Economic%20Growth

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Economic Growth

• AS Economics

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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)

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Trend and actual output
Actual output
Trend output
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Trend and actual output with negative and
positive output gaps
Actual output
Positive output gap
Trend output
Negative output gap
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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

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Economic Cycle Table
Boom 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
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Business/Economic Cycle

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

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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

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Recessions in the UK
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The UK Economy from 1971
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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.

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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).

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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

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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
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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)

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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.

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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

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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

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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

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• Inflation

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Two types

• Cost push
• Demand pull

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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

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Diagrammatic cost push inflation
SRAS1
Price Level
SRAS
P1
P
AD
0
Real GDP
Y
Y1
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Demand Pull - Causes

• Consumer boom (high confidence more likely to
  buy)
• Increase in government spending
• Net exports rise
• Money supply growing faster than output

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Diagrammatic effect of demand pull inflation
(Keynesian)
LRAS
Price Level
P1
P
AD1
AD
0
Y
Y1
Real GDP
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Diagrammatic effect of demand pull inflation (New
Classical)
LRAS
Price Level
P1
P
AD1
AD
0
Y
Real GDP
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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

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Inflation

• 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

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Inflation questions

1. If you expect prices to rise by 20 next year,
   would you buy a new car now or wait until next
   year? Why?
2. If you expect prices to fall next year would you
   buy the car now or wait? Why?
3. Would you expect the government to want (a) fast
   rising prices (b) slow rising prices (c)
   falling prices and why?

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Inflation questions

• For each of the 3 people, explain what the impact
  of rising prices (at 3.1) would be for them
• A pensioner. Their pension rises by 3.1 over
  the next year
• A job seeker. Their income rises by 1 over the
  next year
• A salaried worker who expects their income to
  rise by 4.5 over the next year

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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

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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

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Recent trends in inflation
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Longer trend in inflation (RPI only)
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Inflation around the world
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Question 1

• Real incomes rise whenever
• nominal incomes rise
• the price level rises by more than nominal
  incomes
• nominal incomes rise by more than the price level
• the rate of inflation slows down

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Question 2

• The following table gives index numbers for a
  measure of an economys money national income,
  20022006. 

• From the data it can be concluded that in the
  period 20022006 there must have been a fall in
• aggregate demand
• the size of the labour force
• the rate of inflation
• the governments budget deficit

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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
• 2.5
• 0
• 2.5
• 5.0