2.5 Economic Growth

• Economic growth is defined as the expansion of the productive potential of the economy
• What casues economic growth :

  • Improving the labour force, with better quality due to higher eduction
  • A larger labour force - due to migration, birth rates or improved participation rates
  • Improved technology -> more productive -> resources are used more efficiently
  • more investment
  • discovering new resources
  • incentives for enterprise,e.g. tax breaks or subsidies
• Actual growth is the percentage increase in a country's real GDP and it is usually measured annually. It is caused by increases in AD
• Causes of 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
• Land:

  • The discovery of new resources e.g. oil will increase economic growth
  • Developing countries tend to grow the most from exploiting new resources
  • Saudi Arabia has experienced large growth rates almost purely because of their discovery of oil
• Labour:

  • 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
  • Raising the retirement age will increase the population of working age
  • Quality of the workforce:
  • Improving the quality of labour is important in the long run
  • Improved education will improve labour quality and efficiency
  • More skilled workers contribute to new technology, business ideas, and innovation
• Capital:

  • Sustained investment allows access to new technology and improves productivity
  • More machines can be bought and used to increase production
• Enterprise:

  • Government tax benefits and grants encourage business development, creating jobs and increasing goods and services production
  • Wealth distribution affects incentive to work hard and invest, impacting economic growth
• Technological progress:

  • Improved technologies lower production costs and create new products for the market
  • Increased spending drives economic growth
• Efficiency:

  • Efficiency means less resources are needed to produce each good, allowing for more goods to be produced
  • Government can ensure efficiency by keeping up competition and protecting property rights
  • Lack of efficiency can result from government intervention or market failures
• Actual and potential growth:

  • Actual growth is the percentage change in GDP, while potential growth is the change in productive potential of the economy over time
  • The PPF shows the potential output of the economy, with an outward shift indicating economic growth
• Output gaps:

  • An output gap is the difference between the actual level of GDP and the estimated long-term value for GDP
  • A positive output gap is when GDP is higher than estimated, while a negative output gap is when GDP is lower than estimated
  • Output gaps are difficult to measure due to unknown LRAS position and inaccurate initial estimates of real GDP
• Aggregate demand and supply:

  • Output gaps can be illustrated using AS and AD diagrams
  • LRAS shows the full capacity output where all resources are fully utilised
  • Equilibrium to the right of LRAS shows the economy working over capacity in the short term, while to the left shows the economy working under capacity
  • Equilibrium is reached when AD=SRAS=LRAS
  • Negative output gap at AD1 when SRAS equilibrium is less than LRAS equilibrium
  • Positive output gap at AD2 when SRAS is higher than LRAS
• Trade (Business) Cycle:

  • Periodic up and down movements in economic activity
  • Four main phases: boom, downturn, recession (slump), and recovery
  • Characteristics of a boom:
  • National income is high
  • Economy is likely working above PPF with a positive output gap
  • Consumption, investment, tax revenues, and wages are high
  • Inflationary pressure increases
  • Characteristics of a recession:
  • High unemployment
  • Low consumption, investment, and imports
  • Low inflationary pressure or deflation
  • Recovery/expansion phase follows with increasing national income and output
• The impact of economic growth:

  Consumers:

  • Increased demand for housing and rising house prices
  • Shares likely to increase in value
  • Improved productive efficiency may lead to lower prices or higher quality goods
  • Economic growth may not necessarily lead to increased happiness
  • Increased economic growth may lead to increased inequalities and inflation
• Firms:

  • Investment increases with more successful businesses
  • Business confidence improves leading to increased investment
  • Technology improves with higher profits due to lower costs
  • Economic growth allows new firms to establish themselves
• The government:

  • Tax revenues rise with more goods and services being bought
  • Budget deficit may reduce or turn into a surplus
  • Expectations for better services increase with economic growth
• Current and future living standards:

  • Economic growth leads to lower poverty levels and increased jobs
  • More goods and services available for everyone
  • Housing standards, food quality, and health tend to increase
  • Increased government spending improves living standards
  • Economic growth benefits developing countries the most
• Costs of economic growth:

  • Exploitation of the environment
  • Increased inequalities between rich and poor
  • Depletion of non-renewable resources
  • Concerns about sustainability and increased pollution/waste/congestion