Economic growth & the economic cycle

How can economists identify an economic boom?

The main characteristics are; -High aggregate demand. -An increase in wage costs. -High demand for imports, usually resulting in an expanding trade deficit. -A fiscal dividend for the government because tax revenues will rise rapidly and a reduction in state spending on welfare payments. -A strong growth in profits, an increase in investment and an increase in the level of optimism in the state of the economy amongst firms. -An increase in the level of inflation. Irrational exuberance on the stock market.

What is meant by the term economic cycle?

The term economic cycle refers to "fluctuations in economic activity over a given period." There are four stages; Upswing. Denotes a recovery in the state in economy. Boom. Reached at the peak of economic activity in which the economy is operating at a point where aggregate supply cannot meet the increased level of aggregate demand. Downswing. Occurs when economic growth continues but at a reduced rate. Recession. A recession is defined as a period of two consecutive quarters (or 6 months) in which real GDP declines. During a recession the economy is operating below its potential. The 2008/09 recession in the UK lasted for 6 quarters, longer than any of the G7 economies.

Why are economists interested in long-run and short-run economic growth?

-A comparison between actual and potential economic growth enables economists to do their job more effectively in terms of making predictions and policy recommendations. -The different facets of economic growth also enable economists to make relevant connections with other economic factors (such as the output gap, inflation and unemployment).

How should we respond to an economic boom? Greater state intervention:

-Keynesianists argue that the state should prevent the damaging effects of boom-bust economics. -Governments should therefore borrow during times of downturn/recession in order to kick start the economy. -The amount of money borrowed can be gained back during an upswing

Long-run economic growth

-Long-run economic growth can be defined as "the rate at which the economy's potential output could grow as a result of changes in the economy's capacity to produce goods and services." -It is sometimes referred to as potential economic growth. -Long-run economic growth enables us to consider the long-term capacity for economic growth for the country concerned. -Long-run economic growth can only happen if there is an increase in either the quantity or the quality of the four factors of production (land, labour, capital and enterprise). -A comparison between actual and potential economic growth enables economists to do their job more effectively.

Short-run economic growth

-Short-run economic growth can be defined as "the actual annual percentage increase in an economy's output." -It is sometimes referred to as actual economic growth.

How can we evaluate the causes of economic growth in the short-run?

-Short-run economic growth occurs from the economy making more intensive use of its existing factors of production. Growth therefore derives from a higher level of AD leading to an expansion in AS. -In doing so, the total output of the economy moves closer to the PPC. In other words, economic resources are being used more effectively when the economy experiences short-run economic growth.

How should we respond to an economic boom? Lesser state intevention

-The free market will always allocate resources more effectively than state intervention. -Joseph Schumpeter argued that governments should allow a recession to occur because it allows inefficient firms to go to the wall. Those who made unprofitable investments during booms should suffer the consequences

The trend rate and the output gap

-The trend rate of economic growth can be defined as "that rate at which output can grow, on a sustained basis, without exerting pressure upon inflation." -In order to understand the trend growth rate we need to consider the output gap. -The output gap can be defined as "the difference between the actual level of GDP and the level it would be were the economy to grow continuously at the trend rate of growth." -The output gap is either positive or negative. -A positive output gap occurs where the economic cycle is below the trend growth rate. A negative output gap occurs where the economic cycle is above the trend growth rate.

How can we evaluate the causes of economic growth in the long-run?

-There are various causes of economic growth in the long-run. Economic growth in the long-run has nothing to do with changes in AD and everything to do with changes in long-run AS (i.e. in terms of the quantity and quality of the labour force). -In the long run, economic growth comes from increasing the stock of available inputs (land, labour and capital) together with improvements in factor productivity and also technological change. These factors cause an increase in long-run aggregate supply and allow the economy to operate at a higher level of potential output.