4.5 Economic Growth

Economic growth

Increase in the level of national output which is the annual percentage change in GDP

Gross domestic product

Measures value of goods and services produced within a country for a period of time usually one year (total output in a country).

Ways to measure economic growth

Output method

Income method

Expenditure method

Output method

Measures GDP by adding up all the output produced by all the industries in the country, Makes sure that output is not counted twice so economists must include the value added by each firm and at each stage of production

Value added

Difference between sales revenue received and cost of raw material used

Income method

Includes all incomes which have been earned in producing the country’s output. Transfer payments are not included because there is no correspondence to output of goods and services.

Expenditure method

Adding up all expenditures on the country finished output which is calculated by adding up consumer expenditure (C), investment expenditure (I), government expenditure (G), export earnings (X) minus import expenditure (M), making the formula GDP = C+I+G+(X-M)

Consumer expenditure

Total spending on goods and services by individuals or households in the economy

Investment expenditures

Capital Expenditure of firms which is used for further production and expands the economy’s productive capacity.

Government Expenditure

Total consumption and investment expenditures of the government.

Export earnings

Measures monetary value of all exports sold to foreign buyers

Import expenditures

Measures monetary value of all payments made for all imports.

Circular flow of income

Nominal GDP

Total output produced by a country not adjusted for inflation. GDP at current prices

Real GDP

Total output of a country adjusted for inflation

How to calculate real GDP

Nominal GDP x CPI of previous year / CPI of current year

CPI

consumer price index

Real GDP per head

Real GDP divided by total population of a country

Why is real GDP difficult to measure

Existence of informal economy which has unrecorded economic activity, Can be referred to grey, hidden or shadow economy such as illegal drugs dealing, work done by immigrants who do not have permission to work in the country or businesses who want to avoid government intervention.

Non marketed goods and services such as products which are not bought or sold such as subsistence farming, family members who produce their food for their own use or people who provide services for themselves by cleaning their own house or repairing their own car and are not accounted in GDP.

How to increase economic growth in short term

Increase in any component in GDP.

For example an increase in consumer consumption due to increase confidence or a cut in income tax will increase demand causing it to shift outward causing the firm to increase, output. This will cause movement from within the PPC to towards the PPC.

Long term economic growth causes

Increase in quality or quantity of factors of production

Investment expenditures as it will invest in capital resources increasing quantity of capital causing economic growth

Foreign Direct investment

Investment done by foreign multinational companies to an overseas market

Advantages of economic growth

Economic growth leads to increased employment as the demand for labour will increase as it is derived demand which will increase income so increasing standard of living as people have real income so can spend it on necessities such as housing and food, reducing absolute poverty.

Increase government tax revenue which the government can spend on tax revenue like health care and education

Higher exports will increase exports so increasing international competitiveness so the country can improve its current account of the balance of payments

Disadvantages of Economic Growth

Economic growth has an opportunity cost which is reallocating resources from making consumer goods to capital goods if the economy is working in full capacity reducing living standard and reduce consumer goods in short term as they are already at max capacity

Can cause external costs like congestion, air pollution, environmental damage.

Depletion of resources damaging wellbeing of people and their quality of life in the long term.

Increase stress on the workers as it will increase the number of working hours decreasing their leisure time

Can cause demand pull inflation as if income increase, spending increase, demand increase, prices increase.

Increase demand for imported raw materials and capital goods increasing imports expenditure and worsening balance of payments.

Sustainable economic growth

Economic growth that does not endanger the country’s ability yo grow in the future

How will conserving resources affect the government

Avoids rapid depletion of resources as it takes into consideration the future generations but it will reduce output reducing economic growth and increasing unemployment leading to lower standards of living

Exploiting resources

In the short term it will increase the economic growth and employment but will lead to rapid depletion of resources due to scarcity and does not take into account future generations

Recession

GDP declines over a period of 6 months or more or two successive quarters.

Period of negative output and less being produced than that in the previous period

Causes in recession

Decrease in aggregate demand or aggregate supply

Effects of recession

Lower output

Cyclical unemployment likely

Lower standards of living

Lower investment

Negative demand side shocks

Lower confidence in the economy led to lower consumer and investment expenditure

Government decrease expenditure

Net exports fall due to rise in exchange rate

Negative supply side shock

Rise in cost of production causing businesses to produce less

Actions by the government to increase economic growth in a country

Expansionary Fiscal Policy through its policies of government spending and taxes

Lowering taxes on businesses or foreign investment to decrease cost and increase production

Increase expenditure on health care and education so increasing quality of labour so increasing their skills and productivity

Expansionary monetary policy

Encourage technological advances through financial support increasing the productivity of capital so able to produce more products in less time

Promote free trade and no trade restrictions like tariffs to encourage foreign investment and to decrease the price of imported raw materials and capital goods will be cheaper so reducing cost of production

Reduce exchange rate to increase the demand on exports and reduce the demand on imports so increasing GDP

Supply side policies

Limitations of using government policies to correct a recession

Households and firms may not spend more as they lack confidence in the economy so might save instead of spending

As income will increase, spending will increase and demand will increase so the general price level will also increase causing demand pull inflation

People may demand more imported products rather than local produced one so reducing total demand and reducing firms incentive to produce more