Economics Unit 4 Economic Growth

What is a Recession?

A recession is when an economy experiences two or more consecutive quarters of negative economic growth.

What is an External or Exogenous Shock?

An external shock is an unexpected or unpredictable event that affects an economy. These can be demand side (shocks affecting the rate of growth of demand). An example of this is the credit crunch, due to banks not lending, a lack of tourism to the US after 9/11, high government spending and a sudden devaluation of the currency. They can also be supply side (shocks that affect the productive capacity of the economy either in the short run or long run). Examples include volatility in the price of oil and war and natural disasters.

Explain Schumpeter's 'Creative Destruction' Theory.

Creative destruction literally means that new technology 'benchmarks' the new standard. Other companies then develop advances beyond the new benchmark, thereby that innovation becomes the new benchmark. This is seen in companies like Xerox or Polaroid, which used to be revolutionising and dominated the industry, but now have falling profits and are vanishing as their rivals take over through improved designs or by cutting manufacturing costs.

Explain Endogenous Growth Theory.

Endogenous growth economists (Such as Romer) believe that improvements in productivity can be linked directly to a faster pace of innovation and extra investment in human capital. They stress the need for government and private sector institutions which successfully nurture innovation, and provide the right incentives for individuals and businesses to be inventive.

Which Government Policies can Increase the Trend Rate of Economic Growth.

Government policies which can be used are: 1. Encouraging savings, therefore banks have more money to finance investment. 2. 'Crowding in' effects of improved infrastructure. 3. Improving factor mobility. 4. Education and training (human capital investment). 5. Subsidising research and development. 6. Promoting supply-side policies.

What does a Kondratiev Wave show?

Kondratiev waves show that, although growth occurs in the economic cycle, there is a much larger change from prosperity to recession to depression to improvement that occurs about every 50 years. This backs up Schumpeter's creative destruction as the major causes of prosperity appear to be new inventions, such as the steam engine or railways.

What is Long Run Economic Growth?

Long run economic growth occurs when an economy increases its productive potential (i.e. LRAS increases). It can be shown by an outward movement of the PPF boundary.

Explain Neo-Classical Growth Model.

Neo-classical growth model states that 'new' technology and investment are the vital ingredients for growth. As time goes by 'old' capital becomes obsolete and as such it is the 'new technology' which drives growth. In Solow's model it is important that savings are high in an economy in order to allow banks to lend money for investment. The theory is known as exogenous, due to the rate of growth being determined outside of the model.

What is Short Run Economic Growth?

Short run economic growth is an increase in real GDP per capita over a given time period (usually per year) This is usually due to increased AD (C+I+G+X-M), which can be inflationary. It is also shown by an increase towards the PPF boundary from within.

What are the Benefits of Economic Growth?

The benefits of economic growth include: Economic welfare should improve; living standards should improve; new product innovation leads to further product innovation; reduction in poverty; greater efficient use of resources; improved human development, i.e. knowledge, education and skills; environmental sustainability. The costs of economic growth include: Inequality may rise; exploitation of economies; environmental degradation; using up of non-renewable resources; pollution; regional issues, growth isn't equal everywhere.

Explain the Human Development Index.

The human development index attempts to rank countries in terms of quality of life rather than just material well being. The economist Amartya Sen is associated with linking health, education and the ability to work, which forms a cornerstone of the ideas developed by the HDI. These indicators include: GDP per capita; life expectancy; infant mortality rates; access to clean water; pollution; political freedom; internet access; education and skills.

Name the Three Main Growth Theories.

The three main growth theories are: 1. Neo-classical growth model (Solow growth model or Exogenous growth model) 2. Endogenous growth theory (Romer) 3. Creative destruction (Schumpeter)

What can Increase the Trend Rate of Economic Growth.

The trend rate of economic growth can be increased through: 1. Raising capital investment spending as a share of national income. 2. Achieving higher productivity from both capital inputs and from our labour supply. 3. Expanding the size of the labour supply, perhaps through an increase in the migration of high productivity workers. 4. Increasing the level of research and development and increasing the pace and application of innovation across the economy.

What is Trend Growth?

Trend growth is the smooth path of long run national output. Measuring the trend rate of growth requires a long-run series of macroeconomic data (20 years or more) in order to identify the different stages of the economic cycle and then calculate average growth rates from peak to peak. It is also seen as the underlying speed limit of an economy (how fast the economy can grow without creating unsustainable inflationary pressure).

Explain Rostow's Stages of Growth Theory.

Walt Whitman Rostow modelled economic growth using 5 steps: 1. Traditional Society - Primitive life, living in caves or huts. It seldom occurs in the world these days, other than African tribes or South American natives. There are no real methods of growing in this stage. 2. Pre-Conditions to Growth - In this society education begins. Also there is a formal hierarchy in society and even possibly a banking system. Items have 'value'. 3. Take-Off - This occurs when the economy takes off. This is where mass production and manufacturing occur. This is also when the secondary sector really takes off (similar to the industrial revolution in the UK). 4. Drive to Maturity - This is the introduction of modern technology and 'home comforts'. Typically standards of living improve massively. 5. Age of Mass Consumption - This is when technology is at the forefront and durable 'high-tech' industries are at the forefront. Quaternary industries are developed and new technology appears all the time. The UK is at this stage.