Growth of the Economy And Cyclical Instability

Content

• Economic or business cycle• The Nature and Causes of Fluctuations in economic

activity• The trend rates of economic growth• The costs and benefits of economic growth• The use and limitations of national income as an

indicator of changes in living standards

Economic Cycle• This shows the rate of economic growth compared to long

term trend rates• The economic cycle shows differences over time between

rapid economic growth (boom, recovery) and alternative periods where the economy is not growing or is declining in size (recession or contraction)

• The measure used to assess the growth of the economy is the comparison of gross domestic product or GDP over time.

GDP - definition

• GDP – GROSS DOMESTIC PRODUCT– The Market value of all goods and services produced

within the country. – (what we produce within the UK/output)

What is the Business Cycle?

• Also known as the trade cycle• Most economies over time will see an trend of

upward progression• Does not grow smoothly – fluctuate going through

ups and downs know as the BUSINESS CYCLE

Time

Output

Stages of the Business Cycle• Boom – (peak) Fast economic growth

• Consumer spending and investment high• Business will have high demand for goods/services• Increasing incomes (increasing competition for workers)• Profits high (high demand for resources = prices rise can lead

to inflation)• Wages rising?• High output due to high demand• Steady economic growth• Business and consumer confidence high

Stages of the Business Cycle

Recession– (downturn/economic slow down) • Incomes start to fall• Output starts to fall• Possible fall in demand for products• Decline in profit• Lay off workers – unemployment• Consumer (save) and business confidence is low• Reduced investment

Stages of the Business Cycle

Slump– (depression)• High unemployment• Consumer confidence low• Investment low• Profits low• Closures• Any growth will be slow

Stages of the Business Cycle

• Recovery (expansion/ upswing)• Income starts rise• Output increases• Spending and consumer confidence increases• More employment as a result

Causes of Economic Growth

• Booms / dips in economic growth can occur due to a number of reasons:

1. Increase in aggregate demand caused by:• An increase in consumption – this may be caused by:

a rise in income levels, an decrease in interest rates, house price inflation

• A rise in the level of government spending• A balance of payments surplus

Cause of Economic Growth

2. Labour shortages – if there are shortages of workers in specific areas it means that the economy will not be able to utilise its resources efficiently and therefore economic growth will slow

3. Increase in demand for imports – this will worsen the balance of payments deficit

Demand and Supply side shocks

• Supply side and demand side shocks can lead to instability in the economy

• Shocks are unexpected events that influence the demand / supply in an economy

• As the UK operates in a global market their economy is open to shocks from across the world

Demand Side Shocks

• These can include:• A significant rise or fall in exchange rates in short

term • Changes in the rate of economic growth for

countries that you trade a lot with• Changes in aggregate demand • A boom in capital expenditure e.g. in construction or

ICT

Supply Side Shocks

• These affect the costs and prices of supply• These can include:

– Technology– Natural disasters which impact the supply of particular

goods e.g. crops– Political situations that influence the supply of particular

products e.g. oil

Trend rate of economic growth

• The trend rate of economic growth shows the rate of economic growth is the average rate of economic growth over a period of time

• The trend rate of economic growth is influenced by a number of factors of supply side including:– Investment– Education– Training– Technological change

Influences on the trend rate of economic growth - Investment

• Investment influences the trend rate of economic growth as higher levels of investment increase AD and expenditure within the economy

• In addition investment expenditure means there are more capital goods for workers to use to produce consumer goods therefore increasing the level of output in the economy

Influences on the trend rate of economic growth – Education and Training

• Education and training can increase the growth rate of the labour force in the economy

• These can both increase the trend rate of growth in labour productivity in the UK therefore driving the level of economic growth

Influences on the trend rate of economic growth - technology

• Changes in technology can reduce the costs of goods in the economy

• If the costs of supplying products decreases then production possibility frontier will shift outwards

The Costs and Benefits ofEconomic Growth

• There are costs and benefits that are associated with economic growth

• Some costs are a result of externalities which occur due to economic growth

• Economists focus on the idea of economic growth as being sustainable which means it can continue over the long term

The Costs ofEconomic Growth

• Economic growth causes costs for the economy:• Inflation risks – either demand-pull or cost-push• The environment – as output increases negative

externalities can increase e.g. pollution • Regional disparities or differences – Can lead to greater

differences between rich and poor• Inequalities of income and wealth – these can

Benefits of Economic Growth

• Economic growth has an accelerator effect on capital investment

• Increases taxation for the government • Environmental benefits – if the economy is growing

there is more money to invest in cleaner technologies thereby reducing pollution

The Benefits of Economic Growth

• Economic growth has a number of benefits:• Improvement to living standards and lower rates of

poverty – especially in developing countries• Falling levels of unemployment – Economic growth

stimulates levels of employment

Sustainability of Economic Growth

• The aim for most economies is sustainable economic growth• Factors of production are finite and more resources are being used at

an increasing rate which means sustainability to economic growth is being questioned

• Other renewable resources are being over used so this is decreasing the sustainability of economic growth

• If economies are to keep growing at the same rate new ways of using resources and strategies to reduce waste and resource consumption need to be enforced

The Use and Limitations of National Income as anIndicator of Changes in Living Standards

• Economic data:– GDP– GDP per capita– Disposable income– Working hours

• GDP figures show the total amount of income generated in the economy over a year

• GDP per capita looks at the income per person in the population• GDP per capita figures allow for comparison between countries • To compare figures they need to be converted into a common currency• To make relevant comparisons also need to look at the differences in the costs of

goods and services between countries – purchasing power parity

Limitations of National Income as anIndicator of Changes in Living Standards

• GDP figures alone cant be the only indicator of economic well being

• The black or shadow economy has a larger value in some countries than others and this will distort GDP figures by making them lower than they should be

Limitations of National Income as anIndicator of Changes in Living Standards

• GDP figures can also be problematic as they fail to account for regional disparities in countries and inequalities in income and wealth

• In addition GDP figures don’t offer any insight into quality of life – they could be used with working time figures to get a clearer view of a countries economy

Limitations of National Income as anIndicator of Changes in Living Standards

• Home working figures are not included in the values and therefore GDP may not be truly representative

• GDP could have grown due to an increase in consumption however if this is not matched by an increase in investment then it will lead to problems in the future as there are insufficient capital goods to produce consumer goods needed

• Changes in life expectancy increase living standards but are not accounted for by GDP figures

Other measures

• Other measures that can be used to compare standards of living can be used

• These include purchasing power parity which compares the cost of living in different countries

• Human development index• Human poverty index

Summary• The economic cycle shows the rate of economic growth over time in an economy• Boom periods are characterised by rapid levels of economic growth• A recession is a period where economic growth has declined• Changes in the rate of economic activity can be caused by factors that influence aggregate supply or

increase the productive capacity of the economy • Fluctuations in economic activity are caused by demand and supply side • The trend rates of economic growth shows the average rate of growth in the economy over a period of

time • Economic growth provides benefits including higher levels of employment and standards of living • Economic growth can also lead to costs including environmental damage and inflationary pressures• National income statistics can be used to compare the standard of living between countries• GDP figures can be crude indicators of economic growth and other factors should be considered