2.1 Economic growth

DEFINITIONS:

1. Gross Domestic Product (GDP): total value of output produced by factors of production in a given period of time.
2. Index numbers: a way of comparing a value of a variable with a base observation such as past period or location.
3. Nominal GDP : Total output measured in current prices. i.e. not taking into account inflation.
4. Real GDP: Total output but taking into account inflation.
5. GDP per capita: The average level of GDP per head of the population.
6. Short Run Economic Growth: An increase in actual GDP.
7. Long Run Economic Growth : Increase in productive capacity in an Economy.

Explain:

1. Economic growth

Economic growth refers to the increase in the real output of an economy over time. It is typically measured by the growth in Gross Domestic Product (GDP), which represents the total value of all goods and services produced within a country in a given period, adjusted for inflation.

There are two main types of economic growth:

• Actual Growth: This is the percentage increase in real GDP and represents the economy moving from one point to another on its production possibility frontier (PPF). It can be influenced by factors such as increased consumer spending, higher investment, and government spending.
• Potential Growth: This refers to the increase in the economy's capacity to produce, and it is represented by an outward shift in the PPF. This type of growth is driven by factors that improve the quantity and quality of factors of production, such as advancements in technology, increased capital investment, improvements in labour productivity, and structural changes in the economy.

Economic growth is essential for improving living standards, reducing poverty, and providing resources for investment in public services. However, it must be sustainable to avoid negative consequences like environmental degradation and resource depletion.

2. The policy objective of economic growth

The policy objective of economic growth aims to increase the real output of goods and services in an economy over time, typically measured by the growth rate of real Gross Domestic Product (GDP). Economic growth is pursued to enhance the overall standard of living, reduce unemployment, and generate higher income levels for the population. By expanding the productive capacity of the economy, growth can lead to increased investment, improved infrastructure, and technological advancements. Additionally, sustainable economic growth helps to increase government revenues through higher tax receipts, enabling better public services and welfare programs. Achieving consistent and stable economic growth is a key objective for policymakers to ensure long-term prosperity and economic stability.

3. The different stages of the economic cycle

The economic cycle, also known as the business cycle, consists of four main stages: expansion, peak, contraction, and trough. Here's a concise explanation of each stage according to the OCR A Level Economics specification:

1. Expansion (Recovery): This stage is characterized by increasing economic activity. During expansion, there is rising GDP, higher employment levels, increased consumer spending, and business investments. Inflation may start to rise as demand increases.
2. Peak: The peak is the highest point of the economic cycle. At this stage, the economy is operating at or near full capacity. Unemployment is typically low, and inflation may be higher due to strong demand. Economic growth begins to slow as the cycle reaches its maximum output.
3. Contraction (Recession): During contraction, economic activity begins to decline. GDP falls, unemployment rises, and consumer and business spending decrease. Inflation typically moderates or may even turn into deflation. A recession is technically defined as two consecutive quarters of negative GDP growth.
4. Trough: The trough is the lowest point of the economic cycle. Economic activity is at its weakest, with high unemployment and low consumer spending and business investment. This stage sets the stage for the next phase of expansion as economic conditions start to stabilize and improve.

The economic cycle is a natural fluctuation in economic activity over time and is influenced by various factors, including changes in consumer confidence, government policies, and external economic shocks.

4. Real and Nominal Gross Domestic Product (GDP)

5. Nominal GDP:

• Nominal GDP is the market value of all final goods and services produced in an economy, measured at current prices.
• It does not account for changes in the price level or inflation.
• Example: If a country produced goods worth £1,000 in 2020 and £1,200 in 2021, the nominal GDP would be £1,000 and £1,200 for those years, respectively.

6. Real GDP:

• Real GDP measures the value of all final goods and services produced in an economy, adjusted for changes in the price level (inflation or deflation).
• It provides a more accurate reflection of an economy's size and how it's growing over time.
• It is calculated by using a base year's prices to remove the effects of inflation.
• Example: If the base year is 2020, and the prices of goods produced in 2021 are adjusted to 2020 prices, Real GDP would reflect the actual increase in production, not just price changes.

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Changes in GDP Over Time

1. Economic Growth:

• An increase in Real GDP over time indicates economic growth, reflecting higher production and a better standard of living.
• Growth can be driven by factors such as technological advancements, increased capital, improved labour productivity, and favourable government policies.

2. Business Cycles:

• Economies experience fluctuations in Real GDP over time, known as business cycles, consisting of periods of expansion (growth) and contraction (recession).
• During expansions, Real GDP rises, leading to higher employment and income levels.
• During recessions, Real GDP falls, resulting in lower output, employment, and income levels.

3. Inflation and Deflation:

• Nominal GDP can change due to inflation (rising price levels) or deflation (falling price levels).
• Inflation increases Nominal GDP but does not necessarily indicate increased economic output.
• Real GDP adjustments allow economists to differentiate between genuine economic growth and changes in price levels.

By understanding the distinctions between Real and Nominal GDP and observing their changes over time, economists can gain insights into the true health and performance of an economy.

Explain & Calculate

2.1.2 Economic Growth Rates

Definition: Economic growth rate is the measure of the increase in a country's economic output, typically measured as the percentage change in Gross Domestic Product (GDP) over a specific period, usually a year or a quarter.

Calculation of Economic Growth Rates:

1. Determine GDP for two periods:

• Identify the GDP for the current period (GDP current).
• Identify the GDP for the previous period (GDP previous).

Example Calculation:

Suppose the GDP of a country was £2 trillion last year and has increased to £2.1 trillion this year.

2. Determine the GDP for two periods:

Interpretation:

A 5% economic growth rate indicates that the country's economy has grown by 5% over the specified period. This growth reflects an increase in the production of goods and services and can result from factors such as increased investment, technological advancements, or improvements in productivity.

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Factors Influencing Economic Growth:

1. Investment in capital: More investment in physical capital, such as machinery and infrastructure, can enhance productivity.
2. Technological advancements: Innovations and improvements in technology can boost efficiency and output.
3. Human capital: Education and training can improve the skills and productivity of the workforce.
4. Government policies: Policies that promote stability, infrastructure development, and efficient markets can facilitate growth.
5. Natural resources: Availability and efficient use of natural resources can contribute to economic growth.

2.1.3 GDP per Capita

Formula:

Calculation Steps:

1. Determine the GDP: The total value of all goods and services produced within a country during a specific period, typically a year.
2. Determine the Population: The total number of people residing in the country during the same period.

Interpretation:

• GDP per capita of £40,000: This means that, on average, each person in the country contributes £40,000 to the total economic output. It helps to gauge the average economic well-being of individuals in the country.

Significance:

• Comparative Analysis: GDP per capita allows for comparison between countries regardless of their population sizes.
• Economic Health Indicator: Higher GDP per capita typically indicates a higher standard of living and better economic health, though it doesn't account for income inequality or non-market transactions.

Limitations:

• Income Distribution: GDP per capita does not reflect the distribution of income among residents of a country.
• Non-Market Transactions: It does not account for non-market transactions such as household labour or volunteer work.
• Quality of Life: It does not measure the overall well-being or quality of life, as it focuses solely on economic output.

Understanding GDP per capita provides a clearer picture of economic performance on a per-person basis, making it a valuable tool for economic analysis and policy-making.

Explain with the aid of a diagram

2.1.4 Short Run and Long Run Economic Growth

Explanation:

Short Run Economic Growth:

• Definition: An increase in real GDP, representing a rise in economic activity within the economy over a short period. This is typically due to the better utilization of existing resources, such as increased labour or capital usage.
• Causes: Increases in aggregate demand (AD), such as higher consumer spending, government expenditure, investment, or net exports.

Long Run Economic Growth:

• Definition: An increase in the productive capacity of the economy over a longer period, leading to a higher potential output (shifting the long-run aggregate supply (LRAS) curve to the right).
• Causes: Improvements in factors of production, such as technological advancements, increases in the labour force, higher investment in capital, and improvements in education and skills.

Diagrams:

1. Short Run Economic Growth:

• Illustrated by a movement along the AD curve or a rightward shift in the AD curve in the short run aggregate supply (SRAS) diagram.

• Explanation: A shift from AD1 to AD2 leads to an increase in real GDP from Y1 to Y2, representing short-run economic growth.

1. Long Run Economic Growth:

The increase in LRAS is also mirrored through an outward shift of the PPF curve

• Illustrated by a rightward shift of the long-run aggregate supply (LRAS) curve.
• Explanation: A shift from LRAS1 to LRAS2 indicates an increase in the economy's productive capacity, leading to long-run economic growth.

Detailed Explanation with Diagrams:

Short Run Economic Growth:

The rightward shift of the AD curve from AD1 to AD2 leads to an increase in real GDP from Y1 to Y2, indicating short-run economic growth.

Long Run Economic Growth:

This diagram reveals the long run economic growth through the neo-classical method

The rightward shift of the LRAS curve from LRAS1 to LRAS2 represents an increase in the economy's productive capacity, resulting in long-run economic growth from Y1 to Y2.