A* notes on 2.5 economic growth. Detailed notes to enable you to understand and be able to apply the knowledge into essays
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2.5.1- Causes of growth
2.5.2 - Output gaps
2.5.3 -Trade (b...
Economic Growth 2.5
Economic growth- measures the rate of change in a country’s output. An expansion of the productive potential of an
economy. Increase in Real GDP
Short run economic growth- the actual annual percentage change in real national output (Real GDP)
Long run economic growth- an expansion in the potential productive capacity of the economy
Actual economic growth- short run growth caused by increased real GDP
Potential economic growth- long run growth caused by increased productive potential
Migration- the movement of people from one country to another
Export led growth- economic growth caused by rises in net exports
Output gap- the output gap is the difference between the trend rate and actual rate of economic growth
Trend rate- the trend rate of economic growth is the average rate of growth of GDP is over time. It shows the potential
output of an economy
Potential output- potential output occurs when the economy is working at full capacity over the long term. This occurs
when all factors of production are working efficiently
Positive output gap- occurs when the actual rate of economic growth is above the long run trend rate. This happens
during periods of high economic growth and is associated with inflationary pressure and low unemployment
Negative output gap- occurs when the actual trend rate of economic growth is below the long run trend rate. This
happens during periods of low or negative economic growth and is associated with deflationary pressure and high
unemployment
Trade cycle- variations in the level of productive capacity of an economy over time
Productive capacity/ productive potential- the maximum amount of goods and services that we can produce with the
resources we have available
GDP- the value of goods and services produced in the economy over a period of time
Boom- a period of high levels of economic activity
Recession- the rate of economic growth starts to fall in a downturn. Two consecutive quarters of negative real GDP
Slump- the bottom of the business cycle which represents a period of serious economic decline. Low or negative economic
growth.
Recovery- when there are often signs that economic growth is starting to rise often referred to as the green shoots of
recovery
, Causes of short run economic growth
A cut in interest rates:
i. Will reduce the cost of borrowing, reducing the opportunity cost of doing so. Upon borrowing the disposable
income consumers have increases allowing them to spend more. This will increase consumption shifting AD to
the right AD1 to AD2.
ii. Reduce the rate of return on savings. This reduces the incentive to save and increases the incentive to spend.
The savings ration in the economy will decrease with more consumer spending taking place. Increases C, AD1 to
AD2
iii. Reduces the monthly payments for those with tracker or variable rate mortgages. Monthly, these homeowners
will receive a boost to their disposable income, increasing the marginal propensity to consume thus boosting
consumption in the economy- AD right AD1 to AD2
iv. Reduce the cost of borrowing for firms, enabling them to reach their hurdle more easily (the required rate of
return for investment projects to go ahead). This increases the marginal propensity for firms to invest
increasing I in the AD equation – shift right
Governments could reduce the marginal rate of income tax for those in lower incomes tax banks or increase the
income tax free allowance. This would increase the disposable income for those on lower incomes. Consumers – higher
MPC, consumption would increase in the economy increasing AD
Reducing the level of corporation tax- increases retained profits, easier to finance investment, increasing MPI. AD
increases shifts right
Government can boost spending, infrastructure, education, healthcare, public sector wages etc. as G is core
component of AD- sig increase AD and generate large multiplier effect in the economy whereby initial increase in
spending will increase incomes in the economy facilitating further rounds of spending and income generation. End
result = greater final increase in AD
The exchanges rate could be weakened- this could happen for example by reducing interest rates (increase hot money
outflows), increasing the money supply or selling domestic currency reserves. WIDEC- economic theory suggests the
demand for imports and therefore expenditure will decrease whereas the demand for exports and thus revenue
generated by exports will increase. Both effects will lead to an improvement in the trade balance of the CA and reduce
a CA deficit or move it to a surplus. AD will rise AD1 to AD2
Actual growth increases from Y1 to Y2. As with greater demand in the economy, firms will increase output exhausting
spare capacity; Y2 is now closer to the FE level of output. This increase in output in an increase in Real GDP- increase in
economic growth.
Actual and potential growth:
§ The actual growth is the percentage change in GDP- economy is actually producing more goods and services.
§ Potential growth is the change in productive potential of the economy over time, so the LRAS or PPF curve
shifts.
The productive potential is determined by the factors of production - so potential growth means there have been
resources discovered or more technology developed that will allow the economy to grow more. They have not yet
produced the extra goods and services so GDP hasn’t grown. The difficulties in measuring productive potential means
changes in GDP are used as a measure of growth.
The PPF shows the potential output of the economy. An outward shift of the PPF is economic growth. If the economy
moves from inside the PPF to on the PPF, this would be classed as economic recovery rather than economic growth.
However, again, it is difficult to know where the PPF of an economy is and so economists tend to treat all increases in
real GDP as economic growth
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