Chapter 15 - Economic Growth and the economic cycle

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Chapter 15 Economic Growth and the economic cycle A recap and testing your understanding

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A: Rising house construction B: The number of job vacancies rises G: Rising quantity of mail C: Increasing hours of overtime D: Rising homelessness H: Slower delivery times K: Falling share prices E: Rising demand for steel M: Rising real income L: Rising lipstick sales F: More people use pawnbrokers I: Home delivered pizza becomes more popular J: Rising air traffic N. Rising car sales

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O: More rental housing available P: Growing mountain of unsold bricks Q: Fast food shops cut their prices T: The cost of shipping goods around the world starts to rise U: More skips start appearing on the streets V: Sales of milk chocolate start to decline X: Oil refineries report a reduction in stocks Y: Citizens Advice Bureau gets more callers W: Shops delivering lunchtime sandwiches to offices raise their prices R: Imports of sewing machines rise S: Increasing supply of credit Z: Rising government spending

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A B C D E F G H I J K L M N O P Q R T U V W X Y Z S

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Real GDP Time The economic cycle in pictures A B C D F G H I J K L M N O P Q R T U V W X Y Z S E

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Measurement and definition Why is growth seen as an important macroeconomic objective? Because it provides more goods and services for the population This is particularly important for developing countries to get out of poverty What are the BRIC ’ s? Brazil, Russia, India and China – examples of rapidly growing economies What is the trend rate of growth for the UK? 2.5% What does this mean in terms of inflation? Defined as the rate at which the economy can grow without exerting either upward or downward pressure on inflation – at this rate the economy will remain stable

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Measurement and definition What does the 2.5% mean where productive capacity is concerned? Growth can be seen as an increase in the productive capacity of the economy of about 2.5% per year. What factors will allow the economy to grow this way? Supply-side factors Such as? Factors than increase the quality or quantity of resources e.g. training people to make them more employable or firms becoming more productively efficient. If the economy is creating output what must there be? Adequate demand to absorb the extra supply The increased demand will incentivise businesses to invest in new capital equipment and increase productive capacity

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Measurement and definition Where would we draw a point on the PPB if we had a negative output gap? Inside the PPB – indicating economic recovery rather than growth If you used an AD/AS diagram to illustrate the same how would you draw it? AD shifts from AD to AD1 that is below full employment in the economy Any factors that shift the curve back to AD or shift the output back to the PPB or close the negative output gap will restore the economy to its trend or potential growth rate Price Level RNO AS AD1 AD

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Measurement and definition What are the factors that shift the AD curve? The components of AD = C + I + G + (X-M) Anything that increases any of these will create short term growth What will happen if an increase in AD is too large? It will push the economy into a positive output gap Why might this be bad? Because inflation will increase What would the MPC do if this happened? Increase interest rates Price Level RNO AS AD1 AD

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Long term growth What is essential for long term growth? Firms take up improved capital equipment and that they are able to increase both capital and labour productivity Government policies need to encourage this If governments tax above levels of other countries they may find that firm ’ s relocate in lower tax countries Those that stay will be reluctant to increase their investment with the hope of increasing profits What diagram do we use to demonstrate sustained long term growth?

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Long term growth What is good about this type of growth Increased output with lower prices Why is this good? The economy will be more internationally competitive assisting the balance of payments What things affect the LRAS? Increase in the factors of production Increase in the productivity of factors of production Advances in technology and their take-up by firms

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Long term growth The UK is limited in terms of natural resources just by the size of its land mass Some countries get high growth rates due to their level of natural resources e.g. Russia with huge deposits of oil and gas In addition it is not easy to increase the quantity of labour What has the UK done to do this? Imported labour with the EU expanding particularly polish people What have they done to improve the quality of labour? Improve education and encourage students to go on to university Industry often criticises government education policy saying that it does not produce the people they need Improve flexibility through part time working – encouraging women to work etc

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Long term growth Why are advances in technology important? They reduce the costs of production They lead to new products that generate extra spending that drives growth Investment needs to be in areas that are expanding rather than contracting Take up of new technology in the UK is often slow compared to Europe and the US What reasons are given for this? The UK is said to be too concerned with making short term profit and Taxes are too high which means there is less profit to be invested

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Economic growth and the PPB What does the PPB show? The potential output of the economy How can we use the PPB to show that we may be able to increase the potential output by the take up of more capital goods but that there is an opportunity cost of doing that?

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Economic growth and the PPB

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Economic growth and the PPB If we reduce our consumption of consumer goods by WX we can increase the amount of capital goods by ZV. The opportunity cost is WX This additional capital goods can be used to increase our potential growth as shown by the shift of the PPB. This shift will potentially give us more consumer and capital goods This gives rise to the saying ‘ less jam today means more jam tomorrow ’ The issue with this is that living standards will increase in the future and some such as the elderly will not get to see the benefits Economists stress that there are substantial costs to continuing growth and that it will not necessarily lead to an increase in living standards.

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Why do governments want economic growth? The case FOR growth Economic growth means more goods and services for the country as a whole more people can live in more comfort free of financial worries Economic growth can make it easier to reduce the difference in income and wealth between the rich and poor people will be less concerned about being taxed when they see their incomes rising Government can use this tax to distribute to poorer people Economic growth means more leisure people as they earn more can give up some working hours for leisure without seeing a drop in their living standards Economic growth can mean a healthier environment the country can afford to invest in greener technology e.g. build factories that pollute less.

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Why do governments want economic growth? Case AGAINST Growth 'Growth is good, recession is bad'. This is the standard view of economic growth, and it tends to be treated as However, it may not always be good. The case against economic growth Pollution (and other negative externalities ) Economic growth may mean undesirable externalities the drive for increased output tends to put more and more pressure on the environment the result will often be increased pollution. This may be water or air pollution growth also creates significantly increased noise pollution. Traffic growth and increased congestion are prime examples of this.

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Why do governments want economic growth? Loss of non-renewable resources the more we want to produce, the more resources we need to do that The faster we use these resources, the less time they will last Economic growth means using natural resources this could mean less growth for future generations as natural resources become scarce Lifestyle changes the push for growth has in many areas put a great deal of pressure on individuals This may have costs in terms of family and community life Economic growth raises expectations – growth may lead to us wanting more and more meaning that we may never be entirely happy

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Why do governments want economic growth? An example of how growth may not lead to happiness The UK has allowed many migrants to enter the country to increase the quantity of resources and increase growth the support infrastructures such as hospitals and schools etc were not capable of supporting these additional people citizens of the UK feel that they are worse off. Inequality of income growth rarely delivers its benefits evenly It often rewards the strong, but gives little to the economically weak This will widen the income distribution in the economy. Loss of land increased output puts further pressure on the available land This may gradually erode the available countryside New infrastructure such as new housing developments and motorways destroys the countryside

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Economic growth and the AD/AS Model This diagram is a neoclassical diagram that shows how an increase in investment could lead to an increase in economic growth Firstly you need to note that we are assuming that A is the full employment level for the economy Initial equilibrium is at A AD, SRAS and LRAS are equal An increase in investment causes a shift from AD to AD1 The increased prices cause an expansion (extension) of SRAS The economy will be in a positive output gap at B Insert diagram 15.7 P179

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Economic growth and the AD/AS Model The increased investment expenditure should lead to a shift of the LRAS to point C This will lead to lower prices and increased real output The SRAS curve should shift downwards as the improved technology lowers firm ’ s costs The new equilibrium C reflects the higher potential growth rate will be at C Remember that there is likely to be a time lag between the increase in investment and the increased growth rate in the economy Insert diagram 15.7 P179

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Examination questions testing knowledge and understanding of the way growth is measured should not be confused with the definition of growth Candidates will be expected to use PPB, AD/AS and Business Cycle diagrams in their answers even if they are not specifically asked to. If you want to explain opportunity costs of growth and the possibility of trade offs then a PPB diagram would assist you with that analysis Unless a question explicitly states otherwise the term economic growth should always be taken to mean long-term growth that is mainly determined by supply-side factors. Always state what type of growth you are talking about. When interpreting economic data try to separate long-term trend data from short term fluctuations Exam Tips

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