Economic Growth

Measuring Economic Growth
1. HDI
  1. Better for measuring living standards because it takes into account 3 main areas of living standards - education, health and earnings. It measures life expectancy, literacy rate and GDP/capita and gives a result between 0 and 1. The results are internationally comparable
    1. GDP/capita PPP = taking into account different costs of living
      1. A more appropriate way of measuring equality is the Gini coefficient.
        Globally excepted measure, easy to measure and understand, and in most cases, higher average wages usually lead to more happiness and fewer problems such as lack of necessities
      2. adjusted for exchange rate
2. GDP
  1. Gross Domestic Product is the total value of all output in the economy over a given period of time. Figures are produced every quarter
    1. Real GDP measures the value of goods and services produced within the economy adjusted for inflation
      1. National output has to be above inflation for us to see real economic growth
      2. GDP does not measure the sustainability of the growth. It is a measure of economic activity, rather than a projection method, which means it could be due to unsustainable overuse of resources or poor allocation of investment.
  3. 3 ways of measuring GDP - by output, income or expenditure - all should give the same result
3. PPF
  1. GDP vs PPF
    1. GDP is a proxy measure of growth - it measures actual output, not productive potential like the PPF does
    2. GDP measures short run growth - fluctuations in the economic activity (actual GDP) whereas shifts in the PPF measure long run growth (trend GDP)
  2. The maximum combination of goods that a country produces when an economy is working at its full capacity
4. % working in agriculture//primary school enrollment//clean water access//internet//energy usage
Circular Flow of Income
1. The outer flow is the financial flow - it is measured in monetary terms. The inner flow is a physical flow. The flows run in opposite directions showing the payments received for the supply of labour and goods. Each payment represents an income for another agent.
  1. Firms pay households wages for the labour factor of production. Households then use this to consumer domestically produced goods and services
    1. Any income not spent on consumption is a withdrawal - savings, taxes and imports.
      1. Savings enter the financial sector and banks use these funds to lend to other households (loans) or firms (to fund investment)
        Investment is capital spending by firms to increase their ability to supply goods and services. Investment is an injection as it represents an increase in income in the economy by increasing the profits of firms
        Not all flows remain within the domestic economy. Economic agents may import goods and services from overseas, and foreigners may buy UK exports. Imports are a withdrawal and exports are an injection
      2. The value of withdrawals always equals the value of injections
        Y = C+S+T+M -- this shows the uses of income
        Y = C+I+G+X -- this shows the sources of income
Link bewteen income and wealth
1. Income is a flow of factor incomes such as wages and earnings from work; rent from the ownership of land and interest & dividends from savings and the ownership of shares
  1. Wealth is a stock of financial and real assets such as property, savings in bank and building society accounts, ownership of land and rights to private pensions, equities, bonds etc.
    1. Economic Growth Part 2
      1. Economic Growth and Development
        Economic development is different to economic growth in that it refers to structural changes in the economy which increase the long run productive potential of the economy.
        E.g. the internet boom of the 1990s - new technologies and business models offered opportunities to firms and consumers
        LEDCs face poverty, aid and environmental issues. MEDCs also face development issues, and have also experienced periods of economic development in the past
        E.g. the industrial revolution in the late 18th century when the main industry (and main employer) shifted from primary sector (agriculture and fossil fuel extraction) to secondary sector (manufacturing)
        The late 20th century transition from secondary to tertiary sector (services) - many economies faced crises due to painful adjustments
      2. Economic Growth and Productivity
        Economic growth does not occur uniformly across the economy
        An increase in productivity across the whole economy would shift the whole PPF outwards evenly
        The maximum output of food stays the same even though the motor vehicle industry has become more productive
        Productivity measures output relative to input. In developed economies, the economic growth rate is closely linked to gains in productivity (mostly labour productivity)
        Measured in output per worker
        An economy converts the inputs (the factors of production) into outputs (goods and services). The efficiency with which this is done is the productivity.
      3. PPF
        The shift outwards of the PPF is economic growth - an increase in the quantity and/or quality of the factors of production which increases total potential output
        An economy can operate inside the PPF if there is spare capacity. Moving from a point inside the PPF to a point nearer the boundary incurs no opportunity cost
        Increases in GDP
        Economic growth - long run growth - increases in the productive potential of the economy - shift of the whole PPF outwards
        Economic Recovery - short run growth - fluctuations in GDP resulting from changes in the level of economic activity - movement from a point inside the PPF to one nearer the boundary
        GDP may fall if the PPF shifts inwards or because the economy is making less effective use of resources available
        Unused resources - spare capacity - unemployment of resources
The multiplier
1. Explain the size fof the multiplier using marginal propensity to consume and apply it to shifts in AD
  1. EVALUATION - difficulty of measuring it - each firm/household does things differently, time lag to full effect - money takes time to flow through the system - firms have different business plan period e.g. 5 or 10 years and so they invest differently, size of leakages - figure for imports but also people keep some money at home - can only be estimated
  2. MPC = change in consumption divided by change in income
    1. The greater the MPC, the greater the multiplier effect
      1. Lower savings therefore lower withdrawals therefore more money circulates
        Leakages/withdrawals (MPW) - Marginal propensity to save (MPS) plus the Marginal tax rate (MTR) plus the Marginal propensity to import (MPM).
        1/1-MPC or 1/1-MPW
  3. The Multiplier causes shifts of AD
    1. Governments use the multiplier to stimulate AD in times of recession
    2. The multiplier effect can be positive - shifts out of AD when there is increased investment (injection) and also negative - shifts in of AD when there is a withdrawal from the economy
2. An increase in investment or any other autonomous expenditure will lead to an even greater income
  1. MUST be spare capacity to meet demand
    1. A further assumption is that interest rates remain constant - when AD is rising the central bank may take steps to curb the growth of demand by raising official interest rates which affects MPC
Economic Cycle
1. Output gaps are the difference between the actual level of GDP and the trend rate of growth
  1. Positive output gaps in a boom, negative output gaps in a recession
    1. Sustainable growth rate - ironing out the booms and recessions (Gordon Brown) as these have negative overall impact on living standards
      1. The smaller the output gap the smaller the impact
    2. 5-8 years in between
  2. As the negative output gap widens, unemployment rises. As the positive output gap widens, unemployment should fall to below 0 theoretically indicating a shortage of labour and a need for migrants
    1. Negative output gap = spare capacity
  3. Economic growth vs Economic Recovery - both result in an increase in GDP and therefore both cause a movement from the current point on the PPF outwards. Economic growth causes the whole PPF to shift out representing an increase in the productive potential of the economy, whereas economic recovery causes the current operating point to move closer to the PPF boundary.
2. Trend rate of growth
  1. 2.75%
    1. BRICS need high growth rates due to their large populations and because they produce low value goods. We can grow at lower rates because we have a smaller population and we produce goods of a higher added value
      1. Germany has the finest knowledge and manufacturing expertise so they can charge premiums on their products so they only need a low growth rate
  2. Determined by improvements in the supply side capacity of the economy, such as availability of the factors of production, capital investment etc. all things that shift AS to the right.
3. Unemployment is the last factor to change therefore it cannot be used as an indicator as there is a time lag
  1. During downturns, companies streamline and cut inefficient people
4. Changes in level of GDP VS changes in the rate of growth of GDP - Level of GDP still rises even if the economy is growing at a slower rate, as long as growth is positive
Causes and constraints of growth
1. Benefits of growth
  1. If income rises do living standards rise?
    1. Yes - more spending, more choice, more income for others
    2. No - we have a high propensity to import therefore no one but foreigners benefit in the country
    3. If the rich are not heavily taxed, they can invest more - multiplier effect will mean this trickles down and everyone is better off.
      1. However they don't do this, instead they invest abroad, and so the richer the rich get, the worse off everyone else is. A 10% increase in income for the rich leads to a 2% decline in income for the middle class (1979-2005)
      2. Not taxing the rich heavily creates social tensions - Labour's 50p tax rate makes them seem like the fair party
      3. Taxing the rich could deter income declaration meaning they invest more into capital so we are better off as above.
      4. It could make the rich move abroad which would affect our balance of payments
    4. Increasing in consumption, consumers can benefit from consuming more goods and services, so if consumption levels are high, prosperity will be bigger. Improving in public services, if tax revenues increase, the government can spend more on important public services such as health and education, if the quality of health services improve, the quality of life will improve as well. Reduced unemployment and poverty. Economic growth helps to reduce unemployment by creating jobs and services and it is very important because unemployment is the main source of social problems such as crime.
    5. Also there some disadvantages of economic growth, economic can leads to increase in inequality between people. Economic growth can lead to more hours of work, it means that if incomes are high, it can lead to people working longer hours and it looks that, people are unable to enjoy their higher incomes.
  2. We can tackle our existing problems more easily because we have the increased resources to do so
  3. If we encounter a new problem, having growth will make it easier to cope with, because we will have more surplus to devote to the problem
  4. Without growth it is hard to improve the world we live in
  5. Careful monitoring and action by the gov can put right any undesirable side effects of growth
  6. Economic growth leads to more employment therefore increased tax revenue means gov spending increases, infrastructure and public services improve, consumption increases and AD shifts out more
    1. Spending on merit and public goods
  7. Consumer and business confidence rises
    1. Investment and consumption increases
  8. Increased profits for firms
  9. Economic growth leads to higher level of education and health service. This will result in a better social structure with a more stable political setup
2. Costs of growth
  1. Balance of payments problems - we have a deficit due to import too much. Also other countries benefit due to our increased imports of consumer goods and raw materials
    1. potentially unsustainable
  2. difficulty measuring/changes over time/costs outweigh benefits?
  3. Blind pursuit of economic growth often means we ignore the real problems we face
  4. Interest rates rise to encourage saving
  5. Income inequality - increased relative poverty
  6. Shortage of labour, immigration increases - pressure on services
  7. Negative externalities damage our social welfare and the environment
  8. Could lead to structural unemployment due to structural changes in the economy
3. CONSTRAINTS OF ECONOMIC GROWTH
  1. Absence of capital markets/financial structures prevent borrowing - no investment - no growth
  2. Corrupt governments - e.g. LEDCs - money may not go where it is most needed - misallocation of resources - majority do not benefit - no better off so no increase in consumption, also no gov spending on education/ healthcare/ job creation - productivity decreases and output falls therefore GDP falls
  3. Unskilled labour - can only do basic jobs - unproductive - they are needed but they don't help growth
  4. Migration to other countries - brain drain effect - labour shortages - many dependents - slowed growth, Evaluation - remittances, new skills when they return, job opportunities for those who stay, less pressure on services
  5. War - spending on defence increases - less spending on public/merit goods. Also resources and infrastructure are destroyed, lots of money needed to restore everything. Loss of life means less labour
  6. Geographical location may make growth very hard due to lack of trade possibilities e.g. landlocked countries
  7. Dependence on imports leads to a current account deficit - not export led growth
  8. Lack of capital markets e.g. until 2007 Ethiopia didn't have a coffee market, but now it is one of the biggest exporters in the world. They used intermediaries to sell coffee, the prices were unknown and there was market failure due to asymmetrical information - the coffee farmers had no knowledge of global demand
4. Improvement in the quality or quantity of the factors of production
  1. Land
    1. Land reclamation
    2. Discovery of new resources such as fuels or minerals
      1. Access to energy - North Sea oil and gas in 1980s
      2. Technological improvements in extracting these resources
    3. Use of higher yield methods
  2. Labour
    1. Immigration - larger workforce - increased productivity - selling more - increased GDP. Evaluation: leakages from remittances sent home, however there are also injections from British workers abroad sending money home. A very small % of migrants do not contribute to the economy - they give more than they receive
    2. Investment in human capital - training schemes increase their skills - increased productivity - increased selling and GDP. Also decreased investment in capital leads to more jobs because humans are being used instead of machines. Evaluation: 50% of working population find numeracy hard. The Quality of the training dictates the outcome. Opportunity cost of spending on training rather than capital. This is long term - there are no immediate effects.
    3. Migrants arriving /increases in the birth rate /increase in the retirement age
  3. Capital
    1. Investing in machinery - productivity increases, therefore GDP rises. Evaluation: productivity rises faster, however this won't reduce unemployment
      1. Capital accumilation
    2. Innovations in productive technologies
  4. Entrepreneurship
    1. Innovation - Improvement in technological processes
      1. Need investment for innovation
        Long term
    2. Research and development
    3. More extensive and successful training for managers
5. China's economic growth
  1. Comparative advantage - taking advantage of what they have in abundance
6. UK's growth
  1. The skills of those leaving school at 16 need to be better
    1. Their backgrounds and poverty need to be better
  2. Banks aren't lending - QE is not filtering through - the banks do not want another crisis and they are also forced to hold more cash due to EU laws so they are lending too cautiously
  3. Our welfare state is too big and has cushioned people into not looking for work
  4. Low confidence level - consumers don't spend as they are worried about their job security and investors don't invest
  5. High inflation deters spending
  6. We have a high propensity to import
  7. Baby boom - women out of work - decreased productivity, constraint on resources, also ageing population causes resource reallocation
  8. 1990s internet boom, 2000s readjustment of the value of new technological companies
7. To get out of this recession we need small businesses to develop, but because large companies like Amazon are monopolizing the market, the small businesses get driven out of business
Macroeconomic Policies
1. increased economic growth
2. control of inflation
3. reduced unemployment
4. equilibrium in the balance of payments
5. more equal distribution of income
6. protecting the environment
7. conflicts between objectives
  1. inflation and unemployment
    1. short run Phillips Curve
  2. growth and sustainability
  3. inflation and equilibrium on the BOP
An increase in the productive capacity of the economy
Poverty
1. Relative poverty measures the extent to which a household’s financial resources falls below an average income level.
  1. Absolute poverty measures the number of people living below a certain income threshold or the number of households unable to afford certain basic goods and services.
Macro = the study of economic activity on a national or global scale
1. Large scale processes which determine wealth and the mechanisms through which it can be shared by economic agents
  1. Consumers, firms and gov
    1. Each behaves in a way which maximises welfare - i.e. behave rationally
      1. Consumers aim to maximise utility
        Workers aim to maximise wages
        Firms aim to maximise profits
        Trade unions aim to maximise the welfare of their members
        The government aims to maximise social welfare - total utility of all members of society
        Their main tool of economic policy is government spending, which is funded by taxes or borrowing. The gov gives money or services to households and firms (spending on transport, healthcare etc) and they take money away in the form of taxation
        HDI INDEX
        It only measures 3 indicators of human development; there is no mention of the range of products available to consumers, or the condition of the government/freedom of the people. For an economy to be developed, the population should be able to freely make a wide range of choices.
        The counter-argument to this is that if there were 10 different indicators in the HDI then it wouldn't give an accurate picture of the change in development, as it would be very difficult for countries to improve all 10 areas.
        The second criticism of the HDI is that it gives an equal weighting to each indicator, where some would argue that perhaps less should be given to GDP per head and more should be given to literacy rates.
        This also ties in with the argument that says that the indicators should be more specific; it's no good having 100% of the population in education if the quality of that education is bad.
        Similarly, life expectancy may be high, but at what cost? Perhaps cigarettes, alcohol, fast food, fizzy drinks (things people like) are banned, meaning that the population are healthier, but in no way happier.

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	Created by Kati Christova about 10 years ago