Economic growth and recession: causes and consequences

Last time

Before we start: last time, in Firms, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

Is the economy growing?

The news often reports that the economy grew by 3 per cent, or that it is in recession. What exactly is growing? The total output of goods and services, measured by real GDP. In this lesson: what makes it grow, what makes it shrink, and who gains or loses.

What economic growth is

Economic growth is an increase in a country's real GDP: the total output of goods and services, adjusted for inflation. Real means price changes have been taken out. If GDP rises only because prices rose, there is no more output. Actual growth uses unemployed resources, moving towards the PPC. Potential growth shifts the PPC outwards.

Measuring it

GDP, gross domestic product, is the total value of output produced in a country in a year. If real GDP rises from 200 billion dollars to 210 billion, the rise is 10 billion, and 10 over 200 is a growth rate of 5 per cent. GDP per head is GDP divided by the population. It shows the average output per person, a first measure of living standards.

Booms and recessions

Economies do not grow smoothly. In a boom, output grows fast, unemployment is low and prices may rise quickly. A recession is a period when real GDP falls, usually for at least six months in a row. After a recession comes recovery, and then growth again.

Causes of growth: demand

Total demand is spending by households, firms, the government and foreign buyers of exports. If any of these rises, firms sell more, so they produce more. Output, real GDP, rises. Lower interest rates, tax cuts, rising confidence and a growing world economy all raise demand.

How consumer spending raises growth

Follow the chain. Consumers spend more, so firms sell more and produce more. To produce more they hire more workers, who earn more and spend more. The rise in output is economic growth.

Causes of growth: supply

Growth in the long run needs more or better resources: a bigger labour force, more capital from investment, new natural resources. And better resources: education and training, health care, and new technology that raises productivity. Infrastructure, such as a good transport system, also raises capacity: goods move faster and cheaper, so firms can produce and sell more.

Causes of recession

A fall in total demand: households and firms lose confidence and cut spending, or higher interest rates make borrowing dearer. A fall in exports when trading partners are in recession, or cuts in government spending. Supply shocks, such as a flood, a war, or a sharp rise in the price of oil, can also cut output.

Consequences of growth

Benefits: higher incomes and living standards, more jobs, and more tax revenue for schools and hospitals. Costs: inflation if demand grows faster than output, more imports, and pollution and the using up of natural resources. And the gains may not reach everyone, so inequality can rise.

Consequences of recession

Firms sell less and some close. Workers lose their jobs, so unemployment rises and incomes fall. The government collects less tax but pays more in support, so its budget worsens. One possible gain: inflation usually falls, and imports fall, which can help the current account.

Policies for growth

Fiscal policy: more government spending and lower taxes, to raise total demand. Monetary policy: lower interest rates, to encourage borrowing and spending. Supply-side policy: education, training, infrastructure and lower taxes on firms, to raise productive capacity in the long run.

Mistakes that lose marks

Mistake one: defining growth as a rise in prices or in money GDP. It is a rise in real output. Mistake two: saying more spending causes growth, with no chain in between. Mistake three: giving only benefits of growth in a discuss question. The fix: real GDP, a full chain, and both sides.

The full-marks tip

The full-marks tip: define economic growth as an increase in real GDP, and show the growth rate as a percentage change. For any cause, write the chain from spending to output to jobs.

On one card

So, on one card: economic growth and recession. Keep it for revision.