2 10 Economic Growth How is economic growth

2. 10 Economic Growth How is economic growth measured? Why might a government pursue a policy of economic growth? ECON 2: The National Economy

2. 10 What you need to know �What is meant by the term economic growth �The distinction between short-run and long-run economic growth �The demand-side and supply-side determinants of economic growth

2. 10 You should be able to: �Define the term economic growth �Illustrate with diagrams the difference between shortrun and long-run economic growth �Analyse and evaluate the various demand-side and supply-side determinants of short-run and long-run economic growth

Definition We need to distinguish between short-run and long-run economic growth. Short-Run “The actual annual percentage change in real national output”. Long-Run “An increase in the potential productive capacity of the economy. ”.

How is it measured? Again, using the distinction between short-run and long-run. Short-Run The annual percentage change in Real National Output Or Gross Domestic Product (GDP) Long-Run The maximum potential output of the economy using all factor resources as illustrated on the Production Possibility Frontier.

Causes of Short-Run Economic Growth �In the short-run, the primary cause of an increase in economic growth is an increase in aggregate demand �Recap: AD = C + I + G + (X-M) �Economic growth can also occur if there is an increase in short-run aggregate supply �Recap: SRAS will increase if there is a change in the costs of production (wages, price of raw materials, taxes/subsidies, exchange rates)

2) If there is an increase in AD to 1) Begin with the 3) Or if there is an increase in equilibrium position. AD 1, there will be economic SRAS to SRAS 1, there will also be growth from Y to Y 1. economic growth from Y to Y 1. Price Level SRAS 4) If economic growth is SRAS 1 caused by an increase in AD, this will lead to an P 1 increase in the price level to P 1, but if caused P by an increase in SRAS, P 2 will put downward AD 1 pressure on prices to P 2. AD Y Y 1 Real National Output Short-Run Economic Growth Diagram

Causes of Long-Run Economic Growth For long-run economic growth to occur, there must be an increase in the productive capacity of the economy, that is to say an increase in long-run aggregate supply. Recap. Increases in long-run aggregate supply can occur if there is a change in the quantity or quality of factors of production. �Land �Labour �Capital �Entrepreneurship �Government Intervention

Long-Run Economic Growth Diagram (1) The long-run productive capacity of the economy can be demonstrated on a Production Possibility Frontier (PPF) diagram. Consumer Goods X 2 X 1 1) Initially, with all factor resources fully employed, an economy can produce combination X 1 Y 1 of consumer and capital goods. It cannot produce goods beyond the boundary of the red PPF. 2) If there is an increase in factor resources, for example a growth in the size of the labour force, the PPF will shift to the right. 3) The economy can now produce combination X 2 Y 2 of consumer and capital goods. 4) Just because the economy has the capacity to produce X 2 Y 2, this assumes that all resources are fully employed, which may be difficult to achieve in the short and long-run. Y 1 Y 2 Capital Goods

Long-Run Economic Growth Diagram (2) 1) Using the Classical model, begin with the equilibrium position. Price Level 2) If technological processes become more efficient, there will be an increase in productive capacity. LRAS 1 3) LRAS will shift to the right. 4) Real national output will increase to Y 1, representing economic growth. In addition, the price level will fall to P 1. P P 1 AD Y Y 1 Real National Output

UK Economic Growth Look at the chart tracking UK Economic Growth. Can you find out the causes of the changes observed over the period. Split them into demand-side and supply-side. Source: ONS from BBC News

Evaluating Economic Growth �It is important that the government find a balance between short-run and long-run economic growth policies �Stimulating the demand-side of the economy is vital, but if supply-side of the economy remains constrained, high levels of inflation are likely to occur �Equally, focusing on improving the supply-side of the economy will have limited effect if the demand-side of the economy is suppressed. There will likely be significant spare capacity and unused resources �However, the enhancement of the supply-side of the economy has significant time-lags attached, and not all capital investment yields the desired improvements in productive efficiency

Multiple Choice 1 �Economic growth is usually measured by a) the retail price index b) real national income c) the output of the manufacturing industry d) consumer expenditure ü Can you explain your answer?

Multiple Choice 2 Consumer Goods Y X � The economy is initially operating at point X. Assuming there is no change in the production possibility frontier, a movement from X to Y indicates a) underlying economic growth. b) an increase in spare capacity. c) a rise in real national income. d) an improvement in technology. ü Can you explain your answer? Capital Goods

Multiple Choice 3 �Other things being equal, increased innovation in an economy is likely to lead to a a) fall in the equilibrium level of output b) fall in the size of the labour force c) leftward shift of the aggregate demand curve d) rightward shift of the long-run aggregate supply curve ü Can you explain your answer?

2. 10 You should be able to: �Define the term economic growth �Illustrate with diagrams the difference between shortrun and long-run economic growth �Analyse and evaluate the various demand-side and supply-side determinants of short-run and long-run economic growth