Theme 2.5 Flashcards
What causes economic growth?
For economic growth to occur, there needs to be an increase in quality or quantity of one of the four factors of production: land, labour, capital or enterprise, or these being used more efficiently. All economists agree that an increase in LRAS will increase the potential level of output in an economy. Any factor which increases the LRAS, will also increase economic growth.
How can land cause economic growth?
The discovery of new resources e.g. oil will increase economic growth. Economists argue that developing countries tend to grow the most from exploiting new resources, whilst they do not have a significant effect in developed countries. Saudi Arabia has experienced large growth rates almost purely because of their discovery of oil and without this it is likely they would still be developing.
How can labour cause an increase in economic growth?
An increase in the quality or quantity of labour will improve economic growth.
-Size of the workforce: Changes in the size of the workforce can come from immigration, demography (age profile) of the country or participation rates. A change in the age profile of the population i.e. the amount of people of working age will affect economic growth: the more people of working age there are, the more growth there will be. Raising the retirement age will increase the population of working age. The government can take action such as providing free childcare to encourage mothers to go back to work, which will increase participation rates. Immigration can be vital in enabling economic growth if it provides potential workers with the skills, knowledge and desire to work within the country. On the whole, the larger the workforce the more goods and services that can be produced.
-Quality of the workforce: In the long run, improving the quality of labour is perhaps more important; this can be done through education. Improved education will improve labour quality as it will mean that workers have all the skills they need and are more efficient, so output per worker increases. More skilled workers will also be less likely to suffer from structural unemployment as they will have greater occupational mobility and so this will increase the output of the economy as there are less unused resources. Additionally, more skilled workers will be able to contribute to change i.e. new technology, business ideas, innovation etc. and this will help to improve economic growth.
How can capital cause economic growth?
If a country receives sustained investment, they will be able to access or develop new technology which will enable the country to improve productivity. It will also mean more machines can be bought and used, even if these are not a technological advancement, so more goods can be produced. Not all investment will lead to increased GDP because some investment is unsuccessful whilst it is argued that other investment doesn’t increased GDP because of its nature e.g. building houses.
How does enterprise cause economic growth?
If the government offers tax benefits and grants, they will encourage the development of business, creating jobs and meaning more goods and services are produced, which will increase economic growth. If there is too much wealth distribution (i.e. too high taxes and benefits), there will be little incentive to work hard as the rich know a lot of their money will be taken away and the poor know that there is no need to work as benefits will give them just as much money as a job on minimum wage. This lack of incentive will mean that businesses won’t invest and so there will be little to no economic growth.
How does technological progress cause economic growth?
Improved technologies mean that the average cost of production is lower, whether this is because it is quicker to produce or less labour or equipment is needed. Also, it creates new products for the market and this helps to increase consumption and keeps MPC high as there are new things to buy. Without increased spending, there would be little economic growth.
How does efficiency cause economic growth?
Efficiency is important in bringing about economic growth as it means less resources are needed to produce each good, so more goods can be produced.
-One way the government can ensure efficiency is to keep up competition as it will means producers are forced to lower prices or increase quality so will have to improve efficiency to keep profits high.
-In order for there to be efficiency, the market mechanism must be working properly. In some countries, particularly low and middle-income countries, the mechanism doesn’t work properly due to a lack of protection of property rights. If the government doesn’t intervene to protect property rights, then people will be unwilling to save and invest which will prevent economic growth.
-Similarly, there may not be an efficient capital market (i.e. banks) so farmers will not have access to loans to expand their businesses.
-Countries may experience civil wars or natural disasters which will lead to negative growth as human and physical assets are destroyed.
-In a communist society, there is lack of efficiency as the government is the only supplier and they are not motivated to cut costs to keep profit high. When governments intervene too much, they can cause inefficiency through government failure rather than market failure.
What is the difference between actual and potential growth?
● The actual growth is the percentage change in GDP. It is when the economy is actually produced more goods and services. Potential growth is the change in productive potential of the economy over time, so the LRAS or PPF curve shifts.
● The productive potential is determined by the factors of production and so potential growth means there have been resources discovered or more technology developed that will allow the economy to grow more. They have not yet produced the extra goods and services so GDP hasn’t grown. The difficulties in measuring productive potential means changes in GDP are used as a measure of growth.
● The PPF shows the potential output of the economy. An outward shift of the PPF is economic growth. If the economy moves from inside the PPF to on the PPF, this would be classed as economic recovery rather than economic growth. However, again, it is difficult to know where the PPF of an economy is and so economists tend to treat all increases in real GDP as economic growth.
How can international trade affect growth?
● Many economists argue that AD can affect economic growth, through export-led
growth: a rise in AD through increased exports.
● This has been effective in countries such as Germany, Japan and China and prevents the poor balance of payments that tends to occur as a result of economic growth.
● Although increased exports initially increases AD rather than LRAS, sustained high export levels will encourage, or force, firms to invest and increase demand for labour, which will lead to economic growth.
● Moreover, in order to be competitive in the international market, British firms will have to become more efficient as they are competing with more firms than in just the UK market.
What are output gaps?
An output gap is the difference between the actual level of GDP and the estimated long-term value for GDP- this is shown on the trade cycle diagram which demonstrates how the actual GDP is not always on the trend.
What does a positive or negative output gap mean?
A positive output gap is when GDP is higher than estimated whilst a negative output gap is when GDP is lower than estimated. With a negative output gap, there is spare capacity in the economy with factories, offices and workers not being utilised to produce goods and services.
Why are output gaps difficult to measure?
The output gap is very difficult to measure, firstly because the exact position of the LRAS is unknown and also because initial estimates of the real GDP are often inaccurate. Some economists believe they are so difficult to measure that they are not a valid concept to use from the purpose of economic policy. It is not possible to measure the productive potential of an economy as there is no single monetary value for the level of variables such as machinery, workers and technology.
How can output gaps be illustrated?
● Output gaps can also be illustrated using AS and AD diagrams. LRAS shows the full capacity output i.e. where all resources are being fully utilised, and this can be linked to output gaps between the GDP trend line and the actual GDP.
● An equilibrium to the right of the LRAS shows the economy working over capacity in the short term but to the left it shows the economy working under capacity.
What do classical economists argue about output gaps?
Classical economists would argue that this positive output gap would be filled by long-run economic growth moving the LRAS curve, a recession which would decrease AD or a rise in the costs of production which would decrease SRAS. They would also argue that the negative output gap would be brought back to equilibrium by rising AD or a fall in SRAS due to lower costs of production.
What is the 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. There is no set definition of each phase and sometimes people simply refer to the cycle as a boom and recession, or contraction and expansion.
● There are two main types of trade cycle: a mild trade cycle where GDP does not fall during recessions but instead doesn’t grow by as much as the trend, and a more extreme one like that in the diagram.
