Economic growth

Key terms Economic growth is an

*economic growth: an increase in increase in the real output
the production of real level in an economy . For real
of output in an economy. It is growth to occur it needs to
possible to distinguish be greater than the
between actual and potential increase in inflation.
growth in national output Economic growth can be
measured either in terms on
*Real GDP: nominal GDP adjusted GDP or GNP but it is usually
for changes in inflation, referred to as change in
sometimes called GDP at real GDP
constant prices. Measurement of economic growth
*nominal GDP: total value of The most widely used
goods and services at measurement of economic
current prices. growth is GDP, although GNP
is also used. It is measured
as the percentage rate of increase in real GDP, allowing
therefore for effects of inflation. To allow for comparison
of economic growth either over time or between countries, it
is often measured in terms of GDP per capital thus allowing
for differing sizes of population.
Distinction between growth in nominal GDP and real GDP
Nominal GDP is the value of goods and services using current
prices. Real GDP is nominal GDP adjusted for changes in inflation.
It is sometimes referred to as GDP at constant prices. If
inflation is positive, real GDP will be lower than nominal . If
inflation is negative - deflation- then real GDP will be higher than
nominal. To move from nominal to real GDP we use the GDP
deflator which measures price changes from a base year
 Causes of economic growth
Economic growth can be caused by either shifting AD or AS curves
outwards.

Demand side Supply side

Government expenditure - leading
to higher G
Increased investment

Tax cuts - leading to higher C and I Improved technology

Lower interest rates - leading
Larger workforce
to higher C and I
Higher real wages - leading to more Discovery or development of
C natural resources
Depreciation of the currency - Higher labor productivity,
leading to more X and less M including education and training

Many of the causes mentioned above are closely related. Some

of them are developed below, while others, such as
depreciation, are explained elsewhere

# Government expenditure is mainly in the form of investment

in new or improved infrastructure such as roads and rail and
power supplies. Improved transport allows goods and people
to flow more freely and thus facilitates production .
# Lower tax rates allow individuals to spend more and firms to
invest more, while lower interest rates have similar effects.
# Higher real wages mean that individuals are better off and
feel able to spend on goods and services
# Increased investment is the spending on capital goods
including equipment and machinery. This is likely to increase
output and also improve the quality thus leading to greater
sales. It will also lead to greater labor productivity
# Improved technology means that more can be produced with
the same quantity of capital. This is likely to lead to greater
labor productivity
# Improved education and training affects both the quality and
quantity of goods and services. Increasing education and
training leads to a more literate and skilled workforce and thus
greater labor productivity
# Discovery/ development of natural resources has stimulated
growth in many countries e.g. oil for Saudi Arabia and Norway or
copper in Zambia.

Consequences of economic growth

Traditionally economic growth has been looked on as an
‘economic good’, but it is clear that this overlooks the
considerable costs involved both in terms of human lives, culture
and the environment.
Benefit Costs
Increase in business and consumer Lower quality of life - due to rapid
confidence- growth should encourage urbanization leading to poor housing and
business to take a positive view of the overcrowding together with greater
economy and want to invest, innovate and use stress, breakdown of family networks
new technology. Consumers will be more willing and inferior air quality. This may also
to spend and thus increase aggregate demand involve an opportunity cost, e.g. more
if they feel that the economy is doing well income, but a poorer quality of life
-

Increased tax revenue- to fund better Unequal benefits- growth is likely to mean
infrastructure, schools, hospitals and to changes in economic structure and ways
provide benefits for the poor etc. This of production, leading to some people
increase in revenue will come from more becoming unemployed while others gain
output/higher incomes and profits rather from more work of opportunities.
than from higher taxes Equally, growth may mean some workers
suffer more stress in terms of both
having to learn new skills, but also having
to work longer hours etc.

Environmental damage- resulting from

Rise in the standard of living- leading to more pollution from factories, cars etc.
reduction of absolute poverty. In addition Damage to the landscape by extracting
there should be more consumer goods mineral resources and in terms of
depletion of non renewable resources.
Global warming is another factor here
 Benefits Costs
Improved education and health - Opportunity costs: if a country is
literacy rates should rise while on its production possibility
infant mortality and death rates frontier then more investment in
should fall together with the number capital goods can only happen if
of people dying from diseases there are less consumer goods, i.e.
current consumption will fall

Sustainable economic growth requires that resources are both

used and conserved for future use.
Demand for natural resources is greater than the potential
supply so if nothing is done they will no longer exist. This has led
governments all over the world to think about how to manage
use so as to support growth while, at the same time, conserving
resources.
 Unemployment
Key terms Unemployment means those
*unemployment; those people of people of working age who
working age who are actively are actively seeking work at
seeking work at the current the current wage rate, but
wage rate have been unable to do so. It
*Unemployment rate: the does not include people who
percentage of the working are pensioners, full-time
population who are unemployed students, or those who
*Labor force survey: a survey of a choose to stay at home,
sample of households, counting perhaps to look after
people as unemployed if they children. These are regarded
are actively seeking work, but as inactive
do not have a job Measures of unemployment
*Claimant count: measured One common way of looking
unemployment according to the at unemployment is to
number of people claiming refer to the unemployment
unemployment benefits. rate. This is the percentage
*sampling: when a proportion of the working population
of the population is taken as a who are unemployed. This
representative of the whole. can be measured by:
The figure for the total is no of people out of work
based on the sample being Unemployment rate: ——————————— X 100
working population
accurate measuring unemployment
seems easy at first; just
count up all those who are
unemployed. It is not, however, that simple. Firstly, there are
different ways of measuring unemployment and these can vary
between countries. The International Labour Organization (ILO)
uses the labour force survey and this is used for international
comparisons.
The UK also uses the claimant count, which relates to those
registered as unemployed and claiming the jobseeker's allowance.
Those people who are not eligible for this, or who have not
registered, are not included. This results in the labour force survey
giving a higher figure than the claimant count. The labour force
survey, however, is subject to sampling errors and may not be
entirely representative.
In addition to the possibility of different measures, there are a
number of other problems:

• Inactive workers. Although some of these are genuinely not

interested in work, e.g. those who have retired early, many would
work if either their situation changed, e.g. mothers or fathers
with young children, or if the wage rate was more attractive.

• Discouraged workers are those who are willing and able to

work, but because they have had no success finding a job have
given up actively seeking employment.

• Part-time workers. Many of these may be working part time

because they wish to, e.g. mothers or fathers with children at
school may want hours which fit with the school day. Others,
however, may want to work full time. These are counted as
employed, but could be seen as semi-unemployed.

• Unreported legal employment. Some workers may register as

unemployed to collect state benefits, but in fact work, thus
defrauding the state.
Unreported illegal employment. The so-called "underground
economy" consists of illegal activities, such as gambling, the sale
of drugs and prostitution. People engaged in these illegal
activities, however, are in employment but are registered as
unemployed.
 Causes and types of unemployment
The causes of unemployment are something that different
schools of
economists have differing views about. Causes are not the same
as types See below, although they clearly overlap.
Classical economists maintain that unemployment is due to trade,
or business, cycles which the market is capable of putting right.
Monetarists maintain that external interference in the labour
market causes supply to not equal demand. They would argue that
factors such as minimum wage laws, restrictive union practices,
taxes on companies, unemployment and other benefits, and
regulations and red tape which detract from production and
employment all prevent the market from clearing.
Occupational or geographical immobility will have the same effect.
Keynesians emphasise the cyclical nature of unemployment and
that lack of aggregate demand for goods and services reduces
the demand for workers. This can best be corrected by
government intervention to increase demand.
Marxists claim that it is in the interest of owners to have
unemployment, the "reserve army of labour", as this keeps wages
low thus reducing costs. Their solution is to abolish capitalism and
replace it with socialism.

Different types of unemployment

*cyclical or demand deficit or general: Caused by the trade cycle and
occurs during the downswing of the cycle becoming severe during
the recession. This is the classic Keynesian unemployment due to
lack of aggregate demand in the economy as a whole.
*frictional : This is unemployment that cannot be removed. It
consists of those who are moving from one job to another, but
have not vet started this new work.
*seasonal: In some industries the demand for workers depends on
the time of the year. This is especially the case in industries such
as agriculture, building and tourism.
 *sructural: This is caused by a permanent fall in demand for the
products of an industry. It is caused by either resources being
exhausted or by a country losing its comparative advantage. It
is often associated with rising labour costs causing labour-
intensive industries to move to low-cost countries.
*technological: This is a form of structural unemployment caused by
technology replacing labour.
Consequences of unemployment

Key terms
Unemployment leads both to a
NAIRU: the non-accelerating
wastage of resources and to
inflation rate of
the opportunity cost of lost
unemployment, ie. the specific
potential output. This can be
level of unemployment that
seen in Figure 4.13 where the
exists in an economy that
economy is operating at point
does not cause inflation to
X. It has both economic
increase.
consequences for the
Hysteresis: the tendency for
economy and the individual as
unemployment to lead to
well as social consequences.
longer-term unemployment.
Economic consequences
Quantity of
goods
include the following:
Fig 4.13

• Labour resources are

wasted not only because
output is below what it could
C be, but also because the
Z resources invested in
education and training are
A
not being utilised.
Y
• Fall in living standards as
X unemployment means less
income leading to lower
consumption.
0 B D Quantity of service
• Lower aggregate demand not only from those made
unemployed, but also from those in employment deciding to save
more, and consume less, in case they are made unemployed. This
fall in consumption then leads to further unemployment and the
development of a deflationary gap. The rise in savings can lead
to a reverse multiplier effect.

• Rise in NAIRU as those made unemployed find that their skills

become outdated so that it is harder to find work, leading to a
lack of confidence and motivation and higher long run
unemployment. This is sometimes called the hysteresis effect.

• In many countries governments provide unemployment

benefits, so a rise in unemployment means more money is spent
on these benefits. This increases the cost to the taxpayer of
having to support these people when governments are receiving
less revenue from both incomes and consumer expenditure. This
can lead to a budget deficit.

• Regional problems, as unemployment is often concentrated in

certain areas of a country. This can lead the younger and the
more enterprising people in the area to move away, making it
even more depressed and unlikely to attract new jobs.

• Income inequality can be widened as more people go into

relative
poverty.

Social consequences include the following:

• Health: in some countries the loss of income can make it more

difficult to provide medical care, while in others financial
worries can cause both mental and physical health problems and
even higher suicide rates.
• Education: where education has to be paid for, families may be
tempted to save money by withdrawing children from schools
while at the same time sending them out to work to bring in more
income.

• Family: the stress of unemployment can cause divorce and

family break-ups if homelessness occurs. It can lead to higher
crime rates as people are desperate to survive.
 Price stability
Key terms Inflation can be said to
Inflation: a fall in the value of occur when prices rise and
money shown by a persistent what you can buy with your
rise in the general price level. money falls. This is known as
Alternatively, inflation Is a money value. If, to start
persistent rise in the general with, you had one unit of
price level leading to a fall in the your currency and could buy
value of money. five oranges with it, but then
Deflation: a fall in the general later found that you could
price level. only buy four oranges, you
Disinflation: when the general would be facing inflation. The
price level rises at a slower purchasing power of the
rate. currency has fallen. In
general, inflation is when
most prices rise so that the
the cost of living increases, i.e. it costs people more to buy the
same goods and services. It is possible for some prices to fall
even though prices in general have risen. The rate of inflation is
the rate at which the general level of prices is rising over time and
it is usually expressed as an annual rate.

Deflation is the opposite of inflation. It is when the general price

level falls. In this case the rate of inflation is negative. Using the
example of buying oranges in this case you would find that your
money could now buy six oranges. The purchasing power of the
currency has risen.

Disinflation is the slowing of the rate of inflation. The purchasing

power of the currency is falling at a slower rate. It is often
associated with periods of low inflation such as many countries
had from 2018-20.
 Measurement of changes in the price level

Consumer price index

Key terms The UK and many other
Consumer price index: a measure of
countries use the consumer
the weighted average of prices
price index (CPI).
of a basket of goods and
This is often referred to as
services purchased by
the harmonised consumer
households.
prices index and is widely
Base year: the year which is chosen
used for international
as the point of reference for a
comparisons. Other
comparison of prices in other
countries use the retail
years.
price index (RPI).
Weights: values given to items in an
Price indices are usually a
index to show their relative
weighted average of prices
importance.
Household expenditure: for goods and services. To
the total expenditure by construct an index a base
consumers resident in a country year is chosen and the
whether at home or abroad average price level for that
minus expenditure by visitors on year given the value of 100.
goods and services. This allows price changes to
be expressed as a
percentage change.
A weighted index is used because the weights express the relative
importance of each item in the index. For example, a change in the
price of food is likely to have more effect on household
expenditure than a change in the price of cinema tickets. These
indices are used to measure the rate of inflation.

This can be calculated by: Index for year 2

———————— X 100
Index for year 1
The CPI is constructed by:
1 choosing a base year against which price changes are measured
- this is given the value of 100.

2 selecting the items bought by an average family, the basket of

goods.

3 giving each item a weight showing its relative importance in the

average family budget.

4 obraining new prices for each item from a wide variety of

different
sources across the country.

5 taking this new price for each item and multiplying by its weight
to give the weighted price relative.

6 caking the sum of the weighted price relatives and dividing by the
sum of the weishts to give the change in price index.

Possible difficulties in measurement

There are a number of problems with these indices:

• The base year needs to be one in which there are not unusual
Actuations in prices, otherwise future calculations will be
misleading.

• The basket of goods may not be representative of all groups

(e.g. pensioners); different groups of people have different
baskets of goods and services - they may, therefore, have a
different cost of living.

• Unless the basket is regularly updated the goods and services

included may not represent current expenditure patterns.
• Change in quality/type of good, e.g. mobile phones have many
more features than they had ten years ago.

• The importance of goods and services may change, i.e. weights

need to change.

• There are different measures, e.g. RPI and CPI.

Distinction between money values (nominal) and real data

Key terms Prices, and other figures

Money data, money values nominal measured in money, can be
prices: were figures are quoted either as money data
expressed in current prices (money values), or nominal
Real data: where figures are prices or as real data prices.
adiusted for the change in The difference is that money
the value of money rate of wages, for example, are the
inflation/price level). actual wage that people get,
Demand-pull inflation:
occurs when the total while real wages represent what
(aggregate) demand in the that money can buy.
economy exceeds the total Real data is the money data
(aggregate) supply. adjusted for changes in the
Cost-push inflation: Occurs price level. If prices have risen
when the cost of supplying by 5 per cent then a 6 per cent
goods and services is wage rise means that the real
increased, causing a rise in wage has gone up by 1 per cent,
the cost of final prices. the difference between the
wage rise and the rate of
inflation.
This is an important distinction

and you will meet it in many situations in economics, e.g. gross

domestic product.
 Causes of inflation: cost-push and demand-pull inflation
Many economists argue that inflation is the result of either an
increase in total demand which pulls up prices (demand-pull
inflation) or an increase in the costs of production which
pushes prices up (cost-push inflation).

Demand-pull inflation usually happens when the economy is near

its full employment level. In this situation resources are unable
to supply sufficient goods (scarcity of resources) to meet
demand. This results in prices being bid or forced upwards in
order to bring aggregate supply and aggregate demand into
equilibrium.
Cost-push inflation is caused by, three different factors:

• The most common factor today is the rise in the cost of raw
materials forcing up the costs of production. This is seen, in
particular, by the rise in the price of energy sources, especially
oil. Many other raw materials, as they become scarcer relative
to demand, have risen steeply in price.

• Where trade unions are powerful, they can push up wages in

excess of productivity gains. This means that costs of
production rise so that producers raise their prices so as to
maintain profit levels. This was common in countries such as the
UK in the 1960s and 1970s.

• Monopolies can raise prices due to the lack of competition.

This is often linked to the rise in wages with producers using the
wage rise to justify even higher price increases.

The latter two give rise to a wage-price spiral as rising wages

push up prices leading to more wage demands.
Monetarists, such as Milton Friedman, have argued, however,
that the sole cause of inflation is an excess in the money supply
and the velocity of its circulation. This stems from the Quantity
Theory of Money. They would maintain that demand-pull and cost-
push are then a result of this. If governments, or central banks,
increase the money in circulation by more than the increase in
real output then the excess is "soaked up" by a rise in prices.

Consequences of inflation

It is important to realize that inflation is the

historical norm