29. Economic Growth

1. Circular Flow of Income

The circular flow of income represents how money moves through an economy between different sectors, mainly households and firms in a simplified two-sector model. It is a closed loop showing continuous movement of money, goods, and services.

Key Concepts:

• Households supply factors of production:

• Land (earns rent)

• Labor (earns wages)

• Capital (earns interest)

• Enterprise (earns profits)

• Firms use these factors to produce goods and services, which are then sold to households.

• Households use their income to purchase goods and services from firms.

• This flow of goods/services and money forms the circular flow.

• In a closed economy, there are no government activities or foreign trade involved.

Extension to Four-Sector Model:

• Government: collects taxes and provides public goods.

• Financial Institutions: savings and investments flow through banks and capital markets.

• Foreign Sector: exports and imports included in the flow (open economy).

2. National Income Concepts

• National Income: The total value of all final goods and services produced by the residents of a country in a specific period.

• Gross Domestic Product (GDP): The total market value of all goods and services produced within a country’s borders, irrespective of the ownership of production.

3. Approaches to Calculating GDP

A. Expenditure Approach
Where:

• C = Consumption

• I = Investment

• G = Government Spending

• X – M = Net Exports (Exports – Imports)

B. Income Approach

• GDP is calculated by summing up all incomes earned by factors of production:

• Wages + Rent + Interest + Profits

• Only factor incomes are included; transfer payments are excluded.

C. Output/Product Approach

• GDP is calculated by adding the market value of all final goods and services.

• Adjustments are made to exclude intermediate goods to avoid double counting.

4. Nominal GDP vs Real GDP

• Nominal GDP: Measured using current prices without adjusting for inflation.

• Real GDP: Adjusted for inflation to reflect true growth over time.

Formula:

• Real GDP gives a better understanding of actual economic growth.

5. Problems in Measuring National Income

A. Non-Monetary Transactions:

1. E.g., homemaking services by housewives or self-consumed farm produce are not recorded.

B. Double Counting:

1. Mistaking intermediate goods as final goods can inflate GDP. Only final goods must be included.

C. Underground Economy:

1. Illegal or unrecorded transactions like drug trade or unregistered labor escape official statistics.

D. Petty Production:

1. Small-scale producers often don’t maintain records, leading to exclusion from national income.

E. Public Services:

1. Services like police, defense, or public education are difficult to value monetarily.

F. Price Changes:

1. Inflation can falsely elevate GDP even when output remains stagnant.

G. Wages Paid in Kind:

1. Benefits like food or accommodation may not be accounted for properly in monetary terms.

H. Illiteracy and Ignorance:

1. Many people cannot report or calculate their income correctly, affecting data accuracy.

I. Other Issues:

1. Second-hand sales aren’t included.
2. Environmental degradation is ignored.
3. Depreciation is difficult to estimate.
4. Data availability is often limited or outdated.

6. Economic Growth

Definition:

Economic growth refers to an increase in the output of goods and services in an economy over time, typically measured as the annual percentage increase in real GDP.

Factors That Contribute to Economic Growth:

A. Increase in Quantity of Resources:

• More labor (e.g., via immigration)

• More capital goods (e.g., infrastructure, machinery)

• Increased availability of land and natural resources

B. Improvement in Quality of Resources:

• Better education and training increases human capital

• Technological advances improve productivity

• Quality machinery and innovations boost output

7. Benefits of Economic Growth

• Higher Standard of Living:

• More variety and availability of goods and services

• Increase in Employment:

• Growth generates more job opportunities

• Boost in Business Confidence:

• Firms are more likely to invest and expand

• Increased Government Revenue:

• Through taxes on higher incomes and sales

8. Costs of Economic Growth

• Short-Term Reduction in Consumer Goods:

• More resources may be directed toward capital goods.

• Stress and Anxiety:

• Increased workload and competition

• Longer Working Hours:

• May negatively impact work-life balance

• Environmental Degradation:

• Resource overuse and pollution

• Wage Pressures and Inflation:

• Rising demand for labor can push wages up unsustainably

9. Economic Sustainability

Definition:

Sustainable economic growth is the ability to grow without exhausting natural or human resources, ensuring future generations can meet their needs too.

Key Objectives:

A. Economic Objectives:

• Efficient use of resources

• Investment in human and physical capital

B. Social Objectives:

• Equal access to housing, education, healthcare

C. Environmental Objectives:

• Sustainable resource use

• Minimizing environmental damage

10. Recession

Definition:

A recession is a period of temporary economic decline, typically marked by a fall in GDP for two consecutive quarters.

Causes of Recession:

A. Demand-Side Shocks:

• Fall in consumer confidence and spending

• Drop in investments

• Government spending cuts

• Decline in net exports due to exchange rate changes

B. Supply-Side Shocks:

• Rise in input costs (e.g., oil prices)

• Natural disasters or pandemics

• Production disruptions

Consequences of Recession:

• Higher Unemployment:

• Businesses cut jobs due to lower demand

• Lower Living Standards:

• Incomes fall; poverty may rise

• Reduced Investment:

• Less foreign and domestic capital inflow

• Government Deficits:

• Increased spending on welfare, reduced tax revenue

• Effect on Prices:

• Demand-side recessions may reduce inflation

• Supply-side recessions can cause stagflation (inflation + unemployment)