macro 2.5 - economic growth

Question 1

economic growth?

Answer 1

economic growth —> an increase in real GDP in an economy in a year caused by an increase in AD or an increase in LRAS

what causes economic growth?
increase in Q^2 CELL/productive efficiency —> economic growth
- improvement in labour productivity (better education and skills) —> increases quality of labour —> LRAS shift right
- increase in investment (firms spending money on capital goods e.g. technology) —> increases quantity and quality of capital// LR COP for firms decrease —> productive efficiency increases —> LRAS shifts right
- increase in quantity of labour e.g. immigration and incentives like reducing benefits —> quantity of labour increases —> LRAS shifts right
- competition —> productive efficiency increases as firms want to reduce costs —> LRAS shifts right
- new resource discoveries —> quantity of land increases —> LRAS shifts right

Question 2

output gaps?

Answer 2

negative output gap- where actual output is less than potential output
positive output gap- where actual output is greater than potential output

Question 3

how is SR economic growth shown?

Answer 3

short run growth (actual growth):
- keynesian graph to show SR growth —> shift of AD from AD1 to AD2 —> increase in output from Y1 to Y2 —> shows that the economy is using up spare capacity and moving towards YFE
- PPF: point X and Y inside PPF curve —> actual growth = X// potential growth = PPF curve (PPF curve = YFE) —> negative output gap
- movement from inside the PPF towards the PPF curve (X to Y)—> shows that the economy is using up spare capacity to produce more of both goods and services

• increase in AD
  AD = C + I + G + (X -M)
• lower interest rates —> cheaper for consumers to borrow, cheaper for businesses to borrow to invest —> C + I will increase, lower interest rates can weaken the exchange rate —> (X - M) increases
• lower income/corporation tax —> more disposable income —> more consumer spending/ lower corporation tax —> more retained profit for firms —> more investment
• higher consumer/business confidence —> increase C + I
• higher government spending —> increase G
• weaker exchange rate —> (X - M) increases

Question 4

how is LR economic growth shown?

Answer 4

long run growth (potential growth) —> an increase in LRAS

• classical LRAS graph
  curve shifts from LRAS1 to LRAS2 —> YFE1 to YFE2
• PPF:
  PPF curve = LRAS curve
  curve shifts outwards from PPF1 to PPF2

what causes LRAS curve to shift?
- increase in quality/quantity of FOP, increase in productive efficiency
- improvement in labour productivity (better education and skills) —> increases quality of labour —> LRAS shift right
- increase in investment (firms spending money on capital goods e.g. technology) —> increases quantity and quality of capital// LR COP for firms decrease —> productive efficiency increases —> LRAS shifts right
- increase in quantity of labour e.g. immigration and incentives like reducing benefits —> quantity of labour increases —> LRAS shifts right
- competition —> productive efficiency increases as firms want to reduce costs —> LRAS shifts right
- new resource discoveries —> quantity of land increases —> LRAS shifts right

Question 5

business cycle

Answer 5

boom - (actual growth is higher than trend growth —> positive output gap)
- high profits, low unemployment, high consumer and business confidence, high demand for imports, rising tax revenues, demand pull inflation

recession - 2 successive quarters of negative growth
(between boom and trough)

trough - (actual growth is lower than trend growth —> negative output gap)

• declining AD, high unemployment, sharp falls in consumer/ business confidence, less investment, house prices fall due to high unemployment and less consumer confidence —> less spending and more saving, de-stocking and discounting, lower demand pull inflation, low demand for imports

recovery
- rising consumer/business confidence, higher house prices, higher investment, loose policy to prevent economy going back into recession

why are there fluctuations in actual growth?
- shocks —> unexpected and can’t be predicted

demand side
- sudden increase in interest rates, sudden cut in government spending, sudden strengthening of exchange rate, sudden house market crash, higher taxation rates

supply side
- natural disasters, wars, sudden increase in price of raw materials, sudden increase in wages, sudden increase in business taxes, sudden increase in exchange rate

Question 6

benefits/costs of economic growth on individuals, firms and government?

Answer 6

individuals:
- higher disposable income —> firms are making more profit —> higher wages for workers —> standard of living increases ✅
- higher employment —> economic growth —> more demand for goods and services —> employment increases (key economic objective) ✅
- inflation —> demand pull inflation —> erodes purchasing power —> living standards decrease ❌

firms:
- higher profits for firms —> if people are earning more then demand for goods/services will increase —> profits increase —> firms can invest in capital —> can trigger accelerator effect ✅
- high profits —> business confidence increases —> investment increases —> technology will improve —> COP decreases —> combination of higher demand and lower costs is likely to lead to higher profits ✅
- firms who sell inferior goods may lose out ❌

government:
- fiscal dividend for government (increase in tax revenue) —> income tax will rise as households are earning more income/ VAT revenue will rise as money is spent on goods and services/ corporation tax will rise as firms are making more profit —> government can improve public services ✅
- current account deficit —> income rise —> demand for imports increase —> import expenditure increases —> worsens current account deficit ❌
- income inequality —> if growth comes from 1 dominant sector, high incomes may be contained to that sector/ if growth comes from capital intensive production opposed to labour intensive production, high incomes contained to the owners of capital rather than the whole of the population/ if growth comes from urban areas opposed to rural areas then income divide/ jobs created from economic growth may be bad quality —> all of this will be made worse if there’s a lack of welfare state ❌
- environmental costs —> e.g. deforestation, air pollution and resource depletion —> NE in production ❌

evaluation- we want these things when economic growth occurs// how do we know if growth is good or not?

• we want sustainable growth —> growth without inflation or environmental costs
• we want balanced growth (not just from 1 dominant sector or one variable in the AD equation —> we want growth from a multitude of different sources so if sector goes into decline then growth can come from other avenues
• government —> ensure tax revenues are being used correctly, redistribution of income, policies to make sure environment isn’t destroyed