Growth is the headline objective of almost every government — but it comes in two forms (actual and potential), it carries real costs as well as benefits, and the…
Growth is the headline objective of almost every government — but it comes in two forms (actual and potential), it carries real costs as well as benefits, and the gap between what an economy does produce and what it could produce tells you where it is in the cycle.
Learning objectives — by the end of 2.5 you can…
- distinguish actual from potential growth and explain the causes of each; - evaluate the benefits and costs of growth; - explain positive and negative output gaps and the economic cycle.
Causes: actual vs potential growth
Spec: 2.5.1
Two kinds of growth
Actual growth: An increase in real GDP — using up existing spare capacity. Caused by a rise in the components of AD (C, I, G or X−M).
Potential growth: An increase in the economy's productive capacity — an outward shift of LRAS (and the PPF).
Because demand drives actual growth, anything that raises AD — a consumer boom, an investment surge, a fiscal stimulus, or strong export-led growth from international trade — can lift output while spare capacity exists.
Potential growth comes from expanding what the economy can produce:
Underpinning all of these is productivity — output per worker. Sustained rises in productivity are the single most important driver of long-run growth in living standards.
Costs & benefits of growth
Spec: 2.5.2
| Benefits of growth | Costs of growth |
|---|---|
| Higher average living standards | Opportunity cost: capital goods now mean fewer consumer goods today |
| Lower unemployment | Environmental costs: pollution and resource depletion |
| Higher profits and investment | Balance of trade deficits as growth sucks in imports |
| More tax revenue → better public services | Inequality may widen if the gains are unevenly shared |
| Greater business and consumer confidence | Inflation if demand-led growth runs near full capacity |
Evaluation — not all growth is equal
Whether growth is desirable depends on its type and how it is achieved. Export- and investment-led growth, or "green" growth, is far more sustainable than growth fuelled by debt and a consumer boom, which can store up inflation and trade deficits. Always link your judgement to the source of the growth and the economy's spare capacity.
Output gaps & the economic cycle
Spec: 2.5.3
An output gap is the difference between an economy's actual output and its trend (potential) output. Actual output rarely sits exactly on trend — it swings above and below it through the economic cycle: boom → slowdown → recession → recovery.
2.5 Recap — nail these
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