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Exam theory: Economics(Lecture 1)
GDP
What is economic growth?
Growth of production / income* in an economy, as measured by the change in Gross Domestic Product.
* Production = income, because what you spend on goods forms someone else’s income. (The total
value of production of a country or the total value of the income of that country). If GDP goes up,
production and incomes go up.
Why is economic growth / higher GDP important?
– It leads to more production, and therefore more employment
– It leads to more income, and therefore higher (consumption and) welfare. You can
afford your needs and wants, so hopefully you are happier (welfare).
– Governments receive more tax income to spend on public services
Are there bad sides to striving for a high GDP?
Periods of high growth create more instability in the market because prices will keep on rising and
uncertainty, so will eventually reduce growth. GDP only touches on things that you can put a money
value on, e.g. a forest is beautiful but isn’t worth something until its cut down. If you strive for maximum
production, you also strive for a lot of stress, a lot of pollution, global warming. If you maximise growth
in the short run, you sacrifice the planet in the long run.
Does high GDP always lead to high welfare?
It leaves out quality of social interactions, the quality of the environment, clean air, the value of your
free time.
Who spends money in the economy?
1) Consumers/households (CONSUMPTION)
2) Companies / producers (INVESTMENT)
3) Government (GOVERNMENT SPENDING)
4) Foreign countries (EXPORT-IMPORT)
How do you calculate GDP?
Add these four elements together to get GDP.
What factors influence economic growth?
,economic growth is impacted by changes in consumption, investment, government expenditures, and
import and export. If GDP has changed in a year and has gone up, then one of these have started
spending more.
How can a government stimulate growth? (not super important for exam)
There are two main theories (schools of economic thought).
> Stimulate the supply side (hands-off approach to the economy, let the market forces let sure
everything balanced out in the end)
> Stimulate spending (the Keynesian approach) (hands on, using gov expenditures to stimulate spending
side)
INTEREST RATES
What is an interest rate?
The cost of borrowing (or, conversely, the return on lending).
Expressed as a percentage. Determined by supply & demand of money, and also by the central bank as
its trying to stabilize prices in an economy.
What is a business cycle?
More or less regular (unpredictable) fluctuation of expenditures resulting in higher or lower economic
growth.
What we want is a stable as possible growth path upwards, so periods of high growth usually get
followed by periods of low growth which is disruptive. We try to make peaks flatter and troughs higher,
so the central bank aims for a stable inflation rate of 2%.
What is expansion vs recession of economic growth?
Expansions: large increase in expenditures (and therefore increase in production and GDP).
Recessions: low increase or even a decrease in expenditures.
, Describe inflation. What is the cause for inflation?
In periods of heavy growth, inflation occurs. People are demanding a lot of products, so prices
get driven up. Inflation is the increase in the general price level. (Can be seen as an increase of
price level or decrease in purchasing power). It is measured by comparing prices of a
representative basket of goods each year. See below, the average price of houses in the
municipality of Groningen. Another cause of prices rising in periods of economic growth is
because unemployment is low, so employees can ask higher wages, driving up costs. The inverse
is true for a period of recession.
What’s so bad about inflation?
Inflation can also be bad when it is too high. This is disruptive, since it introduces insecurities
about the future buying power of your money, making investments more risky. Companies will
have a harder time budgeting for the long term. High rates of inflation are often also volatile.
- Decrease in purchasing power
• Unions demanding higher wages
• Higher wages drive up production costs (resulting in turn in cost-push inflation). Your country’s
products become more expensive, international competitors become relatively cheaper, export
decreases
• Redistribution of wealth
• Rise in interest rate
a. What’s so bad about deflation?
- Price level goes down in a period of time (your money becomes worth more), so customers
know that prices are going down so wait to purchase things, which is bad for growth.
- Lower prices = lower return to producers, so they can’t keep up with production
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