The Costs and Benefits of Economic Growth
Economic growth brings both costs and benefits, and these differ depending on whether the growth is short-run (actual growth, closing a negative output gap by using spare capacity) or long-run (trend growth, an outward shift of the economy's productive potential, or LRAS).
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Method
- Distinguish short-run (actual) growth, a movement towards a point on the production possibility frontier (PPF) or the closing of a negative output gap, from long-run (trend) growth, an outward shift of the PPF or of LRAS itself.
- List and explain the benefits of growth, grouping them into economic (higher incomes, more jobs, higher tax revenue, easier government debt financing) and social (poverty reduction, more resources for public services such as health and education).
- List and explain the costs of growth, grouping them into economic (demand-pull inflation if growth is too rapid, structural unemployment from declining industries), environmental (pollution, resource depletion, greenhouse gas emissions), and social (rising inequality if gains are concentrated).
- Distinguish sustainable, supply-led growth (driven by rising LRAS, with little inflationary pressure) from unsustainable, demand-led or credit-fuelled growth (AD persistently growing faster than LRAS, risking a boom followed by a bust).
- Evaluate by considering the type of growth (export-led or investment-led growth tends to be more sustainable than consumption-led, credit-fuelled growth), the pace of growth (gradual growth from spare capacity has few costs; growth beyond potential output causes demand-pull inflation), and the limitations of GDP as a measure (it excludes negative externalities and non-market activity, so it may overstate the genuine welfare gain from growth).
Worked example
In Year 1, a country's nominal GDP is 2,000 billion pounds and its price index is 100. In Year 2, nominal GDP rises to 2,100 billion pounds and the price index rises to 103. Calculate the country's real GDP in Year 2 (in Year 1 prices) and its percentage real growth rate.
- Convert Year 2 nominal GDP into real terms using the price index: real GDP = nominal GDP / (price index / 100).
- Calculate: 2,100 / (103 / 100) = 2,100 / 1.03 = 2,038.83 billion pounds (to two decimal places).
- Calculate the real growth rate: (2,038.83 - 2,000) / 2,000 x 100.
- Calculate: 38.83 / 2,000 x 100 = 1.94%.
- State the answer: real GDP grew by approximately 1.9% once the 3% rise in prices is stripped out of the 5% rise in nominal GDP.
Practice questions
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Q1Define 'trend rate of growth'.Show answer
Answer: The average sustainable rate at which an economy's productive potential (LRAS) grows over the long run.
Q2What is a positive output gap?Show answer
Answer: When actual real GDP is above the economy's estimated potential (trend) output, often associated with rising inflationary pressure.
Q3Give one environmental cost of rapid economic growth.Show answer
Answer: For example, increased greenhouse gas emissions, air or water pollution, or faster depletion of natural resources.
Q4Give one benefit of economic growth for government finances.Show answer
Answer: Higher incomes and spending raise tax revenue, giving the government more to spend on public services or to reduce borrowing.
Q5Nominal GDP grows by 6% and inflation is 4%. Estimate the approximate real growth rate.Show answer
Answer: Approximately 6% - 4% = 2% (an approximation; the exact figure requires dividing through by the price index).
Q6Explain in one sentence why rapid, credit-fuelled growth risks a 'boom and bust' cycle.Show answer
Answer: If consumer spending grows quickly because of rising borrowing rather than rising productive capacity, aggregate demand can outstrip LRAS, causing inflation that eventually forces policy tightening and a sharp slowdown.
Exam-style questions
Written in the style of a A Level Economics exam paper, with a full mark scheme.
Explain two economic costs of a rate of economic growth that persistently exceeds the trend rate of growth.
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Evaluate the view that the benefits of economic growth always outweigh the costs.
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See real A Level Economics past-paper questions, with official mark schemes →
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