4.
6 – ECONOMIC GROWTH
Economic growth is an increase in the amount of goods and services
produced per head of the population over a period of time.
The total value of output of goods and services produced is known as the national
output. This can be calculated in three ways: using output, income or expenditure.
TERMS
GDP (Gross Domestic Product): the total market value of all final goods and
services provided within an economy by its factors of production in a given period of
time.
Nominal GDP: the value of output produced in an economy in a period of time,
measured at their current market values or prices is the nominal GDP.
The components of nominal GDP are:
From this equation, two measures can be used to gauge the level of economic growth:
Real GDP: the value of output produced in an economy in a period of time, measured
assuming the prices are unchanged over time (adjusted for inflation). This GDP, in
constant prices, provides a measure of the real output of a country.
GDP per head/capita: this measures the average output/ income per person in an
economy. Since this considers the population, it provides a good measure of the living
standards of an economy.
GDP per capita = GDP / Population
An increase in real GDP over time indicates economic growth as goods
and services produced have increased. It indicates that the economy is utilizing its
resources better or its productive capacity has increased. On a PPC, economic growth
will be shown by an outward shift of the PPC, which is also called ‘potential growth’.
‘Actual growth’ occurs when the economy moves from a point inside the PPC to a point
closer to the PPC.
This diagram shows ‘actual growth’ as the economy realizes its potential growth. In order to
experience potential economic growth, the PPC would have to shift outwards.
Causes of economic growth
Discovery of more natural resources: more resources mean more the
production capacity. The discovery of oil and gas reserves have enabled a lot
of economies (Norway, Saudi Arabia, Venezuela etc.) to grow rapidly.
Investment in new capital and infrastructure: investment in new
machinery, buildings, technology etc. has enabled firms and economies to
expand their production capacities. Investment in modern infrastructure such
as airports, roads, harbours etc. have improved access and communication
in economies, helping in achieving quicker and more efficient production.
Technical progress- technological advancement: New inventions,
production processes etc. can increase the productivity of existing resources
in industries and help boost economic growth.
Increasing the quantity and quality of factors of production: A larger
and more productive workforce will increase GDP. More skilled,
knowledgeable and productive human resources thus help increase
economic growth. Similarly, good quality capital, use of better natural
resources, innovative entrepreneurs all aid economic growth in the long run.
Reallocating resources: Moving resources from less-productive uses to
more-productive uses will improve economic growth.
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The benefits of economic growth:
Greater availability of goods and services to satisfy consumer wants
and needs.
Increased employment opportunities and incomes.
In underdeveloped or developing economies, economic growth can
drastically improve living standards and bring people out of poverty.
Increased sales, profits and business opportunities.
Rising output and demand will encourage investment in capital goods for
further production, which will help achieve long run economic growth.
Low and stable inflation, if growth in output matches growth in demand.
Increased tax revenue for government (as incomes and spending rise)
that can be
invested in public goods and services.
The drawbacks of economic growth:
Technical progress may cause capital to replace labour, causing a rise
in unemployment. This will be disastrous for highly populated
underdeveloped and developing economies, pulling more people into poverty
Scarce resources are used up rapidly when production rises. Natural
resources may get depleted over time.
Increasing production can increase negative externalities such as
pollution, deforestation, health problems etc. Climate change is a
consequence of rapid global economic growth.
If the economy produces over its productive capacity and if the growth in
demand outstrips the growth in output, economic growth may cause
inflation
Economic growth has also been accused of widening income
inequalities in developing economies, because rich investors and
businessmen gain more than the working class and poor during growth – the
benefits of growth are not evenly distributed. This will cause relative
poverty to rise.
Governments aim for sustainable economic growth which refers to a rate of
growth which can be maintained without creating significant economic problems for
future generations, such as depletion of resources and a degraded natural environment.
Business cycle
Recession
Recession is the phase where there is negative economic growth, that is real
GDP is falling. This usually happens after there is rapid economic growth. High inflation
during the boom period will cause consumer spending to fall and cause this downturn.
Workers will demand more wages as the cost of living increase, and the price of raw
materials will also rise, leading to firms cutting down production and laying off workers.
Unemployment starts to rise and incomes fall.
Causes of recession:
Financial crises: if banks have a shortage of liquidity, they reduce lending
and this reduces investment.
Rise in interest rates: increases the cost of borrowing and reduces
demand.
Fall in real wages: usually caused when wages do not increase in line with
inflation leading to falling incomes and demand.
Fall in consumer/business confidence: reduces both supply and demand.
Cut in govt. spending: when government cuts spending, demand falls.
Trade wars: uncertainty in markets, and thus businesses will be reluctant to
invest during a trade war, causing supply to fall.
Supply-side shocks: e.g. rise in oil prices cause inflation and lower
purchasing power.
Black swan events: black swan events are unexpected events that are
very hard to predict. For example, COVID-19 pandemic in 2020 which
disrupted travel, supply chains and normal business activity, as well
consumer demand, has caused recessions in many countries.
Consequences of recession:
Firms go out of business: as demand falls, firms will be forced to either
reduce production to a level that is sustainable or close shop.
Unemployment: cuts in production will cause a lot of people to lose work.
Fall in income: cuts in production also causes fall in incomes.
Rise in poverty and inequality: unemployment and lack of incomes will
pull a lot of people into poverty, and increase inequality (as the rich will still
find ways to earn).
Fall in asset prices (e.g. fall in house prices/stock market): recessions
trigger a crash in the stock markets and other asset markets as investors’
and consumers’ confidence in the well-being fall of the economy during a
recession. The shares owned by investors will be worth less.
Higher budget deficit: due to falling consumption and incomes, the
government will see a fall in tax revenue, causing a budget deficit to grow.
Permanently lost output: as firms go out of business and employment
falls, it results in a permanent loss of output, as the economy moves
inwards from its PPC.
If the economy was producing at A on its PPC, a recession will cause
production to fall to B.
Policies to promote economic
growth
Effectiveness of such policies:
Demand-side policies that increase the rate of growth above the long-run
trend rate will cause inflation and quickly lead to a recession if not
controlled.
Supply-side policies can take considerable time to take effect. For
example, if the government invested in better education and training, it
could take several years for this to lead to higher labour productivity.
In a recession, supply-side policies won’t solve the fundamental problem of
deficiency of aggregate demand. Increasing the flexibility of labour markets
and encouraging investment may help to some extent, but unless there is
sufficient demand, firms will be reluctant to increase production and make
new investments.
