribute to change

Question 10

capital

Answer 10

• needs to increase for sustainable growth so need sustained investment
• however some investment e.g. housing doesn’t cause growth

Question 11

technological progress

Answer 11

• cuts average cost of production of products
• creates new products - causes consumers to spend more

Question 12

efficiency

Answer 12

• increased efficiency of the use of resources will cause increase rises in output
• in market economy, competition will lead to greater efficiency - drive less efficient firms out of market - gov polices can encourage competition
• gov may also have to step in and reduce market failure

Question 13

low and middle income countries

Answer 13

• many features of functioning market economy may be missing
• resources used inefficiently
• corruption possible
• laws may not protect property rights - less likely to invest
• rural areas may not be able to access banks - can’t take out loans to expand buisnesses

Question 14

economic/business cycle

Answer 14

• Pattern of the level of economic activity which fluctuates over time
• ## measured by GDP

Question 15

Key characteristics of trade cycle

Answer 15

• Peak/boom
• Downturn
• recession/depression
• recovery/expansion

Question 16

Peak/boom

Answer 16

• high national income as well as consumption & investment
• high tax revenue
• increase in wages and profits
• imports will be high and inflationary pressures
• likely economy is working beyond full employment
• high levels of economic growth
• low levels of unemployment

Question 17

Downturn

Answer 17

• output and income all - so does consumption & investment
• tax revenues start to fall
• gov expenditure also increases - more people on benefits
• wage demands are moderate
• unemployment rises
• imports fall and inflationary pressures decreases

Question 18

Recession/depression

Answer 18

• bottom of cycle
• economic activity is low/negative growth
• high unemployment
• consumption, investment & imports may be low
• few inflationary pressures, may be deflation

Question 19

Recovery/expansion

Answer 19

• national income/output start to rise
• unemployment falls
• consumption, investment, imports begin to rise
• workers feel more confident demanding wage increases
• inflationary pressures began to mount

Question 20

Long run growth

Answer 20

• increase in potential output

Question 21

Short run growth

Answer 21

• increase in real GDP, driven by an increase in AD that draws unemployed resources into use

Question 22

Actual vs potential output

Answer 22

• actual output - current level of production (real GDP) in an economy - some resources may be unemployed
• potential output - economy’s productive capacity or the largest output that could be produced, given the prevailing output of technology and stock of available resources

Question 23

Recession definition

Answer 23

Where GDP falls in at least two successive quarters

Question 24

What are the two types of trade cycle

Answer 24

• traditional cycle with peak/booms etc…
• milder trade cycle

Question 25

Mild trade cycles

Answer 25

• GDP doesn’t fall but economy fluctuates around its long-run real GDP
• doesn’t show recession phase, GDP still rises even in downturn - may be relatively small rise
• can draw trend line as straight line

Question 26

Why does short term growth rate fluctuate around long term rate

Answer 26

Due to demand-side shocks and supply-side shocks
Shocks can be positive and negative

Question 27

Demand side shocks

Answer 27

• affects AD
• housing market bubble bursts, prices rise too high causing a sudden collapse in housing demand and prices - decrease in consumer confidence
• stock market crash - may be as prices are too high - causes decrease in wealth & AD
• sharp interest rate rise due to inflation, reduce durable spending & investment - can lead to recession
• sharp increase in tax/decrease in gov spending - to balance budget/due to inflation - decreases AD
• world economy may go into recession, decreases exports, decreases AD
• sharp rise in pound value, X decreases, M increases

Question 28

Supply side shocks

Answer 28

• Affect Aggregate supply
• large rise in world commodity prices - raise UK price level & imports if Inelastic, if import prices increase, it reduces AS, lower output
• outbreak of trade union militancy - large wage increase, so then does price level, decreasing AS (real wage unemployment)

Question 29

Output gaps

Answer 29

• difference between actual level of real GDP & estimated long term value at point in time
• straight line - trend rate - associated with productive potential of economy
• actual level of real GDP varies around trend rate - trade cycle

Question 30

Negative output gap

Answer 30

• economy in recession, high unemployment & deflation
• below trend line
• has spare capacity in economy
• actual GDP below productive potential of an economy

Question 31

Positive output gap

Answer 31

• inflationary boom
• actual GDP above trend line
• actual GDP above productive potential of an economy
• boom period

Question 32

How to show positive output gap

Answer 32

• use AD/AS
• vertical LRAS - equilibrium with AD at Y1
• SRAS & AD equilibrium at Y2
• +ve output gap at Y1Y2
• to fix - long term economic growth - moves LRAS to Y2
• or recession shifts AD down & SRAS up

Question 33

How to show negative output gap

Answer 33

• use AD/AS
• vertical LRAS - equilibrium with AD at Y2
• SRAS & AD equilibrium at Y1
• -ve output gap at Y1Y2
• to fix AD rises faster then LRAS
• shift in AD moves to equilibrium

Question 34

Size of output gaps

Answer 34

• can be hard to gauge size of output gap - as don’t know exact position of LRAS curve
• initial estimates of GDP showing where SRAS & AD meet are almost always inaccurate - GDP figures constantly revised