2.5 Economic growth

• What is 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 is an output gap?

  Difference between actual GDP and potential GDP
• What is actual growth?

  The increase in real GDP
• What is potential growth?

  The level of output that an economy could produce at a constant rate of inflation
• What factors will cause an increase in AD and cause economic growth?

  Increase in consumption, increase in investment, increase in government expenditure, increase in net exports
• What factors will cause an increase in LRAS and cause economic growth?

  Increase in investment, new technology, increase in net migration, supply-side policies
• What factors inhibit economic growth?

  Labour market problems, Absence of efficient capital markets, External constraints, Lack of access to funds for investment, Corrupt governments, Currency instability or an overvalued exchange rate, Poor quality human capital, Protectionism by other countries limiting free international trade
• When does a negative output gap occur?

  Occurs when actual growth rates are below potential growth rates
• When does a positive output gap occur?

  Occurs when growth rates are higher than the economy can sustain
• When does a peak occur?

  Occurs when an economy is working beyond full employment. However this is not sustainable in the long run as the economy will be overheating and the consequences will be inflation
• What is a recession?

  Two consecutive quarters of negative economic growth
• What is a boom?

  A period of rapid or prolonged economic growth
• What are characteristics of a boom?

  Low unemployment, Less underemployment, Increased living standards, Increased levels of investment, Increasing rate of inflation, Increasing income inequality
• What are characteristics of a recession?

  Rising unemployment rates, More underemployment, Falling living standards, Falling levels of investment, Falling rate of inflation, Increasing income inequality
• How do economic booms come to an end

  Rising inflation, Spending power of consumers begin to drop, Capital investment may decline, Asset price booms burst, Banks may become reluctant to lend
• What is the actual growth rate of economic growth?

  The rate at which real GDP changes from one year to another
• What is the long term trend rate of economic growth?

  The average rate of economic growth over several years
• What are benefits to economic growth?

  • Higher disposable income
  • Higher employment
  • HIgher profits for firms
  • Fiscal dividends for governments (increase in tax revenue)
• What are costs to economic growth?

  • Inflation
  • Income inequality
  • Environmental costs
  • Current account deficit
• What are points for evaluation discussing economic growth?

  • Sustainable growth
  • Inclusive growth
  • Balanced growth
  • Role for private/government sector
• What are benefits of growth on consumers?

  • Economic growth is associated with rising real incomes
  • Consumers are able to afford more goods and services leading to an increase in living standards
  • More real income means people can eat more healthier and increase life expectancy
• What are benefits of growth on firms?

  • With higher real incomes and increased demand for goods and services, firms are likely to benefit from increased profit
  • Shareholders are likely to enjoy increased returns
• What are benefits of growth to the government?

  • Due to the increase in real income, government tax revenue is rising as workers are paying more tax on their income, people are spending more so VAT revenues rise, firms pay more tax as profits are higher
• What are benefits on current and future living standards?

  • Economic growth can lift people out of poverty
  • Developing countries can gain foreign investment, foreign currencies can flow into an economy, and there is likely to be improvement in infrastructure of all types
• What are costs of growth on consumers?

  • Rapid economic growth could lead to an increase in the rate of inflation
  • If the rate of inflation is higher than the increase in wages, wages would fall
  • An increase in the rate of economic growth may be at the expense of working longer hours, so increasing stress for workers and consumers
  • Economic growth and rising real incomes might not increase subjective happiness after incomes have risen beyond a certain level
  • Economic growth may be associated with an increase in health conditions associated with higher incomes
• What are costs of growth on firms?

  • Rapid economic growth would cause a demand for workers and raw materials
  • This would cause an increase in wages and in the price of raw materials 
  • Firms’ costs would increase, which could reduce their profits
• What are costs of growth on the balance of trade?

  • Higher incomes mean that people can afford to import more, and the need for firms to export is no longer pressing, as higher profit margins can be made through selling at home rather than abroad. (Exports fall, imports rise and the balance of trade deteriorates)
  • If there is export-led growth then an improvement of the balance of trade is expected
• What are costs of growth on the distribution of income?

  • When the economy grows, those who benefit may be those who are already rich 
  • With continued growth, workers may lobby for higher incomes and the rewards may trickle down to those with lower pay 
• What are costs of growth on the environment?

  • With increased economic growth there is frequently an increase in external costs 
  • Higher incomes may mean that the government has more tax revenue to clear up environmental damage
• What are the costs of growth on current and future living standards?

  • Increasing the rate of economic growth may force an economy to forgo current consumption
  • Future living standards would increase as the PPF shifts to the right