Unit 11

• Short run growth

  Percentage increase in a country's real GDP, usually measured annually, caused by increases in AD
• Long run economic growth

  Increase in the productive capacity of the economy, refers to the trend rate of growth of real national output, caused by increases in AS
• Potential output


  What the economy could produce if resources were fully employed
• Output gap

  Difference between the actual level of output and the potential level of output, measured as a percentage of national output
• Negative output gap

  Actual level of output is less than the potential level of output, puts downward pressure on inflation, indicates unemployment of resources
• Positive output gap

  Actual level of output is greater than the potential level of output, puts upward pressure on inflation, could be due to resources being used beyond normal capacity
• Classical economists believe markets clear in the long run, so there is full employment. They believe there are output gaps in the short run.
• Business cycle


  The stage of economic growth that the economy is in, goes through periods of booms and busts
• Business cycle stages

  1. Recovery (real output increases)

  2. Boom (fast economic growth, could be inflationary or unsustainable)

  3. Recession (real output falls, negative economic growth)

  4. Governments may increase spending to stimulate economy during recessions, decrease spending during booms
• Characteristics of a boom

  • High rates of economic growth
  • Near full capacity or positive output gaps
  • Near full employment
  • Demand-pull inflation
  • High consumer and business confidence, high investment
  • Improved government budgets
• Characteristics of a recession

  • Negative economic growth
  • Lots of spare capacity and negative output gaps
  • Demand-deficient unemployment
  • Low inflation rates
  • Worsened government budgets
  • Lower consumer and business confidence, less spending and investment
• Costs of economic growth

  • Does not benefit everyone equally, higher inflation, more shoe leather costs, diminishing returns to consumption
• Benefits of economic growth

  • Higher average consumer incomes, increased consumer confidence and living standards, improved firm profits and investment, economies of scale, more competition, improved government budgets
• Growth is sustainable when the rate of economic growth can be maintained in the long run, so future generations can enjoy the same rate of growth
• Unsustainable growth occurs around the boom and bust sections of the business cycle, these are deviations from the trend rate of growth
• Excessive growth can lead to inflation in prices, wages, and assets, excessive credit, and low savings rates
• Growth financed by public debt may not be sustainable, productivity improvements are more likely to lead to sustainable growth
• Asset price bubble

  Market bubble where the price of an asset rises significantly beyond its intrinsic value, then suddenly falls, causing panic and economic decline
• Destabilising speculation


  Speculation that leads to changes in price levels, as speculators buy assets expected to appreciate and sell assets expected to depreciate
• Animal spirits


  Instincts and emotions of human behaviour that drive the level of confidence in an economy
• Herding


  Reacting to the behaviour of other economic agents rather than the market, as some think others are better informed
• Claimant Count


  Counts the number of people claiming unemployment related benefits, such as Job Seeker's Allowance (JSA). They have to prove they are actively looking for work.
• Not every unemployed person is eligible for, or bothers claiming JSA. Those with partners on high incomes will not be eligible for the benefit, even if they are unemployed. Although there may be instances of people claiming the benefit whilst they are employed, the method generally underestimated the level of unemployment.
• International Labour Organisation (ILO) and the UK Labour Force Survey (LFS)


  Directly asks people if they meet the following criteria: Been out of work for 4 weeks, Able and willing to start working within 2 weeks, Workers should be available for 1 hour per week. Part time unemployment is included.
• Since the part time unemployed are less likely to claim unemployment benefit, the LFS method gives a higher unemployment figure than the Claimant Count.
• Voluntary unemployment


  Occurs when someone chooses not to work at the current wage rate. This could be encouraged if welfare payments are generous relative to real wages. A high income tax rate might also discourage people from participating in the labour market.
• Involuntary unemployment


  A person is willing and able to work at the current wage rate, but they cannot find work. It is usually cyclical, since it is caused by a fall in AD. Moreover, it occurs when there is an excess supply of labour, which 'sticky wages' are unable to correct. When an economy experiences involuntary unemployment, it is not operating at full employment.
• Consumers are unemployed

  They have less disposable income and their standard of living may fall as a result. There are also psychological consequences of losing a job, which could affect the mental health of workers.
• Firms have a higher rate of unemployment


  They have a larger supply of labour to employ from, causing wages to fall, which would help firms reduce their costs. However, with higher rates of unemployment, since consumers have less disposable income, consumer spending falls so firms may lose profits. Producers which sell inferior goods might see a rise in sales. It might cost firms to retrain workers, especially if they have been out of work for a long time.
• Workers are unemployed


  There is a waste of their resources. They could also lose their existing skills if they are not fully utilised.
• Unemployment rate increases

  The government may have to spend more on JSA, which incurs an opportunity cost because the money could have been invested elsewhere. The government would also receive less revenue from income tax, and from indirect taxes on expenditure, since the unemployed have less disposable income to spend.
• Unemployment rate increases

  There is an opportunity cost to society, since workers could have produced goods and services if they were employed. There could be negative externalities in the form of crime and vandalism.
• Economically inactive


  Those who are not actively looking for jobs. These could include carers for the elderly, disabled or children, or those who have retired. Some workers are discouraged from the labour market, since they have been out of work for so long that they have stopped looking for work.
• If the number of the economically inactive increases, the size of the labour force may decrease, which means the productive potential of the economy could fall.
• Structural unemployment


  Occurs with a long term decline in demand for the goods and services in an industry, which costs jobs. This is especially true of jobs in industries such as car manufacturing, where labour is replaced by capital (this is also called technological unemployment). Moreover, the decline of the coal and ship building industries in the UK, led to a great deal of structural unemployment.
• Structural unemployment is worsened by the geographical and occupational immobility of labour. If workers do not have the transferable skills to move to another industry, or if it is not easy to move somewhere jobs are available, then those facing structural unemployment are likely to remain unemployed in the long run.
• Frictional unemployment


  The time between leaving a job and looking for another job. It is common for there to always be some frictional unemployment, and it is not particularly damaging since it is only temporary.
• Seasonal unemployment


  Occurs during certain points in the year, usually around summer and winter. During the summer, more people will be employed in the tourist industry, when demand increases.
• Demand deficiency (cyclical unemployment)


  Caused by a lack of demand for goods and services, and it usually occurs during periods of economic decline or recessions. It is linked to a negative output gap. Firms are either forced to close or make workers redundant, because their profits are falling due to decreased consumer spending, and they need to reduce their costs. This then causes output to fall in several industries.
• Real wage unemployment

  Wages above the market equilibrium may cause unemployment. This is because the supply of labour exceeds demand. Classical economists argue that by letting wages fall to the equilibrium level, there would be no unemployment.