4.2.3.1 - Economic growth and the economic cycle

What is short run growth?

Short run growth is the percentage increase in a country's real GDP, and it is usually measured annually. It is caused by increases in AD.

What is long run economic growth?

When the productive capacity of an economy rises. Trend rate of growth of real national output in an economy over time

What is long run economic growth caused by?

Increases in AS

What is the potential output of an economy?

What they couldn't produce is all factors of production were fully employed

What is a positive output gap?

Occurs when the actual level of output is greater than the potential level of output.

What is a negative output gap?

Occurs when the actual level of output is less than the potential level of output.

What are the consequences of a negative output gap?

Puts downward pressure on inflations. Means that there are high levels of unemployment of resources --> high levels of spare capacity.

What could lead to a positive output gap?

When resources are being used beyond the normal capacity. if productivity is growing the output gap becomes positive

What are consequences of a positive output gap?

Upward pressure of inflation

What is the classical economist view of output gaps?

They believe that markets clear in the long run, so there will be full employment of resources. Therefore, output gaps only exist in the short run

What are characteristics of a boom?

High rates of economic growth
Near full capacity or positive output gaps
Near full employment
Demand pull inflation
High levels of confidence in the economy
Government budget improves

What are characteristics of a recession?

- Negative economic growth
- Lots of spare capacity and negative output gaps
- Demand-deficient unemployment
- Low inflation rates
- Government budgets worsen due to more spending on welfare payments and lower tax revenues
- Less confidence amongst consumers and firms

What are the benefits of economic growth on the consumer?

Income rises as more people are employed so wages increase. --> therefore consumers will feel more confident --> increase in consumption --> higher standards of living

What are the benefits of economic growth on the firm?

Firms take in more profits -->increase firms confidence --> increase investment --> new technologies --> improves productivity --> lowers the average costs in the long run --> benefit from economies of scale

More economic growth in export markets --> more competition --> more productive and efficient --> more sales and opportunities

What are the benefits of economic growth on the government?

Government budget deficit might improve --> fewer people require welfare payments --> more people paying tax --> focus on public services --> improving living standards

What are the benefits of economic growth on current and future living standards?

Consumers income increases --> people might show more concern about the environment

Development of technology --> this can produce more goods and services sustainably

Public services improve --> gov receive higher tax revenues --> afford to spend on improving services --> healthcare and education --> improves living standards and overall human capital

What are the costs of economic growth on the consumer?

Does not benefit everyone equally --> people on low and fixed incomes might feel worse off due to high inflation --> increases inequality

High levels of consumer spending --> higher demand pull inflation

High prices --> more shoe leather costs --> spend more time and effort to find the best deal due to increasing prices.

The benefits of more consumption might not last after the first few units --> law of diminishing returns

What are the costs of economic growth on the firms?

Firms could face more menu costs as a result of higher inflation --> they have to keep changing their prices to meet inflation rate

What are the costs of economic growth on the government?

Might increase their spending on healthcare if the consumption of demerit goods increases --> tend to be overconsumed --> more people are willing and able to purchase demerit good even if taxes have been placed on them

What are the costs of economic growth on the current and future living standards?

High levels of growth --> damages the environment in the long run --> increased negative externalities from consumption and production of some goods and services

What are the causes of cyclical instability ?

The sustainability of economic growth
Excessive growth in credit and levels of debt
Asset price bubbles
Destabilising speculation and animal spirits
Herding

How can excessive growth in credit and levels of debt lead to cyclical instability?

If growth is financed by public debt then it might not be sustainable. --> Difficult to pay back in the future --> does not contribute to improvements in productivity --> this means that economies productive capacity does not increase

How can assess price bubbles lead to cyclical instability?

Asset is traded more --> demand exceeds supply --> prices rise beyond its value --> the bubble bursts as prices steeply and suddenly fall to its ordinary level --> low confidence and investors try to sell their assets --> can lead to economic decline

What is a market bubble?

Occurs when the price of an asset is predicted to rise significantly

How can destabilising speculation and animal spirits lead to cyclical instability?

DESTABILISING SPECULATION --> changes in the price level in a market due to speculation --> purchase assets as they believe price will appreciate --> higher demand leads to sharp increases in price --> affects the actual price of assets in an economy.

What is herding?

Act of reacting to behaviours of other economic agents rather than the market --> due to investors thinking economic agents are better informed about the market so follow their actions

How can sustainability of economic growth lead to cyclical instability?

Growth might be excessive --> leads to inflation in the average price level, wages and assets.
There could be excessive credit --> unsustainable in the long run
Savings ratio might be low and falling