(2.5) Economic Growth

• Factors of production


  Land, labour, capital, enterprise
• An increase in quality or quantity of one of the four factors of production, or these being used more efficiently, is required for economic growth to occur
• Land


  The discovery of new resources e.g. oil will increase economic growth
• Labour


  An increase in the quality or quantity of labour will improve economic growth
• Size of the workforce

  • Changes can come from immigration, demography (age profile) of the country or participation rates
  • The more people of working age, the more growth there will be
  • Raising the retirement age will increase the population of working age
  • Government can encourage mothers to go back to work to increase participation rates
  • Immigration can provide workers with skills, knowledge and desire to work
• Quality of the workforce


  • Improving through education
  • More skilled workers are more efficient and less likely to suffer from structural unemployment
  • More skilled workers can contribute to change, new technology, business ideas, innovation
• Capital


  • Sustained investment allows access to or development of new technology, improving productivity
  • More machines can be bought and used, even if not technologically advanced, to produce more goods
• Enterprise


  • Tax benefits and grants encourage business development, creating jobs and increasing production
  • Too much wealth distribution reduces incentive to work hard and invest
• Technological progress


  Improves production efficiency and creates new products, increasing consumption and MPC
• Efficiency


  • Means less resources are needed to produce each good, so more goods can be produced
  • Government can ensure efficiency by maintaining competition
  • Market mechanism must be working properly, with protection of property rights and efficient capital markets
  • Civil wars, natural disasters, and excessive government intervention can reduce efficiency
• Actual growth


  Percentage change in GDP when the economy actually produces more goods and services
• Potential growth


  Change in productive potential of the economy over time, as determined by factors of production
• PPF


  • Shows the potential output of the economy
  • An outward shift of the PPF is economic growth
  • Moving from inside the PPF to on the PPF is economic recovery
• Export-led growth


  A rise in AD through increased exports can affect economic growth
• Long run trend rate of growth


  The average sustainable rate of economic growth over a period of time
• Actual growth


  The actual change in real GDP over time, making up the business cycle
• Output gap


  The difference between the actual level of GDP and the estimated long-term value for GDP
• Positive output gap


  GDP is higher than estimated
• Negative output gap


  GDP is lower than estimated, indicating spare capacity in the economy
• Output gaps are very difficult to measure due to unknown position of LRAS and inaccurate initial estimates of real GDP
• 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
• An equilibrium to the right of the LRAS


  Shows the economy working over capacity in the short term
• An equilibrium to the left of the LRAS


  Shows the economy working under capacity
• Economists believe they are so difficult to measure that they are not a valid concept to use from the purpose of economic policy
• Output gaps


  Illustrated using AS and AD diagrams
• LRAS


  Shows the full capacity output i.e. where all resources are being fully utilised
• Equilibrium to the right of the LRAS


  Shows the economy working over capacity in the short term
• Equilibrium to the left of the LRAS


  Shows the economy working under capacity
• At AD1, there is a negative output gap because the SRAS equilibrium is less than the LRAS equilibrium, so the full capacity of the economy is not being met
• At AD2, there is a positive output gap as SRAS is higher than LRAS
• Classical economists' view on output gaps


  • 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
  • Negative output gap would be brought back to equilibrium by rising AD or a fall in SRAS due to lower costs of production

  
• Trade (business) cycle


  Periodic but irregular up and down movements in economic activity, measured by fluctuations in real GDP and other macroeconomic variables
• Phases of the trade cycle

  • Boom
  • Downturn
  • Recession (slump)
  • Recovery
• Mild trade cycle


  GDP does not fall during recessions but instead doesn't grow by as much as the trend

  
• Extreme trade cycle


  GDP falls significantly during recessions
• During a boom, national income is high and the economy is likely to be working above PPF where there is a positive output gap
• During a downturn, output and income fall which leads to a fall in consumption and investment as well as tax revenues
• During a recession, there tends to be high unemployment causing low consumption, investment and imports
• In the UK, the government defines recession as where real GDP falls in at least two successive quarters
• As the economy moves out of a recession, it moves into a recovery/expansion phase as national income and output begin to increase with unemployment falling and consumption, investment and imports increasing