2.2 Economic growth and the cycle: the causes of short-run and long-run growth, the phases of the economic cycle, output gaps, and the costs and benefits of growth.

What this dot point is asking

OCR wants you to explain the demand-side and supply-side causes of economic growth, to describe the phases of the economic cycle, to define positive and negative output gaps, and to weigh the costs and benefits of growth.

The causes of economic growth

• Demand-side causes: rising consumption, investment, government spending or net exports raise AD; with spare capacity, output and employment rise. This growth is limited by capacity and can cause inflation near full employment.
• Supply-side causes: more labour (population, participation, migration), more capital (investment), better human capital (education and training), improved technology and productivity, and enterprise. These shift LRAS and the PPF outward, the only source of sustained long-run growth.

The economic cycle

Output gaps

The costs and benefits of growth

• Benefits. Higher living standards and real incomes, more employment, higher tax revenue to fund public services, reduced absolute poverty, and greater business and consumer confidence.
• Costs. Demand-pull inflation if growth is demand-led near capacity, environmental damage and resource depletion (negative externalities), a possible worsening current account (more imports), and widening inequality if the gains are unevenly shared. Rapid, unsustainable booms also risk a sharp correction.

The balance depends on whether growth is demand-led or supply-led and whether it is sustainable: green, productivity-driven growth raises welfare with fewer costs than an inflationary boom.

Examples in context

• The 2008 to 2009 recession. A textbook recession: falling real GDP, rising unemployment and a large negative output gap, met with fiscal and monetary stimulus.
• China's investment-led growth. Decades of rapid potential growth driven by investment and rising productivity shifted its PPF out dramatically, though with environmental costs.
• Net zero and green growth. UK policy aims for growth that shifts LRAS right through clean technology, reducing the environmental cost of growth.

Try this

Q1. Distinguish between a positive and a negative output gap. [4 marks]

• Cue. Positive: actual output above trend (boom, inflation); negative: actual output below trend (downturn, unemployment).

Q2. Explain one supply-side cause of long-run economic growth. [3 marks]

• Cue. For example better education and training raising labour productivity, shifting LRAS right.