Actual and potential growth, the causes of growth, the phases of the economic cycle, output gaps, and the costs and benefits of economic growth.

What this dot point is asking

AQA wants you to distinguish actual from potential growth, explain the causes of growth, describe the phases of the economic cycle and output gaps, and weigh the costs and benefits of growth. The actual-versus-potential distinction and output gaps are tested repeatedly.

Actual and potential growth

Actual growth in the short run comes from rising aggregate demand using up spare capacity, a move from inside the PPF towards it. Sustained, non-inflationary growth requires potential capacity to grow too, otherwise rising demand simply causes inflation once full capacity is reached. The distinction is the key to evaluating any growth policy.

Causes of growth

Long-run (potential) growth comes from increases in the quantity and quality of the factors of production: a larger and better-trained workforce (from immigration, education and training), more investment in physical capital, technological progress, and improvements in productivity and efficiency. Short-run (actual) growth is driven by the components of aggregate demand, especially consumption and investment, and is amplified by the multiplier.

The economic cycle and output gaps

Output gaps are hard to measure precisely because potential output is unobservable, which is a key evaluation point: policymakers may misjudge the gap and so set policy wrongly. In a boom, demand-pull inflation and a current account deficit tend to rise; in a recession, unemployment rises and the budget deficit widens via automatic stabilisers.

Costs and benefits of growth

• Benefits. Higher average incomes and living standards, lower unemployment, higher tax revenues to fund public services and reduce the deficit, the accelerator boosting investment, and improved business and consumer confidence.
• Costs. Demand-pull inflation if growth is too fast, widening income inequality if gains accrue to capital owners, environmental damage and resource depletion (negative externalities of production), and a worsening current account as rising incomes pull in imports.

Whether growth is desirable depends on whether it is sustainable (not depleting natural capital or storing up environmental costs) and inclusive (shared across society). This is why "green growth" and inequality feature heavily in modern evaluation.