AQA A-level Economics: Economic growth and the economic cycle (7136) – Revision Notes

Condensed notes for AQA A-level Economics (7136), version 1.3 of the specification (29 June 2022). The content point is “Economic growth and the economic cycle”, numbered 3.2.3.1 on the AQA website and 4.2.3.1 in the combined AS and A-level PDF. For full explanations use the study guide. Test yourself with the practice set, find the course hub and printable checklist, and take a free diagnostic to find weak spots. For the AD/AS model itself see the aggregate demand and supply guide.

All numbers on this page are invented for illustration.

Definitions to know

Term	Meaning
Economic growth	Increase in real GDP, at constant prices
Short-run growth	Increase in actual output, usually from higher AD using spare capacity
Long-run growth	Increase in productive capacity; the trend rate of growth of real output over time
Trend rate	Average rate at which potential output grows
Positive output gap	Real GDP above the economy’s productive potential
Negative output gap	Real GDP below the economy’s productive potential
Economic cycle	Fluctuations of actual output around the trend
Shock	Unexpected event that shifts AD or aggregate supply
Sustainable growth	Growth that does not reduce future generations’ ability to meet their needs

Formulas and methods

Item	Method
Growth rate	Change in real GDP as a percentage of its starting level
Real growth from nominal	(1 + nominal growth) / (1 + inflation) − 1
Output gap (%)	(actual − potential) / potential × 100
Real GDP per person	One plus real GDP growth, divided by one plus population growth, minus one
Trend rate over n years	(final / start)^(1/n) − 1
Emissions per unit of output	Emissions / real GDP

Method in steps for a gap question

1. Write the formula.
2. Use potential output as the denominator.
3. Keep the sign: positive means above potential, negative below.
4. State what the sign means for the economy.

Worked reminders

Gap: actual 612, potential 600 -> (612-600)/600 = +2.0%
Gap: actual 585, potential 600 -> (585-600)/600 = -2.5%
Real growth: nominal +6.0%, prices +2.5% -> 1.060/1.025 - 1 = 3.4%
Per head: GDP +2.4%, population +0.6% -> 1.024/1.006 - 1 = 1.8%
Bubble: index 100 -> 140 -> 91. Fall from peak = (91-140)/140 = -35.0%

Short-run versus long-run growth

	Short run	Long run
Cause	AD rises (or a temporary supply improvement)	Productive capacity rises
PPC	Move from inside the curve towards it	Whole curve shifts outward
AD/AS	AD shifts right along SRAS	LRAS shifts right
Lasts	Until spare capacity runs out	Permanent if capacity is kept
Risk	Inflation and a positive gap	Slow to achieve; costs now, gains later

PPC points to remember: a point on the curve is full use of resources; inside is unemployment or waste; outside is unattainable until capacity grows. Moving along the curve is opportunity cost, not growth.

Diagrams in words

• PPC for long-run growth: capital goods on the vertical axis, consumer goods on the horizontal. Draw the original curve, then a second curve further from the origin. Label both axes and both curves.
• PPC for short-run growth: mark a point inside the curve, then a point on or nearer the curve. The curve itself does not move.
• AD/AS, short-run growth: AD shifts right along upward-sloping SRAS. Equilibrium moves to a higher real GDP, with prices up too. If it lies right of LRAS, the gap is positive.
• AD/AS, long-run growth: LRAS (and usually SRAS) shifts right. Potential output rises and the price level is lower than it would have been.
• Shock: state which curve moves, the direction, and what happens to the price level and real GDP.

Determinants

Demand side (short run): consumption (confidence, wealth, interest rates, taxes, credit), investment (expected profit, interest rates, finance), government spending, and net exports (world growth, exchange rate).

Supply side (long run): labour quantity and quality, capital stock, technology, productivity, enterprise, natural resources, infrastructure, competition, and a banking system that channels savings to business investment funds.

Link: investment raises AD now and capacity later. Education and training raise labour quality but pay off slowly.

Costs and benefits of growth

Group	Benefits	Costs
Individuals	Higher incomes, jobs, choice	Inequality, stress, structural change, skills made obsolete
Economy	Tax revenue, lower unemployment, investment	Overheating, inflation, bigger import bill
Environment	Funds for green technology	Depletion, pollution, climate damage

Evaluation prompts

• What type of growth is it, and who gains?
• Is output growing faster than population? Check growth per head.
• Is growth driven by demand (short-run) or capacity (long-run)?
• Is it sustainable: does it use renewable inputs, and are emissions falling per unit of output and in total?
• Time: costs may fall on later generations; benefits may arrive sooner.

The cycle and its indicators

Phase	Real GDP	Output gap	Inflation	Unemployment	Investment
Boom	Growing fast	Positive, may widen	Rising	Low and falling	Strong
Slowdown	Growth slowing	Positive but shrinking	Peaking	Low, starting to rise	Slowing
Recession	Falling	Negative	Falling	Rising	Falling sharply
Recovery	Growth returns	Still negative until output passes potential	Low	Still high, falls later	Rising

Use at least two indicators and say which lag. Unemployment often lags the turning point. A common convention defines recession as two consecutive quarters of falling real GDP.

Causes of phase changes

	Global	Domestic
Demand shock	Fall in trading partners’ incomes; world financial turmoil	Confidence shifts; policy tightening; credit squeeze
Supply shock	World commodity price rise; supply chain disruption	Natural disaster; strike; new technology; regulation change

Chain for a negative demand shock: AD falls, output falls, firms cut jobs and investment, incomes fall, AD falls further. Chain for a negative supply shock: costs rise, SRAS shifts left, price level rises and output falls.

Evaluate by size, duration, and how open or flexible the economy is.

Cyclical instability

Cause	Mechanism
Excessive credit and debt	Spending runs ahead of income; a rate rise or income fall forces repayment
Asset price bubble	Prices exceed fundamentals; a wealth effect lifts spending; a fall causes negative equity
Destabilising speculation	Buying because prices rise pushes prices up, then selling because they fall pushes them down
Animal spirits	Confidence swings not based on calculation
Herding	Copying others amplifies swings

Boom-bust chain: easy credit, rising asset prices, higher collateral values, more lending, more spending, then a trigger, falling prices, negative equity, cuts in lending and spending, recession.

Must-know distinctions

• Actual growth versus potential growth.
• Real versus nominal GDP.
• Movement along a PPC versus a shift of a PPC.
• Output gap (a level) versus growth rate (a change).
• Growth in total GDP versus growth per head.
• Demand-side shock versus supply-side shock.
• Global shock versus domestic shock.
• Growth versus sustainable growth.

Quick self-test

1. Define long-run economic growth.
2. Real GDP is 840 and potential output is 800. Calculate the output gap.
3. Real GDP rises from 400 to 412. Calculate growth.
4. Nominal GDP rises 5.0% while prices rise 2.0%. Calculate real growth, to one decimal place.
5. State two demand-side determinants of short-run growth.
6. State two supply-side determinants of the trend rate.
7. Population grows 1.0% and real GDP 3.0%. Calculate growth per head, to one decimal place.
8. What shift on a PPC shows long-run growth?
9. Give an example of a global supply-side shock.
10. Asset prices rise 100 to 160 then fall to 120. Calculate the fall from the peak.
11. Why might a recovery still have a negative output gap?
12. Explain herding in one sentence.

Answers

1. An increase in the productive capacity of the economy; the trend rate of growth of real output over time.
2. (840 − 800)/800 × 100 = +5.0%, a positive gap.
3. (412 − 400)/400 × 100 = 3.0%.
4. 1.050/1.020 − 1 = 2.9%.
5. Any two of: consumer confidence, interest rates, investment, government spending, exports.
6. Any two of: labour quality, capital stock, technology, productivity, infrastructure.
7. 1.030/1.010 − 1 = 2.0% (1.98% unrounded).
8. An outward shift of the whole curve.
9. A rise in world commodity prices raising firms’ costs.
10. (120 − 160)/160 × 100 = −25.0%.
11. Output is growing again but is still below potential, so the gap is not yet closed.
12. Individuals copy what others do, so trends in buying or selling are amplified.

Where marks are usually lost

• Writing growth for any increase in output and ignoring the short-run and long-run distinction.
• Dividing an output gap by actual GDP instead of potential.
• Dropping the sign of a negative gap.
• Using nominal figures when asked about real growth.
• Drawing a PPC shift for a recovery from recession.
• Naming a shock but not saying whether it moves AD, SRAS or LRAS.
• Describing a bubble without a chain of reasoning to spending and output.
• Giving costs and benefits as lists, with no judgement about size, timing or who is affected.

Official syllabus

AQA, AS and A-level Economics (7135 and 7136), specification version 1.3, 29 June 2022, section 3.2.3.1 on the AQA website (4.2.3.1 in the combined PDF).