Week 9 slides growth&business cycle [core]

Week 9: The National Economy

Economic Growth and the Business Cycle

Key termsGross Domestic

ProductGross National

ProductNominal national

incomeReal national incomeActual economic

growthPotential economic

growth

Business CycleUpturnExpansionPeaking outSlowdown /

recession / slump

Measuring national incomeNOTICE:The difference between

Gross Domestic Product (GDP) – eg everything produced INSIDE the UK (it does not matter who owns it – UK or overseas company)

Gross National Product (GNP) = GDP plus net profits = GNP

[net profits from UK companies which are overseas]

Measuring national incomeNOTICE:The difference between nominal

(money) income - and - real national income (inflation-adjusted)

So – if nominal GDP = 5.4% and inflation = 3.7%

What is real GDP = 1.7%

Economic Growth and the Business Cycle

Two types of economic growth

Actual Growth

Potential Growth

Actual Economic Growth

percentage increase in national output (real GDP) from one period to another

Potential Economic Growth

The percentage annual increase in the capacity of the economy to produce

It measures what the economy could produce when all resources are employed at normal rates of utilisation

Allows a degree of spare capacity so is below full capacity

The Output Gap

The difference between the actual level of national output and its potential level

If actual > potential then output gap positive

If actual < potential then output gap negative

NB ‘potential’The highest level of sustainable, long-term

output

Two economic growth timeframes

In the short-run, ensure actual output is as close as possible to potential output

In the long-run, consider the determinants of the rate of potential economic growth

O

Growth and the production possibility curveGrowth and the production possibility curveG

ood

X

Good Y

a

b

Growth in actual output

O

Growth and the production possibility curveGrowth and the production possibility curveG

ood

X

Good Y

a

b

I II

Growth in actual output Growth in

potential output

Actual Growth and the Business Cycle

Business CycleThe short-run alternation between economic

downturns, known as recessions,

and economic upturns, known as expansions

Actual Growth and the Business Cycle

The phases of the business cycle Upturn Rapid expansion Peaking out Slowdown or recession

Length and magnitude of phases

O

Nat

iona

l out

put

Time

Actualoutput

Trendoutput

The business cycleThe business cycle

Full-capacityoutput

Why does actual growth fluctuate in the short-run?

Aggregate demand (largely)

A speedy increase in AD leads to shortages, which then lead to increased output (increased utilisation of resources – seen in a boom)

A decrease in AD leads to surpluses, which then lead to stocks of unsold goods – seen in a bust

What determines actual growth in the long-run?

Two determinants

The growth in aggregate demand (this determines whether potential growth will be realised)

The growth in potential output

O

Growth and the production possibility curveGrowth and the production possibility curveG

ood

X

Good Y

a

b

I II

Potential Growth

Two main determinants

The quantity of resources available

The productivity of those resources

Increases in the amount of resources available

Increases in the quantity of factorsCapitalLabourLand and raw materials?

Note the problem of diminishing returns

Increases in the productivity of resources

Main determinantsLand?

Capital

Labour

Other determinants of growthOther determinants

Economic and political stabilityStrong export performanceWillingness to change/innovateEffectiveness of capital marketsQuality of infrastructure

Benefits of Growth

Increased standard of livingPotential for work-leisure choiceCapacity to reduce povertyIncreased economic status and power

(including political)

Costs of GrowthIncome and wealth inequality?

Happiness deficit?

Environment may suffer more damage – pollution / depletion of non-renewable resources

Work pressures

DiscussionFor what possible reasons may one country

experience a persistently faster rate of economic growth than another? (remember that potential growth depends on the country’s resources, technology, and productivity)

Extension discussion

Are worries about the consequences of economic growth a ‘luxury’ that only rich countries can afford?

Extension discussion

Is it possible to find a middle road; that is, pursue economic growth but set constraints to growth.

consider costs and benefits

types of constraints