Chapter 9.

The
macroeconomy
Economic growth
Economic growth is an increase in an
economy’s output.
Economic growth rate is the annual
percentage change in output.
For people to enjoy more goods and services,
output has to increase by more than growth in
population. In this case, GDP per capita/per
head would increase.
It was assumed that poverty would be
eradicated if countries managed to sustain
economic growth.
In reality, economic growth does not result in a
rise in living standards and quality of life.
It’spossible for people to achieve an
improvement in their living standards and
quality of life even if economic growth does
not occur, if there is a more even
distribution of income or a reduction in
pollution.
Economic development: an increase in
welfare and the quality of life. Includes better
education, health and nutrition, a cleaner
environment, more equality of opportunity,
greater individual freedom, a rich cultural life.
Higher income in itself is not sufficient to
ensure that there is a rise in the quality of life
for the citizens of a country.
Sustainable development: development that
ensures that the needs of the present
generation can be met without compromising
the well-being of future generations.
Pursuing sustainable development ensures
that economic growth improves living
standards and the quality of life in the
present and the future.
To achieve this requires a deliberate effort
to balance economic, social and
environmental objectives.
Economic objectives requires a better use
of resources. Growth should ensure
sufficient resources are available to invest
in human capital and physical capital.
Education and training are central.
Social objectives focus on the distribution of
the benefits of growth. Food, housing,
health care, secondary education are
essential. This involves education system
that gives the same opportunity for boys
and girls, is serious about reducing fertility
rates, controlling the spread of HIV/AIDS
and providing for the elderly.
Environmental objectives requires the
responsible use of natural resources.
Mineral extraction and forest depletion
should be done in such a way that the
benefits are not just short-term.
Actual and potential economic
growth
Actualeconomic growth: an increase in real
GDP/output.
PPC diagram can be used to show economic
growth resulting from greater use of existing
resources.
Actual economic growth can also be
shown using AD/AS diagram. An increase
in AD in an economy with spare capacity
will bring into use previously unemployed
resources and output increases.
 Potential economic
growth: an increase
in the productive
capacity of the
economy.
 Both PPC and AD/AS
diagram can
illustrate an
increase in the
maximum output.
Output gaps and the trade cycle
Output gap: the difference between actual
and potential output.
 Negative output gap: a situation where actual output is
below potential output – there is a lack of AD and there is
unemployment of resources.
 A negative output gap indicates a lack of demand for goods
and services in an economy and can lead to companies
and employees operating below their maximum efficiency
levels. A negative output gap is a sign of a sluggish
economy and portends a declining GDP growth rate and
potential recession as wages and prices of goods typically
fall when overall economic demand is low.
 Positive output gap: when an economy is producing more than
its maximum potential for a while. A time will come when
machines have to be repaired, workers want to reduce overtime.
 A positive output gap indicates high demand for goods and
services in an economy, which might be considered beneficial
for an economy. However, the effect of excessively high demand
is that businesses and employees must work beyond their
maximum efficiency level to meet the level of demand. A
positive output gap commonly spurs inflation in an economy
because both labor costs and the prices of goods increase in
response to the increased demand.
Output gaps arise during the course of a
trade cycle.
Trade cycle: fluctuations in economic
activity over a period of years.
Actual output varies around the trend
growth in productive potential.
The factors contributing to economic growth
 Increase in the quantity of resources
1. Labour – natural increase of population, net
immigration, rise in retirement age
2. Entrepreneur – deregulation and privatisation
3. Capital – net investment with firms buying
more capital goods than are needed to replace
4. Land – discoveries of new oil fields and gold
mines
Increase in the quality of resources
1. Labour and entrepreneurship – through
education, training, and better health
care
2. Capital – as technology advances
3. Land – application of fertilisers and
irrigation and drainage schemes.
Economic growth in developing countries
 The main obstacle to increase the quantity and
quality of resources in developing countries is the
opportunity cost of devoting resources away from
their current use.
 Producing more capital goods means sacrificing
consumer goods in the short run, which would lead
to a decrease in living standards.
 China: investment & exports, India: labour force & IT
The costs of economic growth
 The opportunity cost – the current consumption of
goods and services will be reduced (short-run only).
 Increased anxiety and stress – workers need to
learn new skills, may have to change occupation,
increased working hours, pressure to come up with
new ideas
 Depletion of natural resources and damage to the
environment.
The benefits of economic growth
 The main benefit is the increase in goods and
services that become available for the citizens to
enjoy.
 EG makes it easier to help the poor. Higher
incomes and more spending increase tax revenue,
some of this revenue may be given to the poor in
the form of higher benefits, better education,
better housing & better health care.
 Rise in employment. A rise in real GDP cause
by higher AD may create extra jobs. A rise in AS
makes a country’s product more competitive,
so may generate more jobs
 Increase business and consumer confidence.
This encourages investment.
 Increase a country’s international prestige and
power. Ex.: China.
 Using and conserving resources
 Using natural resources can increase economic
growth, at least in the short run. For example,
cutting down trees, hunting animals, extracting gas
can increase output and create jobs. It can increase
exports and so improve the current account
position. The higher output can increase tax
revenue that can be used to improve infrastructure,
education, etc. that will generate further economic
growth.
Some arguments for conserving resources:
 Maintaining rainforest or wildlife in a reserve
may encourage tourism.
 Maintaining rainforest will help the
environment by absorbing carbon dioxide.
 Conserving resources enables future
generation to benefit from them – they can be
sold at higher prices in the future.
Factors that influence the decision whether to use or
conserve resources:
1. Whether demand for the products created by the
resources is likely to increase or decrease in the
future.
 If it is thought that demand will fall in the future,
there is an argument for using the resources now.
 If the resources are non-renewable, it’s essential
that any revenue earned now should be invested into
developing other industries.
2. It’s better to conserve a resource if the country does
not currently have a comparative advantage in
producing the related product but may have in the
future.
 For example, a country may have significant gold
deposits but they may currently be too expensive to
extract. If a country has serious debt problems, it
may feel forced into using its resources now.
 Oil drilling may create income & employment, but will
reduce tourism & generate external costs.