Causes of economic growth

  • Economic growth means an increase in real GDP. Economic growth means there is an increase in national output and national income.
  • Economic growth is caused by two main factors:
      1. an increase in aggregate demand (AD)
      2. an increase in aggregate supply (productive capacity)

Economic growth in UK

Demand side causes

In the short term, economic growth is caused by an increase in aggregate demand (AD). If there is spare capacity in the economy then an increase in AD will cause a higher level of real GDP.

AD= C + I + G + X- M

  • C= Consumer spending
  • I = Investment (gross fixed capital investment)
  • G = Government spending
  • X = Exports
  • M = Imports

Graph showing increase in AD

ad

AD can increase for the following reasons:

  • Lower interest rates – Lower interest rates reduce the cost of borrowing and so encourages spending and investment.

econ-growth

In 2008, base rates were cut to 0.5% to try and stimulate economic growth.

  • Increased wages. Higher real wages increase disposable income and encourages consumer spending.
  • Increased government spending (G). e.g. government investment on building new roads.
  • Fall in value of sterling which makes exports cheaper and increases quantity of exports(X).
  • Increased consumer confidence, which encourages spending (C).
  • Lower income tax which increases disposable income of consumers and increases consumer spending (C).
  • Rising house prices, which create a positive wealth effect and encourages homeowners to spend more.

2. Long term economic growth

This requires an increase in the long run aggregate supply (productive capacity) as well as AD.

Diagram showing long run economic growth

asad

 

LRAS or potential growth can increase for the following reasons:

  1. Increased capital. e.g. investment in new factories or investment in infrastructure, such as roads and telephones.
  2. Increase in working population, e.g. through immigration, higher birth rate.
  3. Increase in labour productivity, through better education and training or improved technology.

labour-productivity

more on labour productivity

  1. Discovering new raw materials.
  2. Technological improvements to improve the productivity of capital and labour e.g. Microcomputers and the internet have both contributed to increased economic growth.

Other factors affecting economic growth

  • Economic and political stability. Stability is important for reassuring firms it is a good idea to invest in increasing capacity. If we see a rise in uncertainty, confidence tends to fall and this can cause firms to delay investment.
  • Low inflation. Low inflation is a good climate for encouraging business investment. High inflation increases volatitlity.

Periods of economic growth in UK

1980s boom

economic-growth-1980-95

In the 1980s, the UK achieved rapid rates of economic growth, this was caused by

  • Cuts in income tax, increasing disposable income
  • Boom in house prices, which caused a positive wealth effect
  • Rise in confidence, especially amongst south
  • Low real interest rates
  • See: UK economy in 1980s

Period of great moderation 1992-2007

inflation-growth-90-12

The longest period of economic expansion on record was from 1992 – 2007. This period of economic growth was caused by

  • Low global inflation, which created period of economic stability.
  • Rise in house prices, which helped increase consumer spending.
  • Growth in productivity, helped by supply side reforms.
  • Inward investment helped create new jobs and better labour relations.
  • See: Great moderation

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