Growth of the Economy And Cyclical
Instability
Content
• Economic or business cycle
• The Nature and Causes of Fluctuations in economic
activity
• The trend rates of economic growth
• The costs and benefits of economic growth
• The use and limitations of national income as an
indicator of changes in living standards
Economic Cycle
• This shows the rate of economic growth compared to long
term trend rates
• The economic cycle shows differences over time between
rapid economic growth (boom, recovery) and alternative
periods where the economy is not growing or is declining in
size (recession or contraction)
• The measure used to assess the growth of the economy is
the comparison of gross domestic product or GDP over
time.
GDP - definition
• GDP – GROSS DOMESTIC PRODUCT
– The Market value of all goods and services produced
within the country.
– (what we produce within the UK/output)
What is the Business Cycle?
• Also known as the trade cycle
• Most economies over time will see an trend of
upward progression
• Does not grow smoothly – fluctuate going through
ups and downs know as the BUSINESS CYCLE
Output
Time
Stages of the Business Cycle
• Boom – (peak) Fast economic growth
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Consumer spending and investment high
Business will have high demand for goods/services
Increasing incomes (increasing competition for workers)
Profits high (high demand for resources = prices rise can lead
to inflation)
Wages rising?
High output due to high demand
Steady economic growth
Business and consumer confidence high
Stages of the Business Cycle
Recession– (downturn/economic slow down)
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Incomes start to fall
Output starts to fall
Possible fall in demand for products
Decline in profit
Lay off workers – unemployment
Consumer (save) and business confidence is low
Reduced investment
Stages of the Business Cycle
Slump– (depression)
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High unemployment
Consumer confidence low
Investment low
Profits low
Closures
Any growth will be slow
Stages of the Business Cycle
• Recovery (expansion/ upswing)
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Income starts rise
Output increases
Spending and consumer confidence increases
More employment as a result
Causes of Economic Growth
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Booms / dips in economic growth can occur due
to a number of reasons:
1. Increase in aggregate demand caused by:
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An increase in consumption – this may be caused by:
a rise in income levels, an decrease in interest rates,
house price inflation
A rise in the level of government spending
A balance of payments surplus
Cause of Economic Growth
2. Labour shortages – if there are shortages of
workers in specific areas it means that the economy
will not be able to utilise its resources efficiently and
therefore economic growth will slow
3. Increase in demand for imports – this will worsen
the balance of payments deficit
Demand and Supply side shocks
• Supply side and demand side shocks can lead to
instability in the economy
• Shocks are unexpected events that influence the
demand / supply in an economy
• As the UK operates in a global market their
economy is open to shocks from across the world
Demand Side Shocks
• These can include:
• A significant rise or fall in exchange rates in short
term
• Changes in the rate of economic growth for
countries that you trade a lot with
• Changes in aggregate demand
• A boom in capital expenditure e.g. in construction or
ICT
Supply Side Shocks
• These affect the costs and prices of supply
• These can include:
– Technology
– Natural disasters which impact the supply of particular
goods e.g. crops
– Political situations that influence the supply of particular
products e.g. oil
Trend rate of economic growth
• The trend rate of economic growth shows the rate of
economic growth is the average rate of economic growth
over a period of time
• The trend rate of economic growth is influenced by a
number of factors of supply side including:
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Investment
Education
Training
Technological change
Influences on the trend rate of economic
growth - Investment
• Investment influences the trend rate of economic
growth as higher levels of investment increase AD
and expenditure within the economy
• In addition investment expenditure means there are
more capital goods for workers to use to produce
consumer goods therefore increasing the level of
output in the economy
Influences on the trend rate of economic
growth – Education and Training
• Education and training can increase the growth rate
of the labour force in the economy
• These can both increase the trend rate of growth in
labour productivity in the UK therefore driving the
level of economic growth
Influences on the trend rate of economic
growth - technology
• Changes in technology can reduce the costs of
goods in the economy
• If the costs of supplying products decreases then
production possibility frontier will shift outwards
The Costs and Benefits of
Economic Growth
• There are costs and benefits that are associated
with economic growth
• Some costs are a result of externalities which occur
due to economic growth
• Economists focus on the idea of economic growth
as being sustainable which means it can continue
over the long term
The Costs of
Economic Growth
• Economic growth causes costs for the economy:
• Inflation risks – either demand-pull or cost-push
• The environment – as output increases negative
externalities can increase e.g. pollution
• Regional disparities or differences – Can lead to greater
differences between rich and poor
• Inequalities of income and wealth – these can
Benefits of Economic Growth
• Economic growth has an accelerator effect on
capital investment
• Increases taxation for the government
• Environmental benefits – if the economy is growing
there is more money to invest in cleaner
technologies thereby reducing pollution
The Benefits of Economic Growth
• Economic growth has a number of benefits:
• Improvement to living standards and lower rates of
poverty – especially in developing countries
• Falling levels of unemployment – Economic growth
stimulates levels of employment
Sustainability of Economic Growth
• The aim for most economies is sustainable economic growth
• Factors of production are finite and more resources are being used at
an increasing rate which means sustainability to economic growth is
being questioned
• Other renewable resources are being over used so this is decreasing
the sustainability of economic growth
• If economies are to keep growing at the same rate new ways of using
resources and strategies to reduce waste and resource consumption
need to be enforced
The Use and Limitations of National Income as an
Indicator of Changes in Living Standards
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Economic data:
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GDP
GDP per capita
Disposable income
Working hours
GDP figures show the total amount of income generated in the economy over a
year
GDP per capita looks at the income per person in the population
GDP per capita figures allow for comparison between countries
To compare figures they need to be converted into a common currency
To make relevant comparisons also need to look at the differences in the costs of
goods and services between countries – purchasing power parity
Limitations of National Income as an
Indicator of Changes in Living Standards
• GDP figures alone cant be the only indicator of
economic well being
• The black or shadow economy has a larger value in
some countries than others and this will distort GDP
figures by making them lower than they should be
Limitations of National Income as an
Indicator of Changes in Living Standards
• GDP figures can also be problematic as they fail to
account for regional disparities in countries and
inequalities in income and wealth
• In addition GDP figures don’t offer any insight into
quality of life – they could be used with working time
figures to get a clearer view of a countries economy
Limitations of National Income as an
Indicator of Changes in Living Standards
• Home working figures are not included in the values and
therefore GDP may not be truly representative
• GDP could have grown due to an increase in consumption
however if this is not matched by an increase in investment
then it will lead to problems in the future as there are
insufficient capital goods to produce consumer goods
needed
• Changes in life expectancy increase living standards but
are not accounted for by GDP figures
Other measures
• Other measures that can be used to compare
standards of living can be used
• These include purchasing power parity which
compares the cost of living in different countries
• Human development index
• Human poverty index
Summary
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The economic cycle shows the rate of economic growth over time in an economy
Boom periods are characterised by rapid levels of economic growth
A recession is a period where economic growth has declined
Changes in the rate of economic activity can be caused by factors that influence aggregate supply or
increase the productive capacity of the economy
Fluctuations in economic activity are caused by demand and supply side
The trend rates of economic growth shows the average rate of growth in the economy over a period of
time
Economic growth provides benefits including higher levels of employment and standards of living
Economic growth can also lead to costs including environmental damage and inflationary pressures
National income statistics can be used to compare the standard of living between countries
GDP figures can be crude indicators of economic growth and other factors should be considered