Economic Growth
AS Economics
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)
Trend and actual output
Trend and actual output with negative
and positive output gaps
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
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
Business/Economic Cycle
• The stages of the classic business cycle can be
illustrated as follows:
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’
Recessions in the UK
-2
-4
-6
-8
1971 Q1
1971 Q4
1972 Q3
1973 Q2
1974 Q1
1974 Q4
1975 Q3
1976 Q2
1977 Q1
1977 Q4
1978 Q3
1979 Q2
1980 Q1
1980 Q4
1981 Q3
1982 Q2
1983 Q1
1983 Q4
1984 Q3
1985 Q2
1986 Q1
1986 Q4
1987 Q3
1988 Q2
1989 Q1
1989 Q4
1990 Q3
1991 Q2
1992 Q1
1992 Q4
1993 Q3
1994 Q2
1995 Q1
1995 Q4
1996 Q3
1997 Q2
1998 Q1
1998 Q4
1999 Q3
2000 Q2
2001 Q1
2001 Q4
2002 Q3
2003 Q2
2004 Q1
2004 Q4
2005 Q3
2006 Q2
2007 Q1
2007 Q4
2008 Q3
2009 Q2
2010 Q1
The UK Economy from 1971
12
10
8
6
4
2
0
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.
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).
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
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
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)
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.
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
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
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
Inflation
Two types
• Cost push
• Demand pull
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
Price Level
Diagrammatic cost push inflation
SRAS1
SRAS
P1
P
AD
0
Y1 Y
Real GDP
Demand Pull - Causes
• Consumer boom (high confidence more likely
to buy)
• Increase in government spending
• Net exports rise
• Money supply growing faster than output
Diagrammatic effect of demand pull inflation
(Keynesian)
Price Level
LRAS
P1
P
AD1
AD
0
Y
Y1
Real GDP
Diagrammatic effect of demand pull inflation
(New Classical)
Price Level
LRAS
P1
P
AD1
AD
0
Y
Real GDP
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
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
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?
Inflation questions
• For each of the 3 people, explain what the
impact of rising prices (at 3.1%) would be for
them
a) A pensioner. Their pension rises by 3.1%
over the next year
b) A job seeker. Their income rises by 1% over
the next year
c) A salaried worker who expects their income
to rise by 4.5% over the next year
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
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
Recent trends in inflation
1971 Q1
1971 Q4
1972 Q3
1973 Q2
1974 Q1
1974 Q4
1975 Q3
1976 Q2
1977 Q1
1977 Q4
1978 Q3
1979 Q2
1980 Q1
1980 Q4
1981 Q3
1982 Q2
1983 Q1
1983 Q4
1984 Q3
1985 Q2
1986 Q1
1986 Q4
1987 Q3
1988 Q2
1989 Q1
1989 Q4
1990 Q3
1991 Q2
1992 Q1
1992 Q4
1993 Q3
1994 Q2
1995 Q1
1995 Q4
1996 Q3
1997 Q2
1998 Q1
1998 Q4
1999 Q3
2000 Q2
2001 Q1
2001 Q4
2002 Q3
2003 Q2
2004 Q1
2004 Q4
2005 Q3
2006 Q2
2007 Q1
2007 Q4
2008 Q3
2009 Q2
2010 Q1
Longer trend in inflation (RPI only)
30
25
20
15
10
5
0
-5
Inflation around the world
60
56.1
50
40
32.3
30
20
7.9
10
2.2
0.7
1.43
France
Germany
7.4
1.61
2.1
1.2
UK
USA
0
Australia
Greece
-2.9
-10
Iran
Japan
Nigeria
Turkey
Venezuela
Question 1
Real incomes rise whenever
A. nominal incomes rise
B. the price level rises by more than nominal
incomes
C. nominal incomes rise by more than the price
level
D. the rate of inflation slows down
Question 2
• The following table gives index numbers for a
measure of an economy’s money national
income, 2002–2006.
From the data it can be
concluded that in the
period 2002–2006 there
must have been a fall in
A.aggregate demand
B.the size of the labour
force
C.the rate of inflation
D.the government’s
budget deficit
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
A. –2.5
B. 0
C. +2.5
D. +5.0