Ch.12 Gross Domestic Product and Growth
Sec.2 Business Cycles
Factors that affect the business cycle:
More Business Investment
Economy is expanding, rise in demand for goods and services.
Additional jobs are created, GDP is increased.
Less Business Investment
Too much or enough expansion, contraction in economy, demand for product is dropping.
Workers are laid off, unemployment rate rises, and cause a recession which will lead to a decrease in GDP.
Rise in Interest Rate
• To slow down the growth of the economy.
• To curb consumer spending.
• Consumers are less likely to purchase “big ticket” items.
• It causes the “contraction” in the economy.
• Businesses will decrease their investment and lead to reduced output and employment.
Drop in Interest Rate
• To encourage consumers to spend money.
• To spurt the growth of the economy.
• Consumers will purchase more cars and houses.
• Businesses will be more likely to expand and invest.
Rise in Consumer Expectations
Expectation of a rapidly growing and robust economy.
A higher aggregate demand is created thus increase the GDP.
Fall in Consumer Expectations
• Fear of a weak economy
• Consumers start to save money and cause a contraction in the economy.
• Decrease in GDP.
Positive External Shocks
• Discovery of large oil depos
• Perfect weather for agriculture
• Increase in GDP.
• Prices drop for most goods.
• Cheaper production costs.
Negative External Shocks
• Wars, floods, natural disasters, terrorist attacks, interruption in trade relations
• Disrupt the sales of goods.
• Reduction in GDP.
• Cause prices to spike.
Interpret this statement:
“Consumer expectations often become self-fulfilling prophecies, creating the very outcome that consumers fear.”
If consumers are worried about a recession, they will hold back on making major purchases and start saving money. If all consumers cut back on their spending drastically, the economy will go into a contraction as a result of the consumers’ spending behavior.
Section 3: Economic Growth
How can the following factors affect economic growth of a country?
1. Capital (Physical and Human) deepening
• Both factors should increase the rate of productivity and also increase the equilibrium wage (which will add to the economic growth).
2. Savings and Investment
• Higher savings leads to higher investment. Therefore, businesses will invest in physical and human capital to increase the GDP.
3. Population Growth
• If the population grows faster than the GDP, the economy will suffer due to fewer resources available per person.
• The government can change the tax rate to affect economic growth. If taxes are too high, then there will be less money available to invest. On the other hand, lower tax rate will stimulate economic growth by putting more money in consumers’ pockets and encourage more business investment.
5. Foreign trade
• A trade deficit could hurt the economy, unless the deficit is caused by long-term investment to promote economic growth.
6. Technological progress
• This usually increases the efficiency of workers and factories by producing more output without using more input.