## Economic Growth and the Business Cycle

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mscmbevan  on July 19, 2012

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# Economic Growth and the Business Cycle

 Define Economic GrowthThe increasing capacity of the economy to satisfy the needs and wants of its members/ the population. or the increasing ability of a country to satisfy the material wants of it people
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#### Definitions

Define Economic Growth The increasing capacity of the economy to satisfy the needs and wants of its members/ the population.
or
the increasing ability of a country to satisfy the material wants of it people
How is Economic Growth measured growth in GDP (Gross Domestic Product) is widely used to measure economic growth
Define Gross Domestic Product the total market value of all final goods and services produced in a country during a period of time (usually a year)
(the key word here is final)
Apart from Nominal GDP there are two other forms of GDP - what are they GDP per capita can be used - this measures GDP per person
Real GDP can be used - this is GDP in constant dollars to take into consideration price changes
What is the formula or using Nominal GDP to measure Economic Growth GDP Growth = GDP2 - GDP1
______________ x 100

GDP 1
where GDP2 is the second year - and GDP1 is the first year
What is the formula or using Real GDP to measure Economic Growth To Calculate Real GDP:
Real GDP 2 = nominal GDP (2) x CPI (year 1)
__________
CPI (year 2)
You should get a lower number
define Real GDPReal GDP is gross domestic product in constant dollars. In other words, it is a nation's total output of goods and services, adjusted for price changes. Real GDP can be compared to nominal GDP, which is GDP in current dollars, (i.e. the nation's output in actual dollars in a given year). Here's an example: suppose in year 1 a country produced a total of five widgets**** priced at \$10 each, or \$50 total. In year 2, it produced the same five widgets, but the price rose to \$12, or \$60 total. Assume year 1 is the base year used to calculate real GDP. In year 1, nominal GDP was \$50 and real GDP was also \$50. In year 2, nominal GDP was \$60; but real GDP was only \$50, because in constant (year one) dollars, only \$50 in widgets were produced. By eliminating the effect of price changes, real GDP allows economists to make useful comparisons of a nation's output and services. Note that real GDP is also known as constant-price GDP and inflation-corrected GDP.
How is GDP per capita measured Real GDP per Capital = Real GDP
____________
Population
What does evaluate mean in assessment items? • form a critical opinion of
• to consider both sides and make a judgment about it; = assess
• Assess, judge, and conclude
what are some of the methological and definition issues surrounding using GDP as a measure of growth?You should be able to list and explain all of these: refer to notes for more information
• GDP does not describe how the benefits of growth are distributed throughout the economy
• GDP understates improvements in working conditions
• GDP does not measure changes in productivity
• Living Standards: GDP data measures the traded aspects of material welfare, but says little about non material (quality of life) aspects of welfare
• Types of Goods: Many goods and services produced under GDP raise GDP but not necessarily raise living standards (defence items)
• GDP does not account for durable goods
• GDP measures value of G & S which are exchanged in the market but does not account for non-market production which makes us a significant component of our welfare.
• GDP does not measure changes in overseas trading relationships - the link between prices received for exports and price paid for imports
• GDP does not measure improvements in the quality of G & S over time
• GDP does not measure the costs of growth
Despite the critisims of GDP is it a good measure of growth?• although alternatives can be used Each of these alternative measures describe the definitional problems associated with GDP, but each has their own methodological problems such as what to include and what to exclude, and how to value goods, services and amenities.
• For this reason, the 'least worse' measure of growth is still GDP because it provides a relatively consistent measure of value over time
what are alternatives to using GDP (real, nominal and or GDP per capita) to measure growth? • Socioeconomic and economic development indicators which measure changing welfare over long term
• Total Quality of Life Index (TQLI)
• Genuine Progress Indicator (GPI)
What model can we use to show Economic Growth?
Outward movement of the Production Possibility Frontier- affects the future production and consumption possibilities for the community) It makes previously unobtainable combinations possible.
explain some benefits of economic growth• Increases material welfare throughout the economy
• Increases level of real income
• Increases consumption of more goods and services (both in terms of quantity and quality)
• Helps the community achieve such goals as:
o More community infrastructure
o improved standards of community health
o high level of education
o a more even pattern of wealth distribution
o improved working conditions
• Generally compatible with the macroeconomic objective of full employment
o Growth creates demand for productive resources, including labour
• (so long as the rate of growth exceeds the rate of growth of pop and work force)
• Generally growth has to be > 3.5% for the unemployment rate can be reduced
o Determined by improvements in productivity and structural change
• EG may not effect sectors where capital for labour substitution has occurred, where productive processes are no longer profitable, or where products are no longer in demand ( matches vs lighter, Walkman, ipod etc)
o Higher employment will tend to breed more growth because more is produced and aggregate levels of expenditure rise
explain some costs of economic growthHigh rates of growth may conflict with macroeconomic and social objectives
The problems associated with the pursuit of materialistic goals leaves many people perceiving that the problems associated with economic growth reduce their standard of living or economic welfare.
These Costs Are:
• Increase demand for imports for both capital and consumer items
o Conflict with external stability if the higher demand for imports is not matched by increase in exports
• Structural Unemployment
• Inflation
o If there is no excess cpity there will be periods of inflationary pressure
o GDP does not account for 'bads' such as pollution and resource depletion
o A wealthier society may show more interest in the environment however is more likely to harm it
• social dislocation and other social problems
o crime, stress related diseases, suicide, loneliness and the break up of the family unit
o 'due to the pursuit of materialistic goals'
what are the detemrinants (sources) or growthDemand Factors: increases in...
Population
Income
Supply Factors: the quantity and quality of productive resources
• Land
o Exploration
o Reclamation
o Scientific techniques
o Fertilisers
o Irrigation
o Organic farming
• Labour: Increasing the quantity of human resources leads toe economic growth because a) labour is a productive resource and b) more people demand more goods and services
o Human Capital: the accumulated stock of knowledge and skills held by the population - increases in this leads to higher economic growth
o Natural increases through migration: creates both supply of labour and demand for goods and services. And adds to the level of education, training and skills.
o Training and further education: increases human capital
o Improved health
o Multiskilling
• Capital
o Social Overhead/public Investment: it creates a framework on which economic activity is founded
• Roads, schools hospitals provide a foundation for private sector productivity
o Private Investment: includes buildings, machinery and equipment - to produce final goods and services for a profit
o Capital Widening: capital is widened when it grows in proportion to other productive resources
• As population grows there is a need to increase stock of capital (more houses, more roads etc.)
o Capital Deepening: increase in capital relative to the stock of other productive resources - causing production to become more capital intensive
• Capital deepening increases productivity - making it possible for the workforce to produce a larger output
o Technological Progress - changes in scientific and technical knowledge which involves new discoveries and new techniques and the application of these to the production process
o Research and Development (R&D): developing and applying production process and innovation
o Savings
• Enterprise
o Foreign investment
o Management training
o Innovation
o Cost management
Define technical efficiency Combining resources to produce most output from input at the lowest cost
define allocative efficiency The economy's resources should be diverted to purpose which has the lowest opportunity cost
define dynamic efficiency The ability of an economy to adapt over time. The adaptability is important for growth - resources in inefficient employment should be diverted to more productive sectors.
define business cycle (also known as the trade cycle or economic cycle) is an economic model which describes fluctuation in economic activity.
The business cycle is the periodic but irregular up-and-down movements in economic activity, measured by fluctuations in real GDP and other macroeconomic variables.
draw and fully label the business cycle
Please Note I prefer the term downswing or contraction rather than recession however will not remove marks for use - also prefer to label 'level of economic activity' rather than real output but same same
the business cycle is characterized by four phases - what are they? • Boom-highest point
o The peak of which is known as the turning point
• Contraction (recession)
o a slow down in the pace of economic activity
• Trough - lowest point
o The peak of which is known as the turning point
• Expansion (upswing)
o a speed up in the pace of economic activity
Define Peak/Boom - what's going on hereo The upper turning of a business cycle
o Period when the rate of economic growth and general level of economic activity is above average
o Booms can endanger the economy because they are associated with speculation, rising prices and bottlenecks in supply
o Governments tend to introduce contractionary economic policy in order to reduce the level of economic activity (policies that contract the economy - take money out of the economy rather than put it in....)
Define Trough/ what's going on hereo The lower turning point of a business cycle, where a contraction turns into an expansion
o Will not continue indefinitely
o Eventually capital equipment will need replacing - this has a multiplier effect - creates new jobs and income
o The downturn forces businesses to focus their efforts on process and product innovations as they fight to develop competitive advantage over their rivals and lower costs to maintain profit
• The level of economic activity gradually rises as the economy resumes its long term growth path.
define expansion/upswing/what's going on here o A speedup in the pace of economic activity
o Will tend to be a long slow buildup in activity
o Over research between 1960 and 2010 the average expansion phases was 30 months in length (compared to 20 months of contraction)
o The business cycle places emphasis on investment; as the levels rise after the trough.
what's going on in the contraction/down swing/recessiono A slowdown in the pace of economic activity
o it is not possible to produce more and more output from fully utilized stocks of capital equipment,
o Demand pressure may result in price increases rather n increases in output (they can't produce anymore because they are fully utilizing their resources therefore a shortage occurs)
o Sales start to level off and returns to investment fall and become more risky
o Lower Investment = lower output ad income
• The rates of increase in income, output and expenditure start to level off
o Profits are squeezed by rising costs
o Profits fall due to falling demand
o Tends to happen more quickly than the expansion phase
o Sometimes appears dramatic due to exposure in press (THE GFC)
When asked to discuss the characteristics of peak/own swing/ trough/ expansion - what are the characteristics one needs to discuss?You should be able to explain what is happening to each of the following at each point of the business cycle: see notes
Consumer expenditure
Confidence/expectations
Profits
Productive capacity
Unemployment
Inflation
Imports
Borrowing/debt/savings
Expenditure/sales/consumption
Interest Rates
Investment
define leading indicator and give examples Predict trends in economic activity, changing before direction becomes evident in the rest of the economy
• Building approvals
• Share prices
• Levels of inventory held by firms
• New employment vacancies
• Consumer sentiment/expectations
• Manufacturer's new orders
define lagging indicator and give examplesAre not expected to show any change until after trends in the rest of the economy have been confirmed, in reaction to developments that occurred some time in the past.
• Unemployment levels
• Savings bank deposit levels
• Consumer debt levels
• Interest rates
• CPI
• Bankruptcies
• Duration of unemployment
define coincident indicator and give examplesAppear to move in line with the level of economic activity
• an economic factor that varies directly and simultaneously with the business cycle, thus indicating the current state of the economy
• Manufacturing output
• Production and building materials
• Sales of consumer durables
• Retail sales
• Interest rates
• Growth of Real GDP
• Cement production
• Overtime hours
• Consumer prices
• Vehicle sales
• Money supply
why do economists use indicators? • Understanding current trends in the economy allows firms to make better business decisions and government to formulate more appropriate policies.
• Collecting data enables economists to understand current trends and make forecasts about future conditions
What is a weakness of indicators? DATA SUFFERS FROM TIME LAGS
• It takes time to collect and collate data (put it together)
• March data is not released until May etc. - describing trends that happened months ago and the economy may have changed direction
Use the table to answer the question below
Bevanland 2006 2007 2008
GDP (nominal) 4billion 4.3billion 4.8billion
CPI 100 102 107
Population 22 m 22.5 m 23.5 m

Calculate the economic growth between 2006 and 2007 (using Nominal GDP)
GDP Growth = GDP2 - GDP1
______________ x 100

GDP 1

= 4.3-4
_________ x 100

4
= 7.5 %
Use the table to answer the question below
Bevanland 2006 2007 2008
GDP (nominal) 4billion 4.3billion 4.8billion
CPI 100 102 107
Population 22 m 22.5 m 23.5 m

What is the real GDP for 2007
To Calculate Real GDP:
Real GDP 2 = nominal GDP (2) x CPI (year 1)
__________
CPI (year 2)
= 4.3 x ( 100/102)
= 4.3 x 0.98
= 4.21 billion

see page 75 of WACE for more practise
Use the table to answer the question below
Bevanland 2006 2007 2008
GDP (nominal) 4billion 4.3billion 4.8billion
CPI 100 102 107
Population 22 m 22.5 m 23.5 m

What is the real GDP per capita for 2008?
This is a two step equation - firstly you have to work out the real GDP

To Calculate Real GDP:
Real GDP 2 = nominal GDP (2) x CPI (year 1)
__________
CPI (year 2)
= 4.8 x ( 102/107)
= 4.8 x 0.95
=4.57billion

then work out per capita divide by population
= 4.57 billion / 23.5million
\$194.46

see page 75 of WACE for more practise
Use the table to answer the question below
Bevanland 2006 2007 2008
GDP (nominal) 4billion 4.3billion 4.8billion
CPI 100 102 107
Population 22 m 22.5 m 23.5 m

What is the nominal GDP per capita for 2006?
4 billion / 22 million
= \$181.81

see page 75 of WACE for more practise

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