Economic Issues – Economic Growth

Written by admin on September 5th, 2011

Economic Issues

Economic Growth

Economic Growth is a country’s productive capacity and can be defined as an increase in the volume of goods and services that an economy can produce over a period of time.

Aggregate Demand and Supply :

John Maynard Keynes Theory:

? Aggregate demand (spending), according to Keynes theory, is the most important influence on economic growth.

? Level of consumer spending is vital because if consumers are too pessimistic their spending will decrease, businesses will decrease their investments, which leads to higher unemployment and eventually a recession will occur.

? The Government should use the Budget to counter economic trends towards recession and inflation. E.g. running a budget deficit to stimulate spending.

Aggregate Demand- is the total level of expenditure in an economy over a given period of time.

AD= C + I + G + (X-M)

Aggregate Supply- is the total level of income in the economy over a given period of time.

Y = C + S + T

The economy is in equilibrium and stable when aggregate supply equals aggregate demand in an economy. A change in demand can change economic activity as the equilibrium at times is not an ideal situation and movement away from equilibrium can cause problems. The government uses Macroeconomic policies to prevent or fix these situations.

Injections and Withdrawals :

In the circular flow of income, equilibrium occurs when the Leakages = Injections.

S + T + M = I + G + X

Components of Aggregate Demand (C + I + G + (X – M) :

à Consumption is influenced by :

? Consumer expectations- expectations of future inflation rates, future real incomes and availability of goods.

? Level of interest rates- rise in rates may discourage spending.

? Level of income- most significant determinant on how much people will spend (MPC and MPS would be considered).

? Distribution of income- more even distribution allows a higher rate of spending. Lower income earners spend more than higher income earners.

Marginal Propensity to Consume- is the proportion of each extra dollar of income that is spent on consumer goods.

Marginal Propensity to Save- is t he proportion of each extra dollar of income that is saved.

à Business investment is influenced by :

? Relative cost of capital equipment which is influenced by:

*Changes in interest rates- falling rates makes capital is cheaper.

*Changes in government policies- related to investment and tax concessions.

*Change in price or productivity of labour- labour substitutes capital.

? Business expectations:

*Increase in expected demand could lead to an investment in more capital.

*Change in the economic outlook.

*Discovery of new resources or technology.

* Inflation and uncertainty of future prices leads to a reduction in investment in capital.

à Government spending and taxation is influenced by:

? The level of economic activity- changes with fiscal policy to maintain a strong a stable rate of economic growth by reducing fluctuations through government policies.

à Exports and Imports are influenced by:

? Overseas income rise then Australia’s exports rise.

? Australia’s income rises, then our imports rise.

? Exchange rate, level of international competitiveness and consumers tastes and preferences.

The measurement of economic growth :

Economic Growth is measured by the annual rate in real GDP ( goods and services produced in an economy in a year, adjusted for inflation).

**Economic Growth (%) = real GDP(current) – real GDP (previous) x 100

Real GDP (previous yr) 1

**Real GDP (%) = Nominal (money) GDP x 100


Every 3 months, ABS calculates quarterly economic growth and Australia‘s yearly economic growth rate. Annual growth is an increase from the previous financial years GDP.

Australia ’s economic growth- After the recession of 90- 91 with negative growth -2%, the economy grew slowly. Growth of 5.3% occurred in 98-99 but fell to 2% in 2000 (Olympics caused the decline). Australia’s growth rate has slowed to 3% and has enjoyed 16-17 years of economic growth.

The multiplier process :

Is the number of times an increase in national income exceeds the increase in aggregate demand that caused it.

** K = 1 . (Marginal Propensity to Consume)


** K = 1 . (Marginal Propensity to Save)


The total increase in national incomes will be the multiplier multiplied by the original change in aggregate demand.

Sources of economic growth :

The main sources if economic growth are exactly the same as the components of aggregate demand. Once again they are:

1. Consumption by households- C (60% of GDP)

2. Investment- I (20% of GDP)

3. Government spending- G (budget deficit or surplus)

4. Net Exports- (X – M)

Technological changes are the most important driver growth as it is all about finding new ways to be more efficient.

The benefits of economic growth :

1. Living Standards- Faster economic growth means higher “material living standards.”

2. Employment- Economic growth creates jobs.

3. Increased Productivity- Producers become more productive to keep up with demand.

4. New Business investment- Businesses will invest more to exploit increased demand.

5. Increased Tax Revenue- High income and spending leads increased tax.

6. Increased exports- Growth leads to increased output, hence incomes can be gained from trade and can be used to produce cheaply in other countries.

7. More Leisure Time- As income rises, people will trade work for more leisure time.

The costs of economic growth :

1. Environmental damage- Natural resources are needed to sustain high growth however this results in pollution and deforestation.

2. Structural Unemployment- Technological and Production changes.

3. Materialism- Loss of traditional values.

4. Widening gap of income distribution- benefits high income earners.

5. Inflation- General price of goods inflate.

6. External Balance- Spending on imports lead to larger CAD.

Trends in Australia’s Business Life Cycle :

One complete cycle averages about 7years and is from Trough to Trough or Boom to Boom.

Four distinct phases of the Business Cycle:

1. Trough- Income is at the lowest level and unemployment is at its highest. Australia’s 1990 recession had growth of 2% and unemployment at 11%.

2. Upswing- Expansion of level of output and employment. 1n 94, real GDP rose to 2.7% and unemployment fell to 8.9%.

3. Boom- Economy has grown to its capacity. In 94-96, the real GDP averaged at 4.5%, unemployment fell to 6.9% but inflation increased by 4.5%.

4. Downswing- Falling unemployment and output. In 00-02, growth slowed to 2% because of a slow down in the US economy.

The Government uses counter cyclical or stabilisation (macroeconomic- fiscal or monetary) policies to smooth out fluctuations in the business cycle. E.g. During a boom the government would run a budget surplus and raise interest rates to decrease spending and prevent inflation.

Policies to sustain economic growth :

The Government uses Macroeconomic policies to minimise and smooth the fluctuation of the business cycle. These policies are short term as they can only make a limited impact in the long run.

The Fiscal Policy (budget) is a macro policy that allows the government to increase economic growth by: reducing taxation and increase government spending.

The Monetary Policy (interest rates) is another macro policy that the government can use by influencing the Reserve Bank of Australia (RBA).

Microeconomic Reforms (long term) are used to increase sustainable economic growth in the future as they look at the whole economy.

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