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Cambridge (CIE) IGCSE Your notes

Economics
4.6 Economic Growth
Contents
Measures of Economic Growth
Causes & Consequences of Growth
Causes & Consequences of Recessions
Policies to Generate Economic Growth

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Measures of Economic Growth

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Economic Growth
Economic growth is the annual increase in the level of national output as measured by the gross
domestic product (GDP)
GDP is the total value for all goods/services produced in an economy in a year

The components of GDP

GDP can be calculated using the value of the expenditure in an economy
GDP = Consumption (C) + Investment (I) + Government spending (G) + Exports (X) - Imports (M)
GDP = C + I + G + (X-M)
If any of the components of GDP increase, then economic growth is likely to occur
Consumption is the total spending on goods/services by consumers (households) in an economy
Investment is the total spending on capital goods by firms
Government spending is the total spending by the government in the economy:
Includes public sector salaries, payments for provision of merit and public goods etc.
It does not include transfer payments
Net exports are the difference between the revenue gained from selling goods/services abroad and
the expenditure on goods/services from abroad

The relative importance of the components of GDP

Depending on the country, the value of each component and its contribution to GDP can vary
significantly:
Government spending in Sweden is 53% of GDP and in the UK it is 25% of GDP
The % that each component contributes to GDP in the UK is approximately
Consumption: 60%
Investment: 14%
Government spending: 25%
Net Exports: 1%

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A 1 % increase in consumption or government spending will have a much larger impact on economic
growth than a 1% increase on net exports
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Real Gross Domestic Product (GDP)
In economics, the use of the word nominal refers to the fact that the metric has not been adjusted for
inflation
Nominal GDP is the actual value of all goods/services produced in an economy in a one-year period
There has been no adjustment to the amount based on the increase in price levels (inflation)
Real GDP is the value of all goods/services produced in an economy in a one-year period - and
adjusted for inflation
For example, if nominal GDP is £100bn and inflation is 10% then real GDP is £90bn

GDP/Capita
GDP per capita = GDP / the population
It shows the mean wealth of each citizen in a country
This makes it easier to compare standards of living between countries
For example, Switzerland has a much higher GDP/capita than Burundi

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Causes & Consequences of Growth

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Causes of Economic Growth
1. Growth caused by a change in total demand
Actual economic growth occurs when there is an increase in the quantity of goods/services
produced in an economy in a given period of time
This is often measured by the percentage change in real gross domestic product (GDP)
If any component of real GDP increases (consumption, investment, government spending, net
exports), there will be an increase in total demand

Any movement from Point E towards the PPC boundary represents actual economic growth
and is caused by an increase in output (rGDP)

Diagram explanation
Previously unused factors of production are now being employed

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This is demonstrated by a shift from inside the production possibilities curve (PPC) such as Point E,
towards the boundary of the PPC
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At any given point in time, the actual economic growth may be less than the potential growth available
to the economy
2. Growth caused by a change in the quantity/quality of
factors of production
Potential growth is the increase in the productive potential of an economy
This occurs when there is an increase in the quantity or quality of the factors of production available in
an economy
One example of how the quality of a factor of production can be improved is through the impact
of training and education on labour. An educated workforce is a more productive workforce and
the production possibilities increase
One example of how the quantity of a factor of production can be increased is through a change
in migration policies. If an economy allows more foreign workers to work productively in the
economy, then the production possibilities increase
Investing in new capital machinery increases the quality of capital
Investing in new technology results in an improvement to productivity

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Outward shifts of a PPC show economic growth caused by changes to the quantity/quality of the FOP
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Diagram explanation
Economic growth occurs when there is an increase in the productive potential of an economy
This is demonstrated by an outward shift of the entire curve represented by A
More consumer goods and more capital goods can now be produced using all of the available
resources

The Consequences of Economic Growth

Economic growth is considered to be the main contributor to an improvement in the standards of
living
Due to the negative aspects of economic growth, there is much controversy about maintaining it as a
central macroeconomic aim
Instead, arguments for a focus on societal well-being are gaining traction
A Table Summarising the Benefits and Costs of Economic Growth

Benefits of Economic Growth Costs of Economic Growth

Increased incomes lead to better Rising total demand causes demand pull inflation
standards of living and the purchasing power of people on fixed
incomes may fall

Decreased levels of absolute poverty Lack of equity in the distribution of income - the
rich may get richer and the poor poorer

Improvement in the quality/quantity of Environmental damage caused by negative

environmentally friendly technologies externalities of production and consumption
increases

Higher sales revenue for firms and greater Increased inflation can harm export sales
profits

Increased investment by firms increases The level of imports usually increases negatively
the potential output of the economy impacting the current account

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Reduced expenditure by governments on Increased income usually leads to greater

benefits consumption of demerit goods
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Higher government tax revenue due to Greater output often requires more time from
rising incomes and surging corporate workers and can decrease leisure time and well-
profits being

Increased employment resolves some of Resources are depleted more rapidly

the negative social impacts of
unemployment

Examiner Tips and Tricks

Remember this distinction as MCQ often checks for this understanding:
Growth caused by a change in total demand is represented by a movement from within the existing
PPC towards its boundary.
Growth caused by a change in the quantity/quality of the factors of production (supply-side
growth) moves the entire PPC curve outwards.

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Causes & Consequences of Recessions

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Causes of Recessions
A recession is a period of at least six months (2 quarters) of economic decline which causes a decrease
in the real gross domestic product (rGDP)
It can be caused by a fall in any of the factors that influence total demand (consumption, investment,
government spending, net exports) e.g. consumption fell during Covid 19 lockdowns causing many
economies to experience a recession
It can also be caused by supply-side shocks that create challenges for firms and consumers. E.g. The
Russian war on the Ukraine has reduced the supply of natural gas, oil and petrol resulting in major
disruptions and increased energy costs

Factors That Reduce Total Demand and Total Supply

Demand-side Factors Supply-side Factors

A fall in consumer confidence reduces Unexpected supply shocks such as the

consumption war on Ukraine or the Japanese Tsunami of
2011
A fall in business confidence reduces investment
A gradual decline in the productive
Increasing levels of unemployment reduce capacity of the economy when capital
consumption (machinery) grows old and is not replaced
Decreasing levels of government spending A gradual decline in the level of
Increased interest rates require borrowers to education/training available in an
repay higher amounts on their loans - this reduces economy
discretionary income which reduces consumption On-going industrial action such as worker
Shocks to other economies can reduce demand strikes which disrupt the supply of labour
for a country's exports thus reducing total demand to an economy
Weather events which destroy
agricultural products or interrupt supply
chains

The economic decline (recession) caused by supply-side interruptions can be illustrated using a
production possibility curve (PPC)

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Your notes

Outward shifts of a PPF show economic growth and inward shifts show economic decline (recession)

Diagram explanation
Economic decline occurs when there is any impact on an economy that reduces the quantity or
quality of the available factors of production as depicted by the movement A
One example of how this may happen is to consider how the Japanese tsunami of 2011 devastated
the production possibilities of Japan for many years. It shifted their PPC inwards causing
economic decline

Consequences of Recessions
The consequences of a recession depend on the severity and length of the recession. E.g. The Great
Depression lasted from 1929 to 1939 whereas some economies are in and out of recession within a year
1. National output (rGDP) falls
2. More firms go bankrupt
3. Both unemployment and underemployment increase
4. Both exports and imports fall
5. Domestic and foreign investment by firms decreases/stops

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6. Deflation may become an issue leading to even lower wage levels

7. Government spending on unemployment benefits increase Your notes
8. Opportunities for entrants to the workforce decrease (youth unemployment increases)
9. Governments may have to spend significant amounts of money to support the economy which carries
several major opportunity costs

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Policies to Generate Economic Growth

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Demand-side Policies
Demand-side policies aim to influence the total demand in an economy
The two demand-side policies are fiscal policy and monetary policy
Any policy that increases consumption, investment, government spending or net exports is likely to
cause an increase in real GDP

Examples of Specific Types of Fiscal Policy Used To Boost Growth

Example Explanation

Many taxes on imports (import Costs of production for firms are reduced and they can
tariffs) are eliminated produce more goods/services at lower prices - which will
increase total demand

Subsidies are provided to Car manufacturers are able to produce their cars more cheaply
manufacturers of electric cars and sell them at lower prices - which will increase total demand

A government increases the level of Unemployed workers have more income available and increase
unemployment benefits their consumption - which will increase total demand

A government creates a free port Both multi-national and domestic companies are incentivised
zone by the low/no tax promise and seek to invest in free port zones
- which will increase total demand

A government announces that it will Building companies have to be employed and building
build 14 new schools in the next materials consumed which is all paid for by the government -
financial year and will increase total demand

Examples of Specific Types of Monetary Policy Used To Boost Growth

Example Explanation

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The housing market is subdued With cheaper loans now available, house buyers demand more
and so the Central Bank lowers loans to purchase properties and to renovate/furnish the
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interest rates by 1% properties - consumption increases and total demand increases

The Central Bank intervenes in The nation's currency is now cheaper for foreigners to purchase
the exchange rate to depreciate and this boosts exports, which will increase total demand
it

The Central Bank commits to a Commercial banks, firms and private investors receive this money
new Quantitative Easing program as the government purchases their bonds - they use some of it to
of $75bn a month invest and consume resulting in greater total demand

An evaluation of the pros and cons of fiscal/monetary policy is developed in Topic 4.3 and Topic 4.4

Examiner Tips and Tricks

When evaluating any demand-side policy, avoid generalisations and focus on the effects of the
specific policy mentioned. To strengthen any response, fully develop how each policy will increase
total demand as this is part of your 'chain of analysis'. Always conclude by explaining the different
elements of GDP (C + I + G + X - M), inflation and output (real GDP)

Supply-side Policies
Supply-side policies aim to influence the total supply in an economy

Examples of Specific Types of Supply-Side Policy Used To Boost Growth

Example Explanation

The Government reduces the level of People who rely on benefits for survival are more likely to
welfare benefits make themselves available for work. With more workers in
the economy there can be a higher level of output and
economic growth

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The Government launches a new This provides a pool of skilled labour in AI and helps to
'Education and Training' fund to help grow a new industry resulting in greater national output and
Your notes
fund University students studying economic growth
artificial intelligence (AI)

The Government decides to remove The removal of this protection lowers prices and
quotas on all imports encourages more competition leading to higher output
and economic growth

The Government decides to build an An additional runway means that more planes can land
additional runway at the national airport which generates more economic activity (e.g. transport of
goods/services) leading to higher output and economic
growth

An evaluation of the pros and cons of supply-side policy is developed in Topic 4.5

Examiner Tips and Tricks

Supply-side policies can be difficult to identify. This is because many supply-side policies are a
fiscal policy in the short term but a supply-side policy in the long term. In the example above,
building a new runway requires government spending in the short term (fiscal policy) as the
government hires firms, workers and buys the necessary materials. However, when it is finished, it
increases the supply of runways to the economy which in turns increases the economic activity - the
potential output of the economy has expanded and it is a long term supply-side policy.

In your exams, when deciding if a specific policy is fiscal or supply-side, determine whether the
government is using it with the intention of increasing total demand or total supply.

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