A) The benefits and costs of economic growth and the impact on:
- Consumer income – An increase in economic growth causes unemployment to decrease and incomes to rise. This can be shown by the following formula: National output = National expenditure = National income. Therefore, if national output increases, so do incomes. One reason for this is that that firms have less people to choose from when hiring new employees due to reduced unemployment. As a result of this, in order to attract certain people in the job market to work for them instead of another firm, they will have to pay them a higher wage. Furthermore, when taking a classical standpoint if economic growth takes the economy to a short term equilibrium past the full employment rate, in the long run workers will revise up their wages. Therefore, there will be an increase in consumer incomes.
- Reduction in unemployment – The increase in AD (AD1 to AD2) causes an increase in real GDP (Y1 to Y2) which results in an increase in economic growth. An increase in real GDP (Y1 to Y2) reduces the amount of spare capacity within the economy. Therefore, the economy moves closer towards the full employment output (YFE). As a result of this, the amount of cyclical unemployment within the economy decreases. This is shown by the reduction in the negative output gap (from Y1 – YFE to Y2-YFE). The reduction in unemployment can be explained by the fact that the demand for labour is derived from the total demand for goods/services within the economy (AD). Therefore an increase in AD will cause an increase in the demand for labour, thus reducing unemployment.
- Cost of living/high inflation – An increase in AD (AD1 to AD2) causes an increase in the general price level of goods/services within the economy (P1 to P2) as a result of an increase in the pressure on existing factors of production. This causes the purchasing power of money to decrease, meaning that the same amount of money cannot buy the same quantity of the same goods/services as before. For example, a consumer’s daily shop may have previously cost them £100. However, if the inflation rate increases by 5% that same daily shop will now cost them £105. Therefore, they can either decide to spend £5 more, or they can remove some items from their shopping list. Overall increase in inflation causes an increase in the cost of living.
- Increased revenues and profits for firms – Increases in economic growth are largely down to increases in consumer spending, as this is one of the main components of aggregate demand. The increase in the demand for goods/services within the economy means that firms are likely to experience an increase in sales revenue. This often causes an increase in the amount of profit that firms receive. Therefore, an increase in economic growth often benefits firms through increased revenues and profits.
- Increased investment – The increase in business confidence and profits that is caused by economic growth often leads to higher levels of investment by firms. This is because they are more confident that they will continue to do well as a business and therefore they’re able to reduce the amount of profit that they save/don’t invest. The increase in investment will benefit firms in the form of increased efficiency/productivity, which in turn will lower their costs. This is due to the technological advancements that come from investment. The accelerator effect can also explain the increase in investment. This is when firms increase their investment due to the fact that they believe there will be an increase in the demand for their goods/services in the future; which is signalled through an increase in the economic growth rate.
- Decrease in the amount of labour to choose from – As the unemployment rate decreases, firms have less people to choose from when hiring new staff. This is because the amount of people that are currently looking for work has decreased. Therefore, it may be harder for firms to fill job vacancies and they may have to offer higher wages in order to attract more people to the job.
- Menu costs – Increases in inflation caused by the reduction in spare capacity that occurs during economic growth will result in menu costs. This is applicable to firms such as restaurants which will have to spend money adjusting the menu prices in order to account for increases in inflation.
- An improvement in the government budget balance – An increase in economic growth is often spurred by increased consumer expenditure. This increase in consumer spending will cause an increase in the amount of tax revenue the government gain from VAT. Furthermore, economic growth causes a reduction in unemployment. Therefore government spending on welfare benefits will reduce and the revenue they gain from income tax will increase. Increased consumer spending also causes an increase in the revenue and often the profit that firms make. This means that firms will have to pay more corporation tax, thus increasing government tax revenue further. Overall, this will lead to an improvement in the government budget balance.
- A worsening in the current account of the balance of payments – As consumer incomes increase, so will the demand for goods/services. However, some of the goods/services that domestic consumers demand are made in countries abroad. As a result of this, the demand for imports will increase as consumer spending does. This often leads to an increase in import expenditure, thus worsening the trade balance and therefore the current account deficit too (or reducing a current account surplus). In addition to this, the increase in inflation that is associated with an increase in economic growth causes an increase in the general price level of goods/services within the economy. This makes domestic goods/services less price competitive in relation to other countries. Therefore, the demand for exports and revenue gained from exports is likely to decrease. Overall, this will lead to a worsening of the trade balance and therefore the current account of the balance of payments. However, as net trade is only a small part of the aggregate demand value (around 1 or 2 percent) the government may not be too concerned about this.
- Macroeconomic instability – High levels of inflation often lead to boom and bust cycles. This is because unstable inflation levels cause uncertainty for firms, consumers and foreign investors. For example, a large increase in inflation can cause long term business contracts to change in value, thus changing the profitability of the project as a whole (in real terms). It can also spur a large increase in the interest rate in order to try and maintain inflation. Both of which can lead to an increase in the volatility of economic growth and therefore the economic cycle.
Current and future living standards
- A decrease in absolute poverty rates – An increase in economic growth causes a reduction in unemployment and an increase in income. As a result of this there is an increase in the number of consumers that have stable and regular incomes. Therefore, the people living in absolute poverty (those who don’t have the minimum amount of income to sustain a basic standard of living) will decrease.