Economic Growth

AS Economics

What is economic growth?

• EG is growth in the productive potential of the economy

• Typically measured by GDP (gross domestic product)

• Actual GDP can be above or below the productive potential of an economy (the trend line)

Trend and actual output

Trend and actual output with negative and positive output gaps

Business/Economic Cycle• The business cycle is characterised by four main phases:• Boom: high levels of consumer spending, business confidence, profits and

investment. Prices and costs also tend to rise faster. Unemployment tends to be low as growth in the economy creates new jobs

• Recession: falling levels of consumer spending and confidence mean lower profits for businesses – which start to cut back on investment. Spare capacity increases + rising unemployment as businesses cut back and reduce stocks

• Slump / depression: a prolonged period of declining GDP - very weak consumer spending and business investment; many business failures; rapidly rising unemployment; prices may start falling (deflation)

• Recovery: things start to get better; consumers begin to increase spending; businesses feel a little more confident and start to invest again and build stocks; but it takes time for unemployment to stop growing

Economic Cycle TableBoom Recession Slump Recovery

Output Increase Down Really down Slight rise

Confidence Increase Down Bad Getting better

Unemployment Down Up Really bad Stable but high

Investment Up Down Decrease Slow increase

Government spending

Down Up Really high Still high

Exports Increase Decrease Down Slow increase

Imports Increase Decrease Down Slow increase

Consumer spending

Increase Decrease Down Slow increase

Business failures

Decrease Increase Way up Stable

Interest rates Stable Drop/Low Really low Slow increase

Business/Economic Cycle

• The stages of the classic business cycle can be illustrated as follows:

A recession

• Economists have a ‘technical’ definition of a recession:

• Two successive quarters of negative economic growth

• This differs from a generic definition of a ‘recession’

Recessions in the UK

The UK Economy from 1971

Measuring GDP• http://www.bbc.co.uk/news/business-13200758

• How is GDP calculated?• Calculating GDP is a huge task• The output measure alone - which is considered the most accurate in

the short term - involves surveying tens of thousands of UK firms.• The main sources used for this are ONS surveys of manufacturing and

service industries.• Information on sales is collected from 6,000 companies in

manufacturing, 25,000 service sector firms, 5,000 retailers and 10,000 companies in the construction sector.

• Data is also collected from government departments covering activities such as agriculture, energy, health and education.

What is GDP?• GDP can be measured in three ways:• Output measure: This is the value of the goods and services

produced by all sectors of the economy; agriculture, manufacturing, energy, construction, the service sector and government

• Expenditure measure: This is the value of the goods and services purchased by households and by government, investment in machinery and buildings. It also includes the value of exports minus imports

• Income measure: The value of the income generated mostly in terms of profits and wages.

• In theory all three approaches should produce the same number (O = E = Y).

Nominal and real

• Nominal are prices which are not adjusted for inflation

• Real price are adjusted for inflation• Real prices are used more often as

comparisons are easier to make

Total and per capita

• Total GDP is the GDP of the whole country added together

• But to make comparisons, a per capita figure is better to make. This is total GDP divided by population

White Hill Lane The Valley

Total GDP 1,000,000,000 5,000,000,000

Population 2,000,000 2,000,000

GDP Per capita

Volume and value

• Real GDP is a measure of the volume of good and services provided – it is equal to the quantity produced in an economy

• The value of goods and services produced is volume x average price (you can work out the volume then by nominal GDP divided by price level)

Falling GDP

• If the rate of growth falls from 4.5% to 2.1%, this does not mean that the level of GDP is falling. Only when the figure is negative is GDP falling.

EG measuring standard of living

• Economic growth can measure the standard of living, and increases in the standard of living

• However it does not measure other things such as – Healthcare (and access to)– Literacy rates– Wellbeing– Access to water

FOP causing economic growth

• How can each of the FOP cause economic growth?

• Take each factor at a time and note how they could do this

FOP causing economic growth

• Land – use of land, new sources of energy• Labour – changes in workforce, net migration

increase, better education and training, flexibility in workforce

• Capital – investment in new machinery and buildings

• Enterprise – innovation and new technology, new (more efficient) ways of doing things

Inflation

Two types

• Cost push• Demand pull

Causes of cost push inflation

• Increase in price of raw materials• Increase in cost of wages• Increase in price of labour• Increase in profit margins• Increase in indirect tax e.g. VAT

Diagrammatic cost push inflation

SRAS

SRAS1

AD

Real GDPYY1

P

P1

Pri

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0

Demand Pull - Causes

• Consumer boom (high confidence more likely to buy)

• Increase in government spending• Net exports rise• Money supply growing faster than output

Diagrammatic effect of demand pull inflation (Keynesian)

AD

PP1

Pri

ce L

evel

AD1

Y Y1

LRAS

Real GDP0

Diagrammatic effect of demand pull inflation (New Classical)

AD

P

P1

Pri

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evel

AD1

Y

LRAS

Real GDP0

Costs of inflation

• Menu costs – changing price lists etc• Shoe leather costs – costs of moving money in

and out of different financial institutions• Admin costs – changing wages etc

• Unstable inflation causes uncertainty• Stable inflation creates confidence• High inflation causes exports to be less

competitive• Measure of inflation used in the UK is CPI• Inflation target is 2% (+/-1%)• Benefits of inflation – if demand is increasing

then productivity can be raised

Inflation

Inflation questions

①If you expect prices to rise by 20% next year, would you buy a new car now or wait until next year? Why?

②If you expect prices to fall next year would you buy the car now or wait? Why?

③Would you expect the government to want; (a) fast rising prices; (b) slow rising prices; (c) falling prices; and why?

Inflation questions

• For each of the 3 people, explain what the impact of rising prices (at 3.1%) would be for them

a)A pensioner. Their pension rises by 3.1% over the next year

b)A job seeker. Their income rises by 1% over the next year

c) A salaried worker who expects their income to rise by 4.5% over the next year

Measuring inflation

• CPI – Consumer Price Index – uses weighted price index to show changes

• CPI is known as HICP in rest of EU• Target for CPI is 2% +/- 1%• RPI – Retail Price Index – differs in

methodology and coverage from CPI

Deflation

• Only occurs when price level is negative• Can lead to a decline in output – consumers

put off purchases• Shares tend to fall as investors prefer cash

holding which rise in real value• Expectations – investment and consumption

suffer

Recent trends in inflation

Longer trend in inflation (RPI only)

Inflation around the world

Question 1

Real incomes rise wheneverA.nominal incomes riseB.the price level rises by more than nominal incomesC.nominal incomes rise by more than the price levelD.the rate of inflation slows down

Question 2

• The following table gives index numbers for a measure of an economy’s money national income, 2002–2006.

From the data it can be concluded that in the period 2002–2006 there must have been a fall inA.aggregate demandB.the size of the labour forceC.the rate of inflationD.the government’s budget deficit

Question 3 (hard)

• An economy had nominal GDP growth of 8% last year, inflation of 5.5% and population growth of 2.5%. The approximate percentage change in real GDP per capita was

A. –2.5B. 0C. +2.5D. +5.0