Unit 2.2 Flashcards
Aggregate demand
the total demand for goods and services within a country. Measures spending on goods and services by consumers , firms, government and overseas consumers.
AD = C + I + G + NX
AD= (consumers) + (investment) + (government) + ( Net exports)
Consumer spending
Amount consumers spend on goods and services, this is the biggest contributor of AD- 60%
Investment
Investment/ spending from businesses, mostly from private sector businesses. Investment is spending which adds to the capital stock ie can only be used to increase output in the economy.
Government spending
This is how much the government spends on goods and services such as schools, hospitals, benefits, defence etc
NX ( exports - imports)
This is known as Net exports and is the value of the current account on the balance of payments ( we are in a deficit so this reduces AD)
Interest rate effect on AD
If I/r increase then investment and consumer spending decreases so AD decreases
Movement along the AD curve
If there is a fall in price level there is an extension in demand, if there is increase in price there is a contraction in demand.
Movement and Shift in the AD curve
If price changes in an economy (and nothing else) there will be a movement along the AD curve. If any of the components change then there will be a shift in the curve. Shift left ( inwards) if components decrease, Shift right ( outwards) if components increase
Reasons for shifts in the curve ( assuming price level is the same)
-Higher confidence levels amongst businesses will encourage more investment
-The wealth effect- most people in the UK own their own houses, so if house prices increase, they feel wealthier and so they spend more
-Bank of England decides to decrease interest rates. This lowers the cost of borrowing , decreases the incentive to save and lowers mortgage payments for homeowners (only for tracker(variable) rate mortgages, around 15-20% of Uk mortgage holders have these so the impact moderated) . All these can result in increased consumptions. Also increase investment but will appreciate E/R so stabliser.
-Decrease in tax rate means more disposable income which shifts AD to right
-An increase in government spending shifts AD to the right
-Weakening pound means we export more and shifts AD to right
factors affecting consumer spending
- Real disposable income
- Household wealth including house prices
- Unemployment / job security
- Interest rates paid on loans and savings
- Availability of credit finance
- Consumer confidence / animal spirits
propensities to spend and save
*Disposable income can be spent or saved
* Marginal propensity to consume (MPC)
* Marginal propensity to save (MPS)
* MPC + MPS = 1
* A rise in the marginal propensity to save implies a lower marginal propensity to spend
How lower interest rates can increase aggregate demand
A fall in interest rate on a property mortgage means that home buyers have less to pay each month paying the interest on a home loan(only for tracker(variable) rate mortgages, around 15-20% of Uk mortgage holders have these so the impact moderated) . This means they have a higher effective disposable income which can be spent on goods and services. Another effect of lower interest rates is usually to lower the cost of servicing a credit card to other types of borrowing. And it also reduces the incentive to save, especially if nominal interest rates on savings are below the rate of inflation. Through these channels, lower interest rates can be expected to lift consumer demand which is the largest component of AD. Cheaper loans might also lead to a rise in planned capital investment spending by businesses which is also a component part of AD.
Disposable income
The amount consumers have left over after taxes ; they can choose to spend or save this money.
Where does income for consumption come from
- Wages
-Pension - Investment
-The wealth effect - assets rising in value
Marginal propensity to consume
MPC: Refers to how much a consumer changes their spending following a change in income.
For individuals the MPC could be greater than 1 if they borrowed money to consume. For the economy as a whole the MPC is likely to be positive but less than .
= change in total consumption / change in income
Marginal Propensity to save
MPS: How much consumers change their saving following a change in income.
=change in total savings / change in income
MPC formula
Positive means a rise in income will increase consumption
Change in consumption/ change in income
Average Propensity to consume
APC: Measures the average amount spent or consumed out of total disposable income in an economy
Consumption (C) / Income (Y)
Other factors affecting C
-The availability and cost of credit - regulations on borrowing money can increase or decrease the level of consumption. Changes in i/r can make it cheaper / more expensive
-Expectations - If people expect a downturn in the economy to a period of slow growth they may save more
-Confidence - If consumers expect to be promoted in the future or are secure and know there are lots of jobs prospects
-Asset prices - changes in the value of shares or houses can influence spending decisions ( the wealth effect)
Wealth Effect evaluation
-Increase in house prices
-Decreases demand for houses, price out market
-Increased demand for rented properties
-Increased price of rented properties in LR (not SR bcs of contracts)
-Decreased disposable income, poorer memebers of society, with a higher MPC (as higher unmet needs, less saving).
Moderates/ decreases extent of wealth effect and decrease mobility of labour
(around 35% rent and 35% own)
Consumption Evaluation
Increased consumption increases Real GDP but:
-Demand-Pull inflation
-Time lags
-May increase imports
-Govt could increase VAT
-RIse in I/r
Time Lags In C
- A fall in Income ( Y ) might not immediately feed through to a fall in C
-Changing interest rates ( i/r ) won’t change C straightaway
Examples of Capital investment
-Robotics
-Integrated Plant
-Machine tools
-Infrastructure
-Software
-Logistics
Factors Influencing Planned business investment
-Actual and expected demand for goods and services
-Expected profits and business taxes
-Intrest rates + availability of business finance
-Business confidence i.e. animal spirits
Key points:
-Government can lift investment by lowering corporation tax or offering other tax incentives as part of their fiscal policy
-Planned investment tend to rise when firms expect rising demand and have limited spare capacity to supply goods and services.
Explaining the basic accelerator effect - examples
-Investment to expand the fleets of delivery companies as online spending surges
-Rising capital investment in renewable energy as energy supply shifts towards renewable
animal spirits
John Maynard Keynes coined the notion of animal spirits which refers to a mix of confidence, trust, mood and expectations
When confidence is low, individuals save more, businesses save more too and because demand and profits lower than expected , they cut back on production and prehaps postpone or cancel capital investment projects.
Significance of investment for the Economy
-Injection of demand for capital goods and industries
-Investment can lift productivity/ incomes
-economies of scale and better competitiveness
-Investment helps to sustain export- led growth
The Basic accelerator effect
- The accelerator effect is a positive relationship between planned capital investment and the rate of change of national income
- Consider an industry (sector) where demand is rising quickly
- Firms may respond initially by using their existing capacity more intensively or running down stocks of finished products
- If they expect high demand will be sustained - they may increase spending on plant and machinery, factories and new technology to increase their supply capacity
- This causes a positive accelerator effect - a rise in demand for consumer goods and services will cause a bigger percentage change in demand for capital goods
Gross Investment
Gross investment is the total amount that the economy spends on new capital. This figure includes an estimate for the value of capital depreciation since some investment is needed each year just to replace technologically obsolete or worn-out plant and machinery.
Net investment
Net investment = gross investment -
capital depreciation.
If gross investment is higher than depreciation, then net investment will be positive. This means that businesses will have a higher productive capacity and can meet rising demand in the future.
Difference between savings and capital investment
Savings represent the total amount of income that is not consumed by households, businesses, or the government.
Capital investment is spending on machinery, equipment, factories, technology & infrastructure to create new capital goods.
Main components of government spending
-Welfare spending ( transfer payments)
-Public spending ( recurring spending )
-State investment ( investment projects)
What is the difference between the current and capital spending by the government
Current government spending- on providing public services
* Salaries of NHS employees
* Drug used in healthcare
* Road maintenance budget
* Army logistics supplies
Capital spending - investment in new public infrastructure
* Construction of new motorways and bridges
* New equipment in the NHS
* Flood defence schemes
* Extra defence equipment
Government spending and aggregate demand
-Increase in Aggregate Demand: When the government increases its spending on goods, services, infrastructure projects, or social (welfare) programmes, it injects money directly into the economy.
-Offsetting Economic Declines: During a recession, by increasing its own spending, the government can help stimulate economic activity, preventing a more severe downturn. This is known as a fiscal stimulus.
-Government spending may not lead to a increase in GDP however because consumers will save in anticipation of a tax increase.
Exporting
exporting is the act of selling goods and services to another country. Income from exports counts as an injection into the circular flow of income and adds to aggregate demand (AD)
Trade Balance
The trade balance is the difference between the value of exports and imports. When the value of exports is greater than the value of imports, the trade balance is in surplus. When the value of imports is greater than the value of exports, the trade balance is in deficit.
Factors influencing exports of goods and services
-Relative prices of exports in world market
-The exchange rate - a stronger currency makes exports more expensive
-Non price demand factors e.g. Design and Branding
- Strength of Aggregate demand in key export markets
Aggregate Supply
AS- The total amount that producers in an economy are willing and able to supply at a given price level in a given time.
Short term aggregate supply
The SRAS is defined as being the total supply in an economy when 1 factor of production is fixed.
The aggregate supply curve
The aggregate supply curve is upward sloping because at a higher price level, producers are willing to supply more as more profits can be earned
What shifts AS curve in short run (affects cost of production)
-Cost of labour- increase in wages, employment taxes, employment regulation …. leads to increased costs, therefore firms less willing and able to supply.
-Cost of commodities/ raw materials - rising costs such as increasing energy costs will decrease the amount supplies are willing and able to supply
-Exchange rates - If pound weakens in value against other currencies. The price of imports will be higher resulting in increased costs of imported component parts.
-Changes in productivity- Increased productivity leads to lower costs so suppliers are willing and able to supply more
-Taxation/ regulation- increase in tax would mean higher costs for suppliers therefore less willing and able to supply
-Technological advancements (SR and LR) - leads to more efficient production therefore increasing the amount suppliers are willing and able to supply.
Macroeconomic equilibrium
Macroeconomic equilibrium for an economy in the short run is established when AD intersects with SRAS. If increase in AD only this will lower inflation and increase GDP. This equilibrium determines the general price level and real GDP level. Changes (shifts) in SRAS and for AD will being about a change in the equilibrium.
Explain the shape of the keynesian AS curve
-When spare capacity is high, aggregate supply will be elastic: this means that a rise in aggregate demand can be met easily by increased output and there is little threat of rising prices (inflation)
-The elasticity of the curve falls as a country moves through an economic cycle:
1.The amount of spare capacity declines
2.There is the possibility of diminishing returns in production
3.Bottlenecks appear in the supply of key inputs including skilled labour
-When AS is perfectly inelastic, an economy is at full capacity (equivalent to being on the PPF boundary); this means that further increases in AD are purely inflationary in the short run with little extra real output
Keynesian Aggregate Supply Curve
The Keynesian aggregate supply curve is non-linear where the elasticity of aggregate supply is dependent in part on the level of spare productive capacity at different stages of a nation’s economic cycle.
At first the line is horizontal- perfectly elastic portion of the AS curve
Then it begins to bend upwards- Elasticity of aggregate supply now starting to drop as economy heads towards productive capacity
Finally it is vertical - Elasticity of supply is zero when full capacity is reached
Keynesian Aggregate Supply Curve - Non-inflationary growth
An outward shift in AD from AD1 to AD2 can be met without an increase in the general price level because aggregate supply is highly elastic
Keynesian Aggregate Supply Curve - Inflationary pressures from rising AD
Here, an outward shift in AD from AD3 to AD4 causes a sharp rise in the general price level because AS is now inelastic - output is close to full-capacity levels
Long run aggregate supply
Long run aggregate supply (LRAS) represents the maximum possible output; it is like a country’s PPF. It represents that maximum output when all factors of production are fully and efficiently at a sustainable lelvel employed.
Labour productivity
A measure of efficiency indicated by output per person employed or value of output per hour worked.
Infrastructure
Infrastructure includes physical capital such as transport networks, energy, power and water supplies and telecommunications networks
key factors influencing long run aggregate supply
-Higher Productivity of Labour and Capital - I.e. a rise in output per person employed or the increased efficiency of technology
-Growing Population & Increased Labour Market Participation - i.e. A growing labour supply and a rise in the number of people in paid work, could be due to migtation
-Innovation and Enterprise- Product and process innovation from research and development and higher rate of increase of business start-ups
-Capital Investment - Including capital spending by businesses, inward investment (FDI) and the Public Sector (Government)
-Stock of natural (environmental resources)-e.g. renewables, stocks of natural resources
-Competition policy: The government can promote competition between
businesses and markets which will force them to improve the quality of their goods or
lower prices. In order for businesses to do this and still make a profit, they have to
improve their efficiency and this efficiency will mean that more goods and services
can be produced, so LRAS will increase. However, less competition can sometimes
be beneficial if it encourages investment and innovation.
-Improvements in technology shift the LRAS curve to
the right, meaning more can be produced. This is because it will speed up
production, so more goods can be produced with the same amount of resources
-Government regulation - supply side policies such as free child care or lowering working age to encourage more workers. Additionally, government policy can increase research and development as
they can offer tax breaks to businesses that invest money into research,
which will encourage them to do so, They could make it easier to set up businesses and increase incentives to be
entrepreneurial (i.e. lower corporation tax) which would increase companies,
jobs and output so increase LRAS.
key factors influencing long run aggregate supply- changes in a nations potential GDP
Changes in a nation’s potential GDP are largely brought about by:
1.Changes in labour supply available for production (i.e. more people joining the labour force)
2.Changes in the stock of capital inputs including infrastructure
3.Changes to the stock of natural resources
4.Changes in the efficiency of allocation of factor inputs e.g. shifting resources from rural to urban areas
5.Improvements in the quality of inputs / productivity
6.Advances in the state of technology (web, AI, renewables)
7.Improvements in institutions such as banking/legal system
Shift in the long run aggregate supply curve
-An outward shift of LRAS signifies an increase in potential output and employment and signifies real economic growth
-In the long run, the ability of an economy to produce goods and services to meet demand is based on the state of technology and the availability and quality of factor inputs.
Importance of infrastructure for developments
Off-grid renewables
Transport infrastructure
Mobile money systems
Drone technologies to improve health care
Improved irrigation in farming
Border infrastructure
Basic sanitation
Waste disposal systems
Circular Flow of Income
A model of the economy which shows the movement of goods and services between households and firms and their corresponding payments in money terms
National Output (O)
The value of the flow of goods and services from firms to households
National Expenditure (E)
The value of spending by households on goods and services
National Income (Y)
The value of income paid by firms to households in return for land, labour and capital
Injections and Withdrawals
-Injection - this is the spending in the circular flow that does not come from households. There are three sources of injections:
1. Investment
2. Government spending
3. Exports
-Withdrawals (or leakage) - there are 3 sources of withdrawals to correspond to the three injections:
1.Saving by households
2.Taxes
3.Imports
Economic equilibrium when injections = withdrawals
Government budget deficit
When the government is spending more than they receive in tax, this is a budget deficit. (not a current account deficit)
Supply-side policies
Supply-side policies are a set of economic measures and strategies that aim to improve the long-run productive capacity and efficiency of an economy.
The primary goal of supply-side policies is to stimulate long-term economic growth, increase productivity, and create a more favourable environment for businesses to operate
Main Aims of Supply-side policies
1.Improve incentives to work and invest in people’s skills (human capital)
2.Increase labour and capital productivity
3.Increase occupational and geographical mobility of labour
4.Increase capital investment and research and development spending
5.Promote contestability and stimulate innovation (dynamic efficiency)
6.Encourage start-ups and expansion of new businesses especially those with significant export potential / promote economic diversification
7.Improve price & non-price competitiveness in global markets
8.Improve the trend rate of sustainable growth of real GDP to help support improved living standards & better regional economic balance
Main UK supply side weaknesses
-Low R&D spending - 1.74% of GDP in 2019, lower than in comparable countries like the US (3.1%) and Germany (3.2%).
-Low Investment - Business investment fell to just 10% of GDP in 2020. Overall, UK investment is lower than OECD average
-Skills shortages - 1.3 million job vacancies. Reported that by 2024 there will be a shortfall of four million highly skilled workers
-Economic inactivity- 400,000 rise in economic inactivity since 2020. Inactivity now 20% of the population of working age.
-Low labour mobility - Low housing affordability (to buy and rent) and structural barriers to social mobility. In 2021, only 6,000 new social housing units supplied in UK.
-Ageing infrastructure- 5 million homes at risk of flooding. Major rise in serious pollution incidents from water/sewerage.
Inadequate transport network
-Regional economic imbalances- GDP per head (2019, £)
London: £56,199
Northeast: £24,068
UK: £33,151
-Productivity Gap-In 2019, ranked on GDP per hour worked, the UK came fourth highest out of the G7 countries. UK productivity 15% below the US & France
What is the likely impact of a government deficit on the circular flow of income
Budget deficit refers to government spending which is greater than government revenue ie from taxation. The budget deficit is a net injection as there is more money flowing around the circular flow, therefore AD increases
Output Gap
The output gap is the difference between the actual level of GDP and its estimated potential level.
The output gap is usually measured as a percentage of the level of potential output.
Negative Output Gap
-A negative output gap refers to a situation where an economy’s actual output or real gross domestic product (GDP) is below its potential output.
-Potential output represents the level of production an economy can achieve when all resources (labour, capital, technology) are fully employed without causing inflationary pressures.
-When actual output falls below this potential level, it results in a negative output gap.
-A negative output gap often corresponds to higher unemployment and under-utilized resources. It might also lead to disinflationary effects
Positive Output Gap
-In economics, a positive output gap refers to a situation where an economy’s actual output or real gross domestic product (GDP) exceeds its potential output.
-Potential output represents the level of production an economy can sustainably achieve when all available resources (labour, capital, technology) are fully utilized without causing inflationary pressures.
-When actual output surpasses this potential level, it results in a positive output gap. This can lead to rising demand-pull and cost-push inflationary effects. Unsustainable, LRAS is when fully utilised at a sustainable level, e.g. employment may be over used, over exhausted resources.
Multiplier Process
- The multiplier effect happens where an initial change in spending, whether it’s from consumers, businesses, or the government, leads to a larger and more widespread final impact on an economy’s total output or income.
*The multiplier effect illustrates how changes in spending can create a ripple effect throughout the economy, generating additional rounds of economic activity. - When an individual increases its spending, the recipients of that spending then have more income, which they, in turn, spend on goods and services.
- This creates additional demand, which prompts businesses to increase production and hire more workers, resulting in higher factor incomes.
Multiplier Process Examples
The government injects £200m in a project to build thousands of affordable new houses. This is an expansionary fiscal policy designed to stimulate aggregate demand and economic growth.
-A new house building project injects £200m of extra demand and output into the economy
-Many businesses benefit directly including building supply industries, architects etc.
-Constructing new houses generates a new flow of factor incomes - including wages and profits
-Will the extra incomes stay inside the circular flow of income and spending? This is key!
-If so, the multiplier effect is likely to be strong and resultant final impact on GDP quite large
The Multiplier
The multiplier is defined as the final change in equilibrium national output resulting from an initial change in AD.
Positive Multiplier effect
when an initial increase in an injection ( or a decrease in a leakage) leads to a greater final increase in the level of real GDP
Negative Multiplier effect
When an initial decrease in an injection (or an increase in a leakage) leads to a greater final decrease in the level of real GDP.
Formula for the multiplier in a closed economy with no government
Multiplier = 1 / marginal propensity to save
-we know that the MPTC and TS must equal 1
-Disposable income can be spent or saved
-MPS + MPC = 1, therefore MPS = 1- MPC
-therefore the multiplier formula can be written as:
Multiplier = 1 / (1-MPC)
Formula for multiplier in open economy with a government sector
Multiplier = 1 / MPS + MPM + MRT
In an open economy with a government sector, there are 3 withdrawals from the circular flow:
1. Savings ( marginal propensity to save)
2. Imports ( marginal propensity to import)
3. Taxation ( marginal tax rate on income)
What Factors Affect the Multiplier value
*Marginal Propensity to Consume (MPC): A higher MPC leads to a larger multiplier effect because a greater proportion of any initial increase in income is spent, leading to multiple rounds of increased spending and output.
*Leakages: Leakages from the circular flow, such as saving, taxes, and imports, reduce the size of the multiplier. If people save a significant portion of their additional income, or if a substantial portion of the increased spending leaks out of the economy in the form of taxes or imports, the multiplier effect will be smaller.
*Degree of Spare Capacity: If an economy is operating close to its full potential (with little
spare capacity), the multiplier effect might be limited.
* Time Frame: In the short run, factors like capacity constraints and rigidities in adjusting production can limit the multiplier’s size. In the long run, adjustments in production capacity, investments, and resource allocation can lead to a larger multiplier effect.
High and Low values for the multiplier
High Multiplier value when:
-Economy has plenty of spare capacity (a
negative output gap) to meet higher
aggregate demand
-Marginal propensity to import and tax is low (important leakages)
-High propensity to consume any extra
Income (people have a low marginal propensity to save)
Low multiplier value when:
-Economy is close to capacity limits during a boom phase of an economic cycle
-Propensity to import goods and services is high- this means extra demand leaks from circular flow
-Higher inflation causes rising interest rates which then dampens the other components of AD
Multiplier and elasticity of Aggregate supply
When SRAS is highly elastic, the multiplier effect is likely to be
high following an increase in an injection of demand.
When SRAS is inelastic, it is
harder for supply
to expand to meet a rising level of AD
Economic growth
Economic growth is defined as the increase in the real value of goods and services produced as measured by the annual percentage change in real Gross Domestic Product (GDP).
Economic growth is also defined as a long-run increase in a country’s productive capacity / potential national output.
Actual growth
Actual growth refers to the real increase in an economy’s GDP over a specific period. Actual growth reflects the economy’s current performance and considers factors such as changes in consumer spending, business investment, government spending, and net exports
Potential growth
Potential growth refers to the economy’s maximum sustainable rate of expansion without generating inflationary pressures. Potential growth is determined by the economy’s productive capacity, which is influenced by factors such as technological progress, labour force growth, and capital accumulation
Potential Output
Potential output refers to an economy’s productive capacity in a physical sense. It is the largest output that could be produced, given the prevailing state of technology and stock of available resources. An increase in potential output signifies long-run economic growth.
Trend growth
Trend growth is the long term non-inflationary increase in GDP caused by an increase in a country’s productive capacity. The trend rate of economic growth is the average sustainable rate of economic growth over time
Drivers of short term economic growth
-Expansionary monetary policy such as lower interest rates and quantitative easing
-Expansionary fiscal policy including direct & indirect tax cuts and increased government spending and borrowing
-Depreciating exchange rate helping to boost exports of goods and services (X)
-Strong growth of asset prices such as property and shares
-Expanding employment and rising real incomes for those in work
-Improved business confidence driving higher capital investment
-Increased export sales from a boom / recovery in countries that are major trade partners perhaps aided by free-trade deals
Short term economic growth- key factors
-Changes in interest rates set by the central bank
-Commodity prices such as oil, gas and food
-Currency changes affect demand for exports and imports
-Confidence of businesses and households
-Recovery from an external shock such as the pandemic
-Fiscal policy- changes in government spending and taxation
How to show short term growth
-Shifts within the PPF graph
-Shift of AD along SRAS on AD-AS graph
Long term economic growth
Long-run growth is a sustained increase in a country’s productive capacity.
Long-run economic growth implies a consistent and prolonged expansion of an economy’s output, rather than short-term fluctuations or temporary increases in economic activity.
The main drivers of long-run growth are improvements in productivity and a growing labour supply alongside the benefits of technological change
Long-run growth can include shifts in the composition of industries, improvements in technology, increased human capital, and advancements in a country’s essential infrastructure.
Long term economic growth- key factors
-Investment in capital including essential infrastructure
-Improved labour productivity
-A growing labour supply
-Higher research and development spending
-Growth that flows from successful innovation
- Enterprise- a growing number of business start-ups.
Main drivers of long run economic growth
-Impact of a rise in investment which can increase a nation’s productive capacity
-Expanding population and active labour supply – perhaps due to net inward migration
-Rise in labour productivity such as an increase in GDP per hour worked
-Growth spillovers (benefits) from invention and innovation
-Growth spillovers from increased government spending on public goods and other essential infrastructure
-Growth potential from business start-ups / entrepreneurship
-New resource discoveries including natural resources
How to show long run economic growth
Shift in PPF outwards
Shift in LRAS to the right on AD-AS graph
Outward shift of AS on Keynesian aggregate supply curve
Main benefits of Economic Growth
1.Higher living standards – i.e. Real GNI per capita – helps to lift people out of extreme poverty and improve development outcomes (e.g. rising HDI)
2.Employment effects – sustained growth stimulates jobs and contributes to lower unemployment rates which is turn helps to reduce income inequality.
3.Fiscal dividend – higher economic growth will raise tax revenues and reduce government spending on unemployment & poverty related welfare benefits
4.Accelerator effect - rising growth stimulates new investment e.g. in low-carbon technologies. Better growth may attract foreign direct investment projects
Main Costs of Economic Growth
1)Risks of higher inflation and higher interest rates
-Fast-growing demand can lead to demand-pull and cost-push inflation – this leads to a conflict between macro objectives
-The central bank may decide to raise interest rates to control inflation
2)Environmental effects
-More negative externalities such as pollution & waste
-Risk of unsustainable extraction of finite resources – i.e. fast growing countries may cause a long-run depletion of natural resources
3)Inequalities of income and wealth
-Rapid increases in real national income can lead to a higher level of inequality and social divisions
-Many of the gains from growth may go to only a few people
export led growth
Export-led economic growth is a development strategy in which a country focuses on increasing exports as a driver of expansion.
This approach involves producing goods and services that can be sold in international markets, with the goal of earning foreign exchange and stimulating economic activity.
The revenue generated from exports can then be used to finance imports, invest in infrastructure, and support domestic industries
High Trade to GDP ratios
A substantial number of countries have a high trade-to-GDP ratio. This ratio measures the combined value of exports and imports of goods and services, expressed as a % of their national output.
Ireland 227%
Singapore 337%
In 21/22
Key features of Export led growth
Specialisation: Countries often specialise in producing goods and services in which they have a comparative advantage. This means they focus on producing items that they can produce more efficiently or at a relatively lower unit cost compared to other countries.
Foreign Exchange Earnings: By exporting, a country earns foreign exchange, which can be used to pay for imports, service external debt, and fund development projects.
Economies of Scale: Export-led growth can lead to economies of scale, where increased production and exports allow firms to achieve lower average costs and higher efficiency.
Technology Transfer and Innovation: Engaging with international markets can expose domestic firms to new technologies and innovation, fostering growth and competitiveness.
Job Creation: As export-oriented industries expand, they create job opportunities in manufacturing, services, and related sectors. There are positive export multiplier effects.
Examples of export led growth
China: Since the late 20th century, China has become the “world’s factory,” exporting a wide range of goods, including electronics, textiles, and manufactured goods.
South Korea: South Korea adopted an export-led growth strategy in the mid-20th century, focusing on electronics, automobiles, and steel. This strategy played a significant role in the country’s transformation from low-income to high-income one.
Taiwan: Taiwan’s export-led growth focused on electronics, textiles, and manufacturing. This approach helped the country achieve rapid economic development.
Vietnam: In recent years, Vietnam has experienced rapid economic growth driven by export-oriented industries like textiles, electronics, and agriculture.
Risks from dependency on export led growth
Vulnerability to External Shocks: When a country’s economy is heavily dependent on exports, it becomes susceptible to changes in global demand and economic conditions.
Dependence on (volatile) Commodity Prices: Exporting commodities like oil, minerals, or agricultural products exposes a country to fluctuations in global commodity prices, which can lead to government revenue volatility and big changes in the net trade balance
Currency Appreciation: Rapid export growth can lead to currency appreciation, making a country’s exports less competitive and imports cheaper
Lack of Diversification: Overreliance on a few key industries or markets can leave a country vulnerable to changes in those sectors or markets.
Environmental Concerns: Export-oriented industries might prioritize production over environmental sustainability, leading to resource depletion and environmental degradation.
Main Benefits of sustained economic growth
-Increased Standard of Living: Economic growth often leads to higher per capita incomes, which in turn can improve the standard of living for a nation’s citizens
-Job Creation: Economic growth can help reduce unemployment rates and provide individuals with greater financial stability.
-Reduced Poverty: Economic growth increases access to education, healthcare, and necessities. Many fast-growing countries have made important progress in reducing extreme poverty and improvements in human development outcomes. (HDI Index)
-Increased Government Revenue: A growing economy generates higher tax revenues that can then be used to fund better public services such as education & healthcare.
-Investment Opportunities: Growth attracts domestic and foreign investment leading to innovation, increased productive capacity (LRAS), and further job creation
Main costs of sustained economic growth
-Inflation: Rapid growth can lead to demand-pull and cost-push inflation. If aggregate supply cannot keep up with demand, prices may rise, eroding real purchasing power and potentially leading to economic instability.
-Resource Depletion: Fast growth of GDP can lead to overexploitation of scarce natural resources, such as water, minerals, and energy sources. This can have long-term environmental consequences and compromise sustainability.
-Income Inequality: Rapid growth doesn’t always guarantee equitable distribution of wealth. Benefits of growth may disproportionately accrue to certain segments of the population, leading to increased inequality as measured by the Gini Coefficient.
-Financial Instability: if rapid growth is fueled by excessive borrowing and speculative investment, this can result in financial bubbles and subsequent crashes.
positive impact on current living standards
Increased Income and Employment: Rapid economic growth often leads to higher levels of employment and increased wages and income for individuals.
Improved Infrastructure and Services: Economic growth can provide governments with more resources to invest in infrastructure such as roads, bridges, public transportation, and utilities.
Technological Advancements: Rapid economic growth often promotes research and development that can improve the quality of life through innovations in healthcare, communication, transportation, and more.
Reduced Poverty: Growth can lift many families out of poverty by creating opportunities for income generation and improving access to necessities.
Why growth can threaten living standards
Environmental Concerns: Rapid economic growth can lead to increased resource consumption and pollution if not managed carefully. Balancing economic growth with environmental sustainability is crucial for ensuring that future generations have access to clean air, water, and natural resources.
Income Inequality: If not properly managed, rapid economic growth can exacerbate income inequality. It’s important to have policies in place that ensure that the benefits of growth are fairly distributed across all segments of society.
Inflation: Rapid growth can lead to higher inflation and threatens real living standards. The impact of high inflation often falls more heavily on families on below-average income leading to an increase in relative poverty.
Environmental limits to economic growth
Resource Depletion: Growth often requires increased consumption of natural resources such as minerals, fossil fuels, and forests. These resources are finite, and as they are extracted and used, their availability diminishes.
Climate Change: The adverse effects of climate change, including extreme weather events, rising sea levels, and disruptions to ecosystems, can limit growth potential and often hit poorer countries that are less able to cope with the impact of climate-change related disasters.
Biodiversity Loss: Economic activities can lead to habitat destruction, pollution, and other factors that contribute to the loss of biodiversity. Biodiversity is essential for ecosystem stability, resilience, and the provision of ecosystem services that support human well-being.
Water Scarcity: As demand for water increases due to population growth and economic activities, many regions are facing water scarcity. Industries, agriculture, and households all compete for limited water resources, which can constrain economic growth and lead to conflicts.
Main characteristics of a recession
Falling real GDP- one of the primary indicators of a recession is a sustained decline in a country’s GDP over at least 2 consecutive quarters ( 6 months). During a recession, economic output shrinks as businesses produce less, consumers spend less and investment declines.
Rising unemployment- During a recession, there is usually a notable increase in the unemployment rate as businesses reduce production and cut back on hiring, leading to job losses and a rise in cyclical unemployment
Disinflation- In a recession, falling demand and a weaker labour market often lead- perhaps with a time lag- to a reduction in the rate of price inflation.
Reduced business investment- Businesses tend to scale back their investment during a recession because of weak or falling demand.
Great Depression in the US
1929
-Duration of depression- 43 months
-Fall in real GDP from peak to trough- 26.5%
-Industrial production fell by 45%
- Increase in unemployment- 24.6%
-Stock prices fell by over 80%
Economic and social effects of a recession
-Fall in confidence- a drop in animal spirits
-Rising cyclical unemployment
-Lower rate of inflation- with risk of deflation
-Rising fiscal deficit for the government
Economic recovery
An economic recovery is the phase of the business cycle that follows a recession. It may take several years for national output to recover to where it was before a recession
There is no single cause of recovery . Monetary and fiscal policy decisions are important so too economic event in other countries
Recovery can come from:
-Cuts in interest rates (monetary policy)
-One or more types of fiscal stimulus
-A rebound in business and consumer confidence
Demand and supply side economic shocks
-Demand side and supply side shocks are two different types of economic disturbances that can impact an economy’s equilibrium. These shocks can lead to changes in various economic indicators such as prices, output and employment
An example of a demand side shock is a financial crisis which reduces consumer and businesses confidence can lead to a sharp decline in spending, causing a demand side shock
An example of supply side shocks is a sudden unexpected rise in commodity prices. Rapid increase in the price of essential commodities can affect production costs and AS
Demand and supply side economic shocks examples
-Global financial crisis 2007-9
-Pandemics such as COVID
-Volatile world commodity prices
-Chinese economic slowdown
-Creeping protectionism/ import controls
-Currency volatility and policy changes such as devaluation
-Extreme weather e.g. droughts
-Geo- Political uncertainty and terrorism
Moving up the Kuznets curve
-Rapid Industrialisation- heavy industries are often energy intensive
- Increased emissions from urbanisation
-Relatively weak environmental laws and pollution regulations
-Many low income countries have limited technology/ infrastructure
-heavy reliance on dirtier fuels such as coal
Moving down the Kuznets curve
Innovation leads to scaled application of cleaner production techniques
Tougher environmental laws- emission zones, clean air acts/ greater awareness
Government policy interventions such as carbon taxes and carbon trading
Change in structure of GDP away from heavy industry towards services
Emergence of policies / capabilities to promote smart urbanisation
Sustainable growth
Sustainable economic growth seeks to achieve long term prosperity while also considering the well being of current and future generations as well as the health of the environment
Unlike traditional economic growth, which can often be associated with resource depletion, environmental degradation and social inequalities, sustainable economic growth aims to balance economic progress with social equity and environmental stewardship.
Environmental stewardship promotes resource efficiency, pollution reduction and the conservation of ecosystems
Threats to sustainable growth
-Waste from production and consumption
-Pollution and increasing climate change risks
-Depletion of national capital
-Loss of biodiversity
Raworths Doughnut model
Inner circle- Social foundation- our basic needs
Outer circle- ecological ceiling
If we stay between these two limitations we are in the safe and just space for humanity
Economic Scarring (hysteresis)
Economic scarring refers to the medium-long term damage done to the economies of one or more countries following a severe economic shock which then leads to a recession.
Scarring can happen for a number of reasons:
* Fall in investment leading to an ageing of the existing capital stock
* Rise in long-term unemployment and economic inactivity
* Increase in business failures
*Shrinkage in the capacity of financial system to lend
Stages of an economic cycle
Boom- A period when the percentage rate of growth of real GDP is fast and higher than the long-term trend
Slowdown- A weakening of the rate of growth, real GDP is still rising but increasing at a slower rate
Recession- A period of at least six months when an economy suffers a fall in aggregate output, employment, investment and business / consumer confidence
Recovery- A phase after a recession, during which reai GDP scars to increase and unemployment begins to fall
Depression - A prolonged downturn in the economy and where a nation’s real GDP falls by at least 10 per cent
Depression vs Recession
A depression is a persistent and severe downturn in output and jobs where an economy operates well below its productive potential and where there can be powerful deflationary forces at work.
Harvard University economist Robert Barro defines it as a decline in per-person economic output or consumption of more than 10%.
Many economic historlans say the line between recession and depression is crossed when unemployment rises above 10% of the labour force and stays there for several years
Demand side shocks
Economic downturn in a major trading partner
Unexpected tax increases or cuts to welfare benefits
Financial crisis causing bank lending
/credit to fall
Bigger than expected rise in
unemployment rates
Supply side shocks
Steep rise in oil and gas prices or other commodities
Lock-down due to the coronavirus pandemic
Natural disasters causing sharp fall in
production
Unexpected breakthroughs in production technology
Key principles of the circular economy
Design for Longevity: Products are designed to have longer lifespans, using durable materials and considering repairability and upgradability.
Closed-Loop Systems: In closed-loop systems, products and materials are recycled, remanufactured, or repurposed rather than disposed of.
Renewable Energy: Clean energy reduces environmental impacts and contributes to a more sustainable system.
Sharing and Collaborative Consumption: Sharing platforms and collaborative consumption models reduces demand for new products and minimizes waste.
Regeneration of Natural Systems: Aim is to regenerate ecosystems and support biodiversity through sustainable land use and resource management.
Policies to promote sustainable growth
Carbon taxes (a tax per tonne of carbon)
Carbon trading schemes (permits / credits for pollution)
Tougher environmental regulations such as plastic bans
Spending to protect bio-diversity (marine reserves)
Subsidies for scaling up clean energy generation
Investment in sustainable technologies such as off grid solar
Tax relief on research and development initiatives
Stages of the environmental kuznets curve
Low-Income Stage: In the early stages of economic development, countries tend to focus on growth and industrialization. This often involves increased pollution, and degradation of natural ecosystems - environmental quality deteriorates.
Middle-Income Stage: As economic growth continues, the negative impacts on the environment tend to peak. At this point, environmental degradation may be at its worst due to increased industrial activity, urbanization, and consumption.
High-Income Stage: Beyond a certain level of income, the theory suggests that societies become more concerned about environmentar issues. They start investing in cleaner technologies, adopting stricter environmental regulations, and promoting sustainable practices. Environmental quality begins to improve despite ongoing economic growth.
The Environmental Kuznets Curve (EKC) suggests a non-linear relationship between environmental degradation and economic development. It’s named after the economist Simon Kuznets.
The Environmental Kuznets Curve posits that as a country’s economy grows, environmental degradation initially worsens, but after reaching a certain level of economic development, environmental quality starts to improve.
In other words, the relationship between environmental degradation and income follows an inverted U-shaped curve.
Multiplier Ratio
This is the ratio of a change in real income to the initial injection that brought it about. For example, if a £2M injection in to the circular flow brought about by government spending caused a £4M increase in national income then the value of the multiplier would be 2.
Income vs wealth
income refers to the money an individual earns through work, investments, or other sources. It’s often measured over a period of time (e.g., weekly, monthly, yearly). Wealth, on the other hand, refers to the total value of a person’s assets (such as property, investments, and cash) minus their debts
Characteristics of a Boom
When economy is at its peak (the boom), national income is high and the economy
is likely to be working above PPF where there is a positive output gap .
Consumption and investment tend to be high as are tax revenues, and wages will be
increasing. Usually, the country will increase imports to meet the demand of
high-income consumers that cannot be met by the goods produced within the
country. There will also be inflationary pressure .
Impact of economic growth on Consumers
There will be an increase in demand for housing as people have more money and so
are able to afford to buy properties, which will increase house prices. Shares are
likely to increase in value as businesses are making more money and future prospects are good. The rising prices of shares and housing will increase wealth and lead to positive wealth effect .
● Improved productive efficiency due to better technology could lead to lower pricesor higher quality goods .
● Some argue that increased economic growth will lead to increased happiness , but
this is not necessarily the case.
● On the other hand, economic growth could lead to increased inequalities and so
may not have any effect on the average consumer and may lead to inflation , which
has negative effects for consumers.
Impact of economic growth on Firms
● Investment will increase since businesses are more successful. They will have more
money to invest and more incentive to invest as they will know they can make money
from their investments.
● Business confidence will improve as there are potential demand increases for
businesses’ products and this confidence will also lead to increased investment.
● As a result of increased investment from both businesses and governments,
technology will improve. There will be more research and development done to invent
more technology and more firms will be able to have the best technology, which is
likely to increase productive efficiency and lead to lower costs.
● The combination of higher demand and lower costs is likely to lead to higher profits.
● Economic growth also provides the opportunity for new firms to establish
themselves and allows existing ones to make more profit.
● On the other hand, firms who sell inferior goods (with negative income elasticities)
may lose out. Changing technologies and globalisation also mean that some firms
find their markets disappearing e.g. DVD rental stores.
Impact of economic growth on The government
● Tax revenues will rise as more goods and services are being bought, more income
is being earnt and more profits being made. This means the government has more
money to put into the NHS, education, benefits etc.; the quality of these systems will
be improved, and this will help to improve living standards .
● It can help to reduce the budget deficit, perhaps even bringing about a budget
surplus which would allow money to be saved for future recessions.
● However, economic growth tends to mean people expect more from the
government i.e. better education, better roads etc.
Impact of economic growth on Current and future living standards
Economic growth will result in lower poverty levels . An increase in the production of
goods and services will increase jobs so there will be less unemployment and less
people on benefits. Wages are also likely to increase.
● There will be more goods and services for people to enjoy , so the poor will be
able to get the goods and services they need instead of only the rich getting what
they want.
● Housing standards and the quality of food increases due to economic growth.
Health also tends to increase: not only does life expectancy rise but people have a
higher quality of life in their old age.
● Increased government spending will lead to improved living standards both now
and in the future, as better educated people usually have higher living standards.
● Economic growth is likely to have the highest benefits in developing countries.
● However, there could be decreased future living standards due to exploitation of the
environment. A rise in income means more people have access to electricity etc.
and use it more freely. This causes depletion of non-renewable resources, concern
about sustainability of growth for future generations and increased levels of
pollution/waste/congestion.
● On the other hand, it could be argued that people with higher incomes are able to
buy cleaner fuels and richer countries can devote resources for research and
development of cleaner resources and ‘greener’, more efficient technology. Also,
higher income households tend to have less children which lowers natural rate of
population growth, meaning less resources are needed for the future.
● Another cost may be that economic growth may result in increased inequalities
between rich and poor. The rich may be the only ones that have gained from the
economic growth and they may even lower the living standards of the poor by
exploiting the poor.
