Economic growth and sustainability

Economics A2 · The macroeconomy. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Actual growth is a rise in real GDP, the output the economy really produces. Potential growth is a rise in the output the economy could produce if all resources were fully used. Actual growth can come from using spare capacity; potential growth needs more or better factors of production and shifts the PPC and LRAS outwards.

The output gap is the difference between actual and potential output. Actual output moves around potential output in the business cycle: recovery, boom, recession, slump.

Growth is inclusive when its benefits are shared widely across the population. It is sustainable when it can continue without reducing the resources and environment available to future generations.

Rules to remember

Output gap = actual output − potential output; often given as a percentage of potential output.
Negative output gap: actual below potential, so spare capacity and cyclical unemployment. Positive output gap: actual above potential, so inflationary pressure.
Recession: real GDP falls for two consecutive quarters. Slower positive growth is not a recession.
Automatic stabilisers: tax revenue and welfare spending change with the cycle without any new government decision, so they reduce the size of booms and recessions.
Accelerator: a change in the growth of output or consumer demand causes a larger proportional change in investment.
Demand-side policies raise actual growth; supply-side policies (education, training, investment, infrastructure) raise potential growth.
A renewable resource is used sustainably only if the amount taken each year is no more than the amount that regenerates.

Common mistake

Students treat a movement from inside the PPC to a point on it as potential growth. It is actual growth only; potential growth is an outward shift of the curve itself.

Worked example

Potential output is $800bn and actual output is $824bn. What is the output gap and what does it suggest?

Output gap = actual − potential = 824 − 800 = +$24bn.
As a percentage of potential output: 24 ÷ 800 × 100 = 3%.
Actual output is above potential, so firms are working beyond normal capacity and bidding for scarce workers and materials.

Answer: A positive output gap of $24bn (3% of potential output), which suggests rising demand-pull inflation.

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