Download Economic Study Notes Economic Growth

Economic Study Notes
Economic Growth
- The description of economic growth
Nominal Gross Domestic Product (GDP): The value of output produced in an economy at current market prices
Real Gross Domestic Product (GDP): Refers to nominal GDP adjusted for price changes relative to some base year –
constant dollar terms
Economic Growth: Increase in the production of goods and services in an economy to improve standards of living
Measures of economic growth
Real Income: Real output i.e. money value of all goods and services produced in an economy in one year, adjusted
for inflation
Strength: Due to constant dollar terms it is possible to compare one year with previous years and countries
Weakness: Only measures goods and services which go through the market – ignores non-market production (e.g.
DIY, volunteer work) so not all activity is accounted for
Productive Capacity: Measures an economy’s economic output potential if resources were used fully and utilised
Strength: Economies changing ability to produce goods and showing of max output that is obtainable
Weakness: If worn capital goods are replaced and increase productivity they contribute to economic growth but if
the new capital does not improve productivity, then productive capacity may be a misleading indicator of economic
growth
Net Social Welfare: Measure included economic factors (output) as well as non-economic factors (quality of life,
pollution, leisure time)
Strength: Longer life expectancy, lower infant mortality rate and less transfer payments indicate higher standards of
living and are good indicators of economic growth
Weakness: Economic growth can lead to an unhealthy lifestyle (fatty foods, drinking, smoking, stress, heart disease)
and reduce life expectancy rates
Changes in real income:
-Arbitrary distribution of real income
-Real GDP per capita falling (population rising faster than output)
-Growth uneven across regions
-Adverse side effects (lower net social welfare)
-Increased output at the cost of less leisure time/increased stress levels (lower net social welfare)
-
The use of economic models
Circular Flow Model
Households
Producers
Money flow: Consumption spending
Real flow: Human resources– work of people e.g. workers
Natural resources – gifts of nature e.g. minerals, animals, plants
Capital resources – man-made goods used to produce other goods e.g. machinery
Entrepreneurs – people who organise factors of production and take risk
Producers
Money flow: Income
Real flow: Goods and Services
Human resources
Natural resources
Capital resources
Entrepreneur’s
Households
wages
rent
interest
profit
Savings
Households
Investment
Financial Institutions
Direct Tax
Households
Producers
Government Spending (Subsidies)
Government Sector
Producers
Transfer Payments
Indirect Tax
Import Payments
Producers
Overseas Sector
Export Receipts
Injections: An addition to the circular flow
-Consumption spending
-Investment
-Government spending
-Export receipts
Withdrawals: A subtraction from the circular flow model
-Savings
-Taxation
-Import payments
GDP = C + I + G + (X – M)
C= Consumption spending
I= Investment spending
G= Government spending (Excludes transfer payments)
(X – M)= Net Exports (export receipts – import payments)
Real flow: Increase if there is economic growth (output increases)
Decreases if there is unemployment of resources (esp. Labour)
Money flow: Increases if there is inflation
Limitations of circular flow model:
-some flows not shown e.g. government borrowing
-simplifies real life – economies are more complex
-size/speed of flows is not shown
-no ne social welfare
Production Possibility Frontier Model
Assumptions:
-two goods only
-fixed resources
-a given level of technology
Good are either:
Capital goods: Man-made goods used to make other goods and services
Consumer goods: Goods sold to consumers (individuals) for their own private use
-More capital goods now, fewer consumer goods can be produced
-Will increase economy’s future productive capacity but lower current standards of living because consumer goods
are sacrificed
-More consumer goods now, fewer capital goods can be produced
-Will increase current standards of living but future output may fall/only increase gradually as capital goods become
obsolete/worn out/not replaced – productivity declines
Slope of PPC: Illustrates increasing opportunity cost – diminishing returns (Resources more suited to the production
of one good over another)
Straight-line PPC: Illustrates constant costs (Resources equally efficient to the production of both goods)
Short-term economic growth: an economy moves from a point within the PPF to a point further out
Long-term economic growth: PPF will move outwards to the right when the productive capacity of an economy rises
Economic growth: Outwards shift of PPC or moving closer to frontier
-New resources discovered
-Investment takes place
-New technology is developed
NB: “Present Consumption” – Production of consumption goods opposed to production of capital goods
-
The causes of economic growth
Increasing output from existing resources / increasing quantity of resources available:
NB: Discovery of new resources (coal, gas, oil) may increase economic growth in the short run but may slow growth
as resources are overexploited
Increasing quality / quantity of human resources:
Quantity as a result of net migration gain or natural increase in population
Quality has direct bearing on output per worker (productivity). More output at same costs = productivity increased =
more competitive
Quality improved through education form institutions (universities) and training programmes supplied by firms
Investment (Replacement or new)
Replacement investment replaces capital goods that are depreciating (wear and tear reducing productive capacity)
for constant demand
New investment only takes place for rising demand
Investment in new technology enables existing resources to be used more efficiently, increasing productivity and
output
Market interest rate less than internal rate of return:
Reward for capital goods is interest. If market interest rates are higher, firms will invest money in interest bank
accounts than buy capital goods. If money is to be borrowed to finance investment, the reward must be higher than
the payment
Savings: Sufficient savings required to borrow for investment form financial institutions
Reached capacity: Only buy capital goods if existing capital goods are fully utilised
Cost of labour: If wages rise faster than cost of capital – labour will be replaced by capital – more routine
tasks/heavy tasks
Importance of world events
e.g. World Rowing Championships, Rugby/Netball World Cups stimulate growth prior and during the events
-Facilities build/upgrade to meet hosting requirements – increasing output and growth prior to event
-Business confidence increases investment to cater for visitor numbers – increasing growth
-Increased consumption spending of tourists will increase demand and thus output – increasing growth
e.g. 9/11, SARS, worldwide recession/boom will impact growth
-If NZ is viewed as safe destination – tourist numbers will increase = sales increase = output increases = economic
growth
-Loss of export markets due to downturn in markets overseas = exporters incomes falling = aggregate demand
decreasing = lower levels of economic growth vice versa
Obstacles to growth:
Productive capacity determined by quantity and quality of resources available
Poor countries:
-Spend time growing crops to feed themselves
-Little surplus to sell
-Little saving as all food production is consumed
Lack of:
-Technology and investment
-Economic and social infrastructures (communication, access to energy, roads, highways)
-Education (workers less skilled, less productive = growth hindered)
-Clean water (drinking, cooking, and washing)
-Public health systems (hospitals, sewerages, vaccinations)
Too much:
-Corruption
-Political instability
-Pollution
-Exploitation/destruction of natural resources
-
The effect of economic growth
Positive:
Employment
-Stimulate employment and decrease unemployment (may not be evenly distributed)
Government revenue
-Tax revenue increases = less welfare spending = can upgrade health, education, public services
Increased investment and new technology
-Demand for more investment = larger capital projects = improved working conditions = reduce working week =
increase leisure time
Better business confidence
-Businesses increase employment opportunities, plans for future investment, better forecasts, better returns
(dividends)
Improved living standards
-Household incomes increase = increased demand = more goods and services available (GDP per capital increases if
population has not grown faster)
Negative:
Risk of inflation
-If economic growth has been triggered by increase in AD = price level will increase = possibly sustained by costpush/demand-pull
Environmental impact
-Accelerated use of resources affects standards of living and growth of future generations as non-renewable
resources depleted
-Waste and pollution can destroy animal/plant habitats
-Toxins endangering lives
-Global warming affecting sea levels and climate changes
-Size of ozone hole leads to skin cancers/damage to crops
Inequality of income
-Greater inequality through increased incomes = regions may miss out = social tension as the gap between the
“haves” and “have nots” widens
-Some unable to access benefits due to less educated, social/political discrimination
Diseases of affluence
-Processed fats/sugars, too little exercise, over indulgence = heart diseases, obesity, diabetes
Uneven impact of growth
-Growth not experienced evenly across regions within a country
-Some industries may grow (sunrise) stimulating employment, incomes and growth while others decline (sunset)
-Individuals shift regions to better job prospects/job opportunities
-Some regions better situated to take advantage of growth opportunities
Calculating Gross National Product
Gross Domestic Expenditure (GDE)
Expenditure method: Calculating spending from households, government, producers, net flow of external sector
i.e. C + I + G + (X –M)
C: Final consumption expenditure private – spending by households on goods and services
+ I: Gross fixed capital formation – investment spending by producers “Gross” – no allowance for depreciation
+ G:Final consumption expenditure government – Local and central government spending on goods and services
(not incl. Investment and transfer payments)
+ Changes in inventories – Changes in values of stocks of goods held
+ X-M: Net exports – Exports of goods + services – imports of goods + services
+ Statistical discrepancies: Differences accounting for errors made between different GDP calculations
Gross Domestic Income (GDI)
Income method: Sum of incomes accruing to factors of production
Compensation of employees – wages, salaries, royalties, commissions etc
+ Gross operating surplus – (Operating surplus (company profits) + consumption of fixed capital (depreciation) )
+ Indirect taxes – e.g. GST, import taxes, company tax
- Subsidies
Gross Domestic Production (GDP)
Production method: Using values added to each stage of production of each industry
Primary industries – agricultural e.g. fishing, forestry, mining
+ Secondary industries – manufacturing e.g. electricity, construction
+ Tertiary industries – retail trade and services e.g. accommodation, restaurants, transport, communications, shops