1. 2.10 Economic Growth How is economic growth measured? Why might a government pursue a policy of economic growth?

2. 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

3. 2.10 You should be able to: Define the term economic growth Illustrate with diagrams the difference between short- run and long-run economic growth Analyse and evaluate the various demand-side and supply-side determinants of short-run and long-run economic growth

4. 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.”.

5. 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.

6. 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)

7. Short-Run Economic Growth Diagram Price Level Real National Output SRAS P Y 1) Begin with the equilibrium position. AD 2) If there is an increase in AD to AD 1, there will be economic growth from Y to Y 1. 3) Or if there is an increase in SRAS to SRAS 1, there will also be economic growth from Y to Y 1. AD 1 P1P1 Y1Y1 4) If economic growth is caused by an increase in AD, this will lead to an increase in the price level to P 1, but if caused by an increase in SRAS, will put downward pressure on prices to P 2. SRAS 1 P2P2

8. 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

9. The long-run productive capacity of the economy can be demonstrated on a Production Possibility Frontier (PPF) diagram. Long-Run Economic Growth Diagram (1) Consumer Goods Capital Goods Y1Y1 X1X1 Y2Y2 X2X2 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.

10. Long-Run Economic Growth Diagram (2) Price Level 1) Using the Classical model, begin with the equilibrium position. 2) If technological processes become more efficient, there will be an increase in productive capacity. 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. Real National Output LRAS P Y AD P1P1 LRAS 1 Y1Y1

11. UK Economic Growth Source: ONS from BBC News 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.

12. 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

13. 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 Can you explain your answer?

14. Multiple Choice 2 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. Can you explain your answer? Consumer Goods Capital Goods X Y

15. 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 Can you explain your answer?

16. 2.10 You should be able to: Define the term economic growth Illustrate with diagrams the difference between short- run and long-run economic growth Analyse and evaluate the various demand-side and supply-side determinants of short-run and long-run economic growth