What this lesson teaches
I can explain the causes of weak growth, unemployment, inflation or deflation and a large trade imbalance.
Syllabus 9570, 3.2.2(a). Macroeconomic Issues: Macroeconomic issues and their causes; Undesirable economic growth - persistently low or negative, unsustainable, non-inclusive due to factors such as changes in AD or AS, environmental degradation, inequitable income distribution; Unemployment - demand-deficient, structural, frictional due to factors such as lack of AD, technological changes, mismatch of skills, transition between jobs; Price instability - demand-pull inflation, cost-push inflation, deflation due to factors such as changes in AD, costs of production, productive capacity; Persistently large balance of trade deficit or surplus due to factors such as changes in global conditions, international competitiveness, exchange rates
Make a guess
Real GDP rises 4% this year as idle factories go back to work. Is this potential growth?
- No. It is actual growth from using spare capacity.
- Yes. Any rise in real GDP is potential growth.
- No. It is a fall in unemployment, not growth of any kind.
Show the answer
No. It is actual growth from using spare capacity.
Potential growth needs more or better resources. Reopening idle factories raises output towards capacity without raising capacity itself.
Actual growth is a rise in real output; potential growth is a rise in the economy's capacity to produce.
Actual growth is an increase in real GDP. It can happen when AD rises and idle resources are put back to work.
Potential growth is an increase in productive capacity: more workers, more capital, better skills or better technology. It shifts AS (and the PPC) outward.
Sustained growth needs both. If AD grows faster than capacity for long, the economy runs into bottlenecks and inflation.
If capacity grows while AD grows at the same pace, output can rise with stable prices. Singapore's growth strategy focuses on productivity, because its workforce is growing slowly.
- Actual growth
- Rise in real GDP.
- Potential growth
- Rise in productive capacity.
Worked example: The same output rise, two stories
Suppose real output rises from an index of 100 to 104 in two economies. In A, potential output stays at 110. In B, new capital and skills raise potential output from 110 to 115.
- In A, the rise comes from using idle resources; spare capacity shrinks from 10 to 6.
- In B, capacity grew too, so spare capacity rises from 10 to 11.
- B can keep growing without inflation for longer.
Watch out for this
Any rise in real GDP means productive capacity has grown.
Real GDP can rise because idle resources are put to use. Capacity grows only with more or better resources.
Check your understanding
Which change causes potential growth?
- More workers gain advanced digital skills.
- Households spend more on holidays.
- The government raises spending during a recession.
Show the answer
More workers gain advanced digital skills.
Right. Better skills raise productive capacity.