Economic Growth. A percentage change in real GDP over a given time period.
The Causes of Economic Growth
Economic growth occurs if AD and/or LRAS shifts right. An increase in C, I, G or (X-M) means AD increases and AD shifts right so real GDP rises. A number of factors could cause one of the components of AD to change and shift AD. An increase in LRAS means LRAS shifts right so real GDP rises. A number of factors could cause LRAS to shift.
Benefits of Economic Growth
- Incomes rise. Real income rises, consumers can buy more goods and services, consumption rises and living standards rise. Additionally, economic growth may mean that assets generate a larger income flow, so consumption rises and living standards rise further.
- Employment rises. Jobs are created because firms produce more, and because labour is a derived demand, firms must employ more workers. The government are closer to achieving their target of full employment.
- Profits rise. Economic growth means incomes are rising, consumers buy more goods and services so firms make more profit.
- Efficiency increases. Firms earn more profit so they invest more in R&D, develop new machinery, become more efficient and LRAS shifts right.
- Tax revenue rises. Economic growth means incomes and profits are rising, consumers pay more income tax and firms pay more corporation tax so the government’s tax revenue increases. Also, firms are producing more and hiring more workers so unemployment benefits fall. The government then has more to spend on health and education.
- Exports may rise. If growth is due to export-led growth then exports are rising rapidly, AD is rising and real GDP is rising. The government are closer to achieving their objective of a current account surplus.
Costs of Economic Growth
- Inflation may rise. Economic growth may mean AD increases and shifts right and, if there are bottlenecks (i.e. the AS curve is inelastic), inflation rises. As inflation occurs, workers cannot afford as much as before, workers demand higher money wages, firms’ costs rise, firms’ prices rise, workers demand higher money wages and the spiral continues.
- Inequality rises. The poor (workers) may benefit from higher wages but the rich (owners of machinery and firms) may benefit from even higher profits. So the rich get richer faster than the poor get richer and income distribution becomes more unequal.
- Environmental damage. More resources are extracted from the ground so the geosphere is damaged, more land is used and trees cut down so the biosphere is damaged. More people drive and use electrical goods, requiring more fossil fuels to be burned, so there are more dirty emissions pumped into the air and the atmosphere is damaged.
- Time lag. It takes time for new machinery to be developed. New machines must first be researched and tested. The benefits of increased efficiency may only occur in the long-run.
- Magnitude. The extent of the rise in economic growth determines how much tax revenue rises by. A small increase in economic growth will only increase the government’s income tax revenue and corporation tax revenue by a small amount.
- Current account deficit. Real incomes rise, domestic consumers may buy more luxury imports so imports rise and the current account moves towards a deficit. Also, domestic firms may sell more goods to domestic consumers rather than sell to foreign consumers who may have a lower income, so exports fall and the current account moves deeper into a deficit.