Theme 2 Topic 5 Flashcards
what does a change to any components of AD cause ?
economic growth in the short run
what does an increase in real GDP cause ?
economic growth
2 diagrams economic growth can be shown by :
- AD=AS diagram (rightward shift in AD)
- PPF curve
PPF model for economic growth :
increase in production causes shift in production combinations for X to Y.
current real output increases, moving closer to maximum possible output of the economy.
increase in real GDP.
causes actual economic growth.
LRAS economic growth :
change in quality/quantity of factors of production increases potential output.
e.g. more rigorous competition policy increases number of firms in each industry, so greater AS in the economy.
shifts LRAS right, causing economic growth.
what does the final impact on price levels depend on ?
the shape of the LRAS curve (Keynesian or classical)
actual economic growth :
an increase in the quantity of goods/services produced in an economy in a given period of time.
measured by the % change in real GDP .
potential growth :
increases the productive potential of an economy as demonstrated by a shift outward of the PPF or the LRAS curve.
at any given point in time, the actual economic growth may be less than the potential growth available to the economy.
International trade :
Exports are a key income source and a driver of growth. UK firms focus on global markets, boosting overseas sales. The liberalisation of markets makes it easier to sell abroad. To meet demand, UK firms invest in production and need skilled labour, making education and training crucial.
export led economic growth :
refers to the growth that occurs as a result of an increase in the sale of goods/services to foreign countries.
net export is a component of AD.
for many developing countries, the exports represent a higher % of the annual AD and GDP.
when the value of exports rise, real GDP rises significantly.
if there is a contraction for 2 quarters of a year, what occurs ?
a recession.
decrease in the level of economic growth, or negative economic growth occurs.
this can be distinguished from the RATE of economic growth
what are the 6 factors that impact LRAS and cause economic growth :
- Investment
- Innovation
- Migration
- Changes in birth rates
- Export led growth
- Increased productivity
increased productivity :
capital and labour are being used more efficiently with increased output for the same input.
export led growth (factor affecting economic growth)
leads to greater investment in capital goods, causing greater productive capacity.
investment :
in capital goods, physical assets used to produce goods/services.
e.g. machinery
changes in birth rates :
increased birth rates cause a shift right on LRAS curve
innovation :
of products and processes.
e.g. assembly lines (catalyst for growth)
Joseph Schumpeter described the ‘creative destruction’ that firms used to make old products and processes obsolete.
e.g. R + D by Apple.
Migration :
Movement of people from one country to another.
Immigration : greater productive capacity and a shift right on LRAS curve.
Emigration : opposite effect
constraints that impact LRAS :
- An absence of capital markets
- Instability of government
Absence of capital markets :
Difficult to raise the finance required for investment.
One of the main cause of the lack of economic development in some African countries.
Instability of government :
Causes short term decision making that impacts on investment, particularly from the government itself.
As regimes change frequently, so do their policies.
This doesn’t provide business from within, and outside the country with the confidence to invest
injections (circular flow) :
increases AD
increases economic growth
size of the increase depends on multiplier effect
provides investment for capital goods
productive capacity increases
Withdrawals (circular flow) :
decrease in AD
Decrease in economic growth
size of the decrease depends on multiplier effect
reduces the finance available for investment on capital goods
causes less growth of productive capacity
Evaluating economic growth :
- Balanced approach: Governments should balance short-term (SR) and long-term (LR) growth policies.
- Demand-side stimulation: Important to stimulate demand to drive economic activity.
- Supply-side constraints: If supply-side policies remain constrained, inflation is likely to rise.
- Demand suppression: Focusing only on the supply side is limited if demand is suppressed, leading to unused resources and spare capacity.
- Supply-side lag: Enhancing the supply side takes time, as capital investment doesn’t always immediately improve productive efficiency.
long run trend rate of growth :
average sustainable rate of economic growth over a period of time.
happens over a long period of time and is determined by the changes in productive capacity of the economy.
Actual growth :
The actual changes in real GDP over time.
it’s changes are what make up the business cycle
output gap :
the difference between the trend rate and actual rate of economic growth
potential output :
when the economy is working at full capacity over the longer term.
occurs when all factors of prediction are working efficiently.
economy can operate above the potential output in the short run, but pressures on factors of production (e.g. labour) means it’s unsustainable in the long run.
positive output gap :
when the actual rate of economic growth is above the long run trend rate.
happens during periods of high economic growth and is associated with inflationary pressure and low unemployment.
worsens current account deficit because of increased incomes and less unemployment, so an increase in the demand for imports.
negative output gap :
when the actual rate of economic growth is below the long run trend rate.
happens during periods of low/negative economic growth and is associated with deflationary pressure and high unemployment.
improves current account deficit due to reduced incomes and higher unemployment, so a decrease in demand for imports.
there is spare capacity as resources aren’t being utilised to produce goods and services.
why is it difficult to measure an output gap :
requires us to measure AD.
requires us to measure AS. this is problematic as we need to measure the skills of the labour force and changes in capital assets (e.g. machinery).
potential output is based on estimates of the supply of labour, capital stock, and productivity of the factors of production.
no monetary value is placed.
as these are estimates, the information is inaccurate.
Classical economists (output gaps)
they believe markets clear in the LR, so there’s full employment.
they believe there are output gaps in the short run.
they would argue that the positive output gaps would be filled by LR growth moving the LRAS curve, a recession which would decrease AD or move SRAS left due to rise in costs production.
Keynesians (output gaps)
Excess AD creates positive output gaps with AS above equilibrium.
national output increases but this causes inflationary pressure.
keynesians believe output gaps exists in LR and SR.
What is the trade cycle ?
Variations in the level of productive capacity of an economy over time.
What is productive capacity ?
Maximum amount of goods/services that we can produce with the resources available
What is a recession ?
Real GDP falls in at least 2 consecutive quarters
hysteresis in the economy :
- Post-recession recovery: The economy returns to its trend line after a recession, but may not fully recover during a boom.
- Recessions: Cause unemployment, leading to lower living standards, even in the short term.
- Booms: Fixed-income individuals suffer from inflation, causing real income to fall.
-
Hysteresis: Some economists argue that deep recessions may prevent full recovery.
-
Causes of hysteresis:
- Permanent labor loss (e.g., early retirements, skill loss, discouraged workers)
- Loss of physical capital (e.g., reduced firm investments during recession)
-
Causes of hysteresis:
- Impact: Leads to decreased potential output.
Characteristics of a boom :
- High national income: Economy operates above the PPF with a positive output gap.
- Increased consumption & business investment
- Rising wages: due to rising incomes
- Higher tax revenues: Due to increased consumption and income.
- Increased imports: High-income consumers demand goods beyond domestic production capacity.
- Inflationary pressure: Increased demand leads to rising prices.
Transition to Downturn:
- Falling output & income: Leads to reduced consumption, investment, and tax revenues.
- Rising unemployment: Increases payments for benefits.
- People accept jobs at lower wages due to higher unemployment.
- Reduced demand helps ease inflationary pressures.
- Falling income and demand lead to fewer imports.
Characteristics of a recession :
- Low national income: Economy is at the bottom of the cycle (slump/recession).
- High unemployment: Leads to reduced consumption, investment, and imports.
- Low inflation or deflation: Reduced demand causes inflationary pressure to ease, and deflation may occur.
Transition to Recovery/Expansion:
- Rising national income & output: Economic activity starts to increase.
- Falling unemployment: As businesses recover, job opportunities rise.
- Increased consumption, investment, & imports: Demand begins to grow as the economy recovers.
- Growing inflationary pressure: Workers demand higher wages as employment and demand rise.
features of a trade cycle :
This is the periodic but irregular up and down movements in economic activity, measured by fluctuations in real GDP and other macroeconomic variables. Each business cycle is different, but they tend to have four main phases: boom, downturn, recession (slump) and recovery.
demand/supply side shocks and the trade cycle :
-
Demand-side shocks:
- Collapse of a housing bubble.
- Political issues or instability.
- A global recession impacting the economy.
-
Supply-side shocks:
- Trade union actions (e.g., strikes).
- Changes in oil prices.
- Fluctuations in exchange rates.
-
Impact of shocks:
- Negative shocks: Can cause a recession.
- Positive shocks: Can lead to a boom.
main types of a trade cycle :
- a mild trade cycle where GDP does not fall during recessions but instead doesn’t grow by as much as the trend
- a more extreme cycle
level of economic activity fluctuates over time and is measured by GDP.
real GDP takes inflation into account
Benefits of growth to consumers :
- Improved standard of living: Economic growth raises the standard of living for consumers.
-
Increased income:
- Allows more spending on necessities at lower income levels.
- Enables spending on luxuries at higher income levels.
-
Real wage growth:
- As wages rise, workers can balance work and leisure.
- Higher incomes allow for more free time and early retirement.
-
Leisure vs. work:
- At higher income levels, people may choose more leisure time as financial needs are met.
Benefits of growth to firms :
- Increased profits: Economic growth boosts demand, leading to higher revenue and profits for firms.
- Higher income for owners: Owners benefit from increased income, such as higher dividends.
- Reinvestment: Firms can use retained profits to reinvest in productive capacity (e.g., new machinery).
- Further benefits: Reinvestment enhances the firm’s growth and benefits the broader economy.
Benefits of growth to the government :
- Improved budget: Economic growth increases tax revenues as more people work.
- Reduced benefit claims: Fewer people rely on government benefits due to higher employment.
- Debt reduction: Increased tax revenue allows the government to pay off public sector debt.
- Policy implementation: The government can use the improved budget to fund policies, such as increased infrastructure spending.
measuring living standards - increases in income :
- Increased income: Provides households with greater purchasing power.
- Impact: Households can afford a wider range and better-quality products.
- Result: Economic growth increases the standard of living.
- Supporting factors: Various factors contribute to this improvement
measuring living standards - quality + availability of employment
- Growth source: Much of the UK’s economic growth has come from low-skilled jobs filled by immigrants.
- Impact on economy: Increases productive capacity by boosting labor supply.
- Potential downside: Existing UK residents may not benefit, as increased job competition could lead to them losing out.
measuring living standards - income inequality
Growth is often skewed to certain sectors of the economy e.g. finance and some citizens do not benefit from the increased income e.g. those suffering structural unemployment
measuring living standards - quality housing at affordable prices
- Positive output gap: Often linked to rising housing prices.
- Impact: Increases in house value boost wealth for homeowners. Leads to an increased stock of wealth
- Downside: First-time buyers and non-homeowners face difficulty entering the housing market.
measuring living standards - life expectancy
- Increased wealth: Allows greater spending on essential services like quality healthcare.
- Higher-income lifestyle: Wealthy individuals tend to seek a more discerning lifestyle, enjoying the rewards of their position.
- Spending trends: Increased spending on health, fitness, and quality food (e.g., organic foods).
- Result: This can lead to longer life expectancy.
Costs of growth - effects on the environment
- Increased pollution: Higher output leads to more pollutants, negatively affecting health and lowering standard of living.
- Increased congestion: Growth strains infrastructure, disrupting transport networks like roads, railways, and air travel.
- Non-renewable resource depletion: As resources are used up, the search for replacements damages the environment, threatening habitats of people and wildlife.
Costs of growth - balance of payments problems
- Higher incomes: Economic growth leads to higher incomes, part of which is spent on imports (measured by marginal propensity to import - MPI).
- Impact of increased imports: Leads to a current account balance of payments deficit.
- Financing the deficit: Often requires borrowing, which can lead to debt servicing problems.
-
Consequences:
- Foreign investors may withdraw funds.
- Currency depreciation occurs.
- Inflation may rise due to higher import costs.
Costs of growth - income distributions may lead to inequalities
- Skewed growth: Economic growth often favors certain sectors, like finance.
- Beneficiaries: Workers in finance benefit from growth.
- Resource diversion: Other firms may shift resources to finance, impacting other industries.
-
Consequences:
- Structural unemployment can arise.
- Income inequality and social divisions may increase.
Opportunity cost of growth :
- Actual growth: Increases real GDP, benefiting people today.
- Potential growth: Increases capital goods, benefiting future generations.
- Investment in potential growth: Requires investment in productive capacity.
- Opportunity cost: The cost of investing in future growth is the foregone benefit of spending on consumption goods today.
Benefits of economic growth outweigh the cost :
-
Benefits:
- Improved living standards for billions of people.
- Wealthy individuals enjoy a dream lifestyle, while many poor people achieve a more comfortable lifestyle.
- Widespread access to products that improve quality of life, like clean water, communication, and education.
-
Challenges:
- Growth leads to increased pollution and congestion.
- Rising stress due to long working hours.
- Climate change impacts and strain on Earth’s resources.
- Increased demand and global population growth could lead to severe water and food shortages.
Changes in economic growth over time :
It remains a key economic objective of the government and one which the media and public use to appraise the success or failure of the government
measuring economic growth :
- Real GDP per capita: Often a better indicator of standard of living within a country.
- Black market: Difficult to measure due to lack of transparency in illegal transactions.
- Unmeasured activities: Economic activities like work done by housewives/husbands are not counted.
- Measurement issues: Quality of measurement varies between countries, leading to inaccurate results.
growth pessimists
they question the long term sustainability of growth.
they argue that renewable resources will be deployed due to the tragedy of commons, where public resources are neglected.
believe growth leads to environmental threats such as increased wage, pollution, species extinction…
