0455 · 4.5Economic growth

Measuring real economic growth

0:00Imagine a country where factories produce more goods, hospitals treat more patients, and cafés serve more meals than last year. Its economy is producing more, but the benefits might reach some households sooner than others. Growth can create jobs while also increasing pollution. By the end of this video, you will understand these connections and how governments can influence them. An economy produces goods and services using resources called factors of production.

0:25These include land, labour, capital and enterprise. Capital means human-made resources used in production, such as machinery, while enterprise organises the other factors and takes business risks. Output is the goods and services produced, so changes in resources affect how much an economy can make. Economic growth is an increase in real Gross Domestic Product, or a rise in the output of an economy. Gross Domestic Product, or G D P, is the total value of goods and services produced in a country in a year.

0:54Measuring value lets us add very different products into one total. Hospital treatments, shoes and restaurant meals cannot be added in their own physical units. The word real is essential because money values can rise when prices increase. Inflation is a sustained increase in the general price level. Nominal G D P is valued at each year's current prices, so inflation alone can raise it. Adjusting for inflation gives real G D P, which changes only when output changes.

1:22Imagine every producer makes exactly the same quantity as last year, but charges higher prices. The money value of production rises, while its physical quantity remains unchanged. Alternatively, output could fall while sufficiently large price increases push nominal G D P upwards. Real G D P reveals the reduction in production in that second situation. For example, a country’s real G D P rises from two hundred and forty billion dollars to two hundred and fifty-eight billion dollars.

1:51The growth rate equals the change in real G D P divided by its original value, multiplied by one hundred. Subtracting the original value gives an increase of eighteen billion dollars. This is the additional output expressed at inflation-adjusted prices. Divide eighteen billion dollars by two hundred and forty billion dollars, then multiply by one hundred. The result is seven point five per cent. Dividing by the starting value measures the increase relative to the economy’s original size.

2:19We can therefore say that real output increased by seven point five per cent. Another question might give nominal G D P growth of five per cent and inflation of three per cent. Approximate real growth equals nominal growth minus the inflation rate. Five per cent minus three per cent gives about two per cent. This subtraction is an approximation, but it clearly separates higher prices from increased production.

Causes of economic growth

2:43Growth can happen because existing resources become more fully employed or because productive capacity expands. Productive capacity is the maximum output an economy can produce with its available resources. Picture a bakery with ovens standing idle during part of the day. More orders could increase production immediately, whereas extra ovens would expand what the bakery could potentially make. Total demand is all the spending on an economy’s goods and services.

3:08It includes spending by households, firms and government, together with exports minus imports. If consumers buy more meals, cafés receive additional orders. With spare tables, equipment and workers available, those businesses can increase output to meet the extra demand. Firms might employ additional workers or give existing staff longer hours. Their employees receive extra income, which supports purchases from other businesses. Increased spending can therefore encourage production across several industries.

3:37This process works especially well when the economy has unemployed resources available. A production possibility curve, or P P C, shows the maximum combinations of two products obtainable with current resources and technology. Point A lies inside the curve because some productive resources are unemployed or used inefficiently. Higher total demand can move production towards point B on the boundary. The economy produces more by using its existing capacity more fully.

4:04An increase in the quantity of resources can also cause growth. More workers expand the labour available, while new machinery adds to the stock of capital. Discovering usable natural resources can provide additional inputs for production. However, these resources must actually be brought into use before they increase current output. An increase in the quality of resources allows more effective production. Education and training develop workers’ skills, while improved technology helps firms produce with fewer wasted inputs.

4:34Productivity is output per unit of input. For example, better equipment can enable each worker to produce more during an hour. More or better resources shift the production possibility curve outwards, from P P C one to P P C two. Point D becomes achievable because the economy’s productive capacity has expanded beyond point C. Greater capacity creates an opportunity for additional output. Firms still need sufficient demand and effective organisation to use that opportunity.

Benefits and costs of growth

5:03One advantage of economic growth is the possibility of higher living standards. These concern people’s material welfare and quality of life. Additional output can give households access to more goods and services. If incomes rise broadly, families may afford better housing, healthier food and improved healthcare. Growth can also reduce unemployment, which occurs when people willing and able to work cannot find a job. As firms expand production, many need additional staff.

5:29However, businesses that increase output mainly through labour-saving technology may create fewer jobs. The employment benefit therefore depends partly on how the extra production is achieved. Higher incomes and spending can increase government tax revenue. That provides funds for public services such as schools, hospitals and transport. Better services can improve people’s welfare and support future production. For example, healthier workers lose fewer working days through illness, while reliable transport helps deliveries reach businesses.

6:01Growth also has disadvantages, because extra production can cause pollution if factories emit more waste or transport burns additional fuel. Resource depletion occurs when stocks of natural resources are used up. Growth based on rapid extraction can therefore reduce the resources available to future generations. The way output expands matters for environmental sustainability. Cleaner technology can reduce pollution per product, while renewable energy can reduce reliance on exhaustible fuels. However, a large increase in production could outweigh these improvements.

6:33Evaluating growth requires looking at both the quantity produced and the environmental damage associated with it. Income inequality concerns differences in income between individuals or groups. If most gains go to highly skilled workers or business owners, other households may receive little benefit. Extra pressure to meet production targets can also increase stress through longer hours or demanding workloads. A rising national total therefore gives only part of the picture of people’s lives.

7:00Another possible disadvantage is inflation when total demand grows faster than productive capacity. Businesses facing more orders than they can fulfil may raise prices. This pressure is especially likely when workers and machinery are already fully employed. Growth supported by expanding capacity is less likely to create the same price pressure.

Recession: causes and effects

7:20A recession is a fall in real G D P for two consecutive quarters. Each of these periods lasts three months, so this means six months of falling real output. Consecutive means that the two periods follow directly after each other. Real output drops in the first period and falls again in the next one. A decrease in total demand can cause recession if it reduces output sufficiently and persistently.

7:44Households might cut purchases because they fear losing their jobs. Firms then receive fewer orders and reduce production. Lower employment and incomes can weaken spending further, so difficulties spread between households and businesses. A decrease in the quantity of resources provides another possible cause. For example, a severe flood could destroy factories, damage roads and remove farmland from production. Businesses would have fewer usable inputs and might struggle to transport their goods.

8:11If the disruption is widespread enough, national output can fall. Recession can also follow a decrease in the quality of resources. Widespread illness could reduce workers’ effectiveness, while prolonged neglect might make machinery less reliable. These changes reduce the output obtainable from existing inputs. Resources become less productive even if their recorded quantity remains broadly unchanged. Consumers can experience lower incomes during recession, so they reduce purchases or use savings to cover essential expenses.

8:41Workers face greater risks of unemployment, reduced hours and slower wage growth. Someone who keeps their job may still worry about future security. That uncertainty can encourage further cuts in household spending. For firms, weaker demand usually means fewer sales and lower revenue, which is income from selling goods and services. Fixed costs do not change with output, so rent must still be paid while sales fall. Profit, the amount by which total revenue exceeds total cost, can therefore fall.

9:11Some businesses close if they cannot cover their expenses. The government faces pressure from both sides of its finances. Lower incomes, profits and spending reduce receipts from associated taxes. At the same time, more unemployed people may qualify for financial support. The combination can create or enlarge a budget deficit. This occurs when government spending exceeds tax revenue.

Policies to promote growth

9:33Policies to promote economic growth should address the reason output is weak. Fiscal policy uses government spending and taxation to influence the economy. A government could increase expenditure on hospital construction, which creates orders for building firms. Those firms employ resources to carry out the work, so current production increases. Reducing income tax can raise households’ disposable income. This is the money left to spend or save after direct taxes.

10:00If families spend the extra money, businesses have a reason to expand output. However, people concerned about the future may save much of it. Spending on imported goods also provides demand for production abroad, which limits the boost to domestic output. Higher government spending can be effective when unused resources are available. Its effectiveness weakens when shortages prevent firms from increasing production, because additional demand then puts pressure on prices.

10:27Borrowing to finance expenditure can also create future interest costs. Governments must weigh the likely growth benefit against these financial and inflation risks. Monetary policy involves changes in interest rates, the money supply and the foreign exchange rate to influence the economy. An interest rate is the cost of borrowing expressed as a percentage of the amount borrowed. Lower rates can make loans cheaper, which encourages purchases financed through credit.

10:51Firms may also undertake investment, which is spending on capital goods. Extra purchases increase total demand, while additional machinery can expand productive capacity. The response may be weak if households avoid debt or businesses expect poor sales. Banks might also remain reluctant to lend to risky borrowers. Lower rates therefore create an incentive, but confidence and access to credit influence the result. Supply-side policies are measures designed to increase productive capacity and improve efficiency.

11:21Education and training raise skills, while improved healthcare supports a more effective workforce. Investment in roads and electricity networks can reduce delays and interruptions for businesses. These policies promote growth through an increase in the quantity or quality of usable resources. Their benefits often take time because training workers and building infrastructure cannot happen instantly. Government spending on these measures also has an opportunity cost, which is the next best alternative forgone.

11:49Success requires suitable courses, well-chosen projects and effective implementation. Capacity will support higher output only when firms have reasons and opportunities to use it. Policies can complement each other when an economy has both weak spending and longer-term production problems. Measures that increase demand help bring idle resources back into use. Improvements in skills and infrastructure support continued growth as those resources become fully employed. Environmental standards and cleaner technology can help make the resulting expansion more sustainable.

Exam skills and recap

12:21An exam question could ask you to discuss whether a reduction in interest rates will promote economic growth. Discuss means write about the issue in depth in a structured way, with both sides considered. Start with the policy named in the question and trace its consequences. Then examine a limitation before reaching a judgement supported by your reasoning. A reduction in interest rates lowers the cost of new loans and variable-rate borrowing for households and firms.

12:45Cheaper credit can encourage household spending and investment by firms. Total demand rises, so businesses with spare capacity increase output and real G D P grows. However, weak confidence may prevent borrowers from responding, so the increase in spending could be small. On balance, lower interest rates usually promote economic growth, because cheaper borrowing raises total demand. This holds when confidence is reasonably strong and resources are unemployed, so firms can expand production.

13:14If the main difficulty is damaged infrastructure, cheaper loans alone will have limited effectiveness. Policies that restore productive capacity would address that problem more directly. For define, give a precise meaning, while state asks you to express an answer in clear terms. Explain requires reasons showing why or how something happens. When asked to analyse, examine the relationships in detail, such as the link from spending to production and employment.

13:40Each step should contribute to the outcome named in the question. Examiners often withhold marks for missing steps, so explain every causal link. Measure growth with real G D P, and look for two consecutive quarters of falling real output to identify a recession. For diagrams, connect fuller resource use to movement towards the existing boundary. An outward shift represents expanded productive capacity, whose actual use requires sufficient demand. Economic growth increases real output through stronger total demand, more resources or improvements in their quality.

14:12It can raise living standards, create employment and increase tax revenue, but its benefits depend on distribution and sustainability. Recession brings falling output and pressures consumers, workers, firms and government. Effective policies address the underlying cause while recognising costs, delays and possible side effects.