Edexcel International Advanced Level Economics: Growth causes, benefits, costs (YEC11) – Revision Notes

Condensed recall for 2.3.5 Economic growth, statements 1 to 3, in the Pearson Edexcel International Advanced Subsidiary/Advanced Level Economics specification (Issue 2, June 2018). Full explanations are in the study guide; test yourself with the practice questions. The specification lists Units 1 and 2 as International AS and Units 3 and 4 as the extra International A2 content; this topic is in Unit 2. Hub: Edexcel A Level Economics. Checklist: printable checklist. Find your weak spots with the free diagnostics. All figures here are invented and illustrative.

Definitions

Term	Meaning
Actual growth	Percentage change in real GDP over a period
Potential growth	Rate of increase in productive capacity (LRAS or PPF shifts right)
Export-led growth	Growth driven mainly by rising exports
FDI	Foreign direct investment: a foreign firm builds or buys productive capacity at home
Net migration	Immigration minus emigration
Productivity	Output per unit of input, such as output per worker or per hour
Opportunity cost	The next best alternative given up

Formulas

Item	Formula
Growth rate	(new real GDP - old real GDP) / old real GDP x 100
AD	C + I + G + (X - M)
Contribution of a component	change in component / old GDP x 100 (percentage points)
GDP	employment x output per worker
Growth (approx.)	employment growth + productivity growth
Net investment	gross investment - depreciation
Real GDP per head	real GDP / population
Extra imports	change in income x marginal propensity to import
Extra tax	tax share of GDP x change in GDP

Method in steps: growth and contribution questions

1. Write the formula.
2. Substitute with units and the correct base year.
3. Give the answer to one decimal place unless told otherwise, with “%” or “percentage points”.
4. Say what it means in context, for example “faster than potential growth”.

Actual versus potential growth

• Actual growth: movement of AD along or against a given AS. Potential growth: shift of LRAS or the PPF.
• Actual growth above potential growth is sustainable only while there is spare capacity.
• Illustration: actual 4.5% and potential 3.0% means spare capacity is being used up.

Causes: one-line chains

• AD components: C rises (confidence, lower interest rates), I rises (expected profit), G rises (policy), net exports rise (competitiveness, foreign incomes) so AD shifts right, so real GDP rises.
• Export-led: bigger market, scale economies, earnings pay for imported capital, competition raises efficiency. Risk: exposure to foreign demand and exchange rates.
• Investment and FDI: capital stock rises, so capacity and productivity rise; FDI also brings technology and skills. Risk: profit outflows and crowding out.
• Innovation: new products and methods, so more output per input. Needs research spending, skills and incentives; arrives with a lag.
• Labour force and net migration: more workers, so capacity rises. GDP per head rises only if the extra workers are productive and capital keeps pace.
• Competition: pressure to cut waste and innovate. Too little competition allows complacency; very intense competition may squeeze the profits needed for investment.
• Productivity: sustained growth in GDP per head depends on it, since the labour force cannot grow forever.

Worked reminders

Growth: (836 - 800)/800 = 4.5%
Contribution: investment +10 on GDP 800 = 1.25 percentage points
Labour 2% + productivity 3% = about 5% (exact: 420.24/400 - 1 = 5.06%)
Net investment: 165 - 110 = 55 on a stock of 2,200 = 2.5%
Extra tax: 0.30 x 36 = 10.8
Per head: 836/40.4 = 20.69 against 20.0, up 3.47%
Extra imports: 0.35 x 36 = 12.6
Emissions: 0.98 x 1.05 = 1.029, up 2.9%

Benefits

Benefit	Chain	Limit
Living standards	More output per person	Must beat population growth; distribution matters
Unemployment	More output needs more labour	Structural unemployment remains
Profits	Higher sales, spread fixed costs	Rising wage costs can offset
Investment	Profits and confidence	Depends on expectations and interest rates
Tax revenue	Larger tax base	Depends on tax system and evasion
Public services	Extra revenue funds spending	Government may choose other priorities

Costs

Cost	Chain	Offset
Opportunity cost	Resources for investment cannot be consumed now	Future consumption is higher
Environment	Resource use, pollution, negative externalities	Cleaner technology, regulation
Trade deficit	Higher income pulls in imports	Strong exports or lower import share
Inequality	Gains uneven across groups	Progressive tax, benefits, skills
Inflation	AD outpaces potential output	Faster growth of capacity

Must-know distinctions

• Actual growth versus potential growth.
• Real GDP growth versus growth in GDP per head.
• Domestic investment versus FDI.
• Growth in the labour force versus growth in productivity.
• Percentage change versus percentage points.

Evaluation toolkit

Use these questions to turn a list into a judgement.

• Source: is growth driven by consumption and borrowing, or by investment and exports? Investment-led growth also raises capacity, so it is more likely to last.
• Speed: growth faster than potential growth tends to bring inflation and a wider trade deficit; growth at or below the trend is safer but slower.
• Distribution: who gains? Average income can rise while the lowest incomes barely move (for example +2% for the bottom group and +10% for the top group).
• Time: costs such as pollution may arrive later than the benefits, and benefits such as higher investment build up over years.
• Context: a country with high unemployment and idle capacity gains more from extra AD than one already at full capacity.
• Policy response: taxes, regulation, training and exchange-rate policy can reduce a cost or spread a benefit.

A good conclusion picks a side and says what it depends on: “Growth is most likely to raise living standards when it is investment-led, faster than population growth and shared across income groups.”

Worked chains to copy

Cause: net migration. Net inflow of working-age people, so the labour force rises (an 80,000 inflow into 10 million is 0.8%), so potential output rises if they are employed, so LRAS shifts right. Limit: capital must grow too, or output per worker falls.

Benefit: tax revenue. Real GDP rises, so incomes and spending rise, so revenue from income tax and sales taxes rises, so the government can spend more or borrow less. Limit: depends on tax rates and compliance.

Cost: trade deficit. Incomes rise, so households buy more imports (marginal propensity to import of 0.35 on a 36 rise in income gives 12.6 more imports), so the deficit widens unless exports rise by as much. Limit: a deficit financed by capital inflows may be sustainable for a while.

Cost: inflation. AD grows faster than capacity, so firms compete for scarce labour and materials, so wages and costs rise, so prices rise. Limit: if growth comes from higher capacity, inflation need not follow.

Exam technique

• Define the key term in the first sentence, then develop one point per paragraph.
• Use the data in the item: quote a figure and say what it shows.
• In calculations, show the formula, the substitution and the unit.
• Draw a labelled diagram when asked, and refer to it. For actual growth, shift AD along a given AS curve. For potential growth, shift LRAS right.
• Keep evaluation separate from analysis, and end with a reasoned conclusion.

Quick self-test

1. Real GDP rises from 1,500 to 1,560. Calculate the growth rate.
2. State which of AD or LRAS shifts for potential growth.
3. Investment rises by 15 when GDP was 1,500. Calculate its contribution to growth.
4. A labour force grows 1.5% and output per worker grows 2.5%. Estimate GDP growth.
5. Define net migration.
6. Tax is 25% of GDP and GDP rises by 60. Calculate the extra tax.
7. Give two reasons why FDI may raise potential growth.
8. Gross investment is 90 and depreciation is 70. Calculate net investment.
9. GDP rises 6% and population 2%. Calculate approximate growth in GDP per head.
10. Give one reason why growth may widen the trade deficit.

Answers

1. 60/1,500 = 4.0%.
2. LRAS (or the PPF).
3. 15/1,500 = 1.0 percentage point.
4. About 4.0% (1.5 + 2.5).
5. Immigration minus emigration.
6. 0.25 x 60 = 15.
7. It adds capital; it can transfer technology and skills (also export links).
8. 90 - 70 = 20.
9. 1.06/1.02 - 1 = 3.9% (approximately 4%).
10. Higher incomes raise spending on imports.

Where marks are usually lost

• Using the wrong base year when calculating growth.
• Writing “GDP” and not “real GDP”.
• Giving a list of causes with no chain of reasoning.
• Confusing a shift of AD with a shift of LRAS.
• Citing FDI as a benefit without any limit such as profit outflows.
• Concluding “growth is good” without weighing costs.
• Forgetting that the same growth rate has different consequences depending on its source.
• Missing the context in a data question, such as the country’s stage of development.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics, Specification, Issue 2, June 2018, Pearson Education Limited: Unit 2, section 2.3.5 Economic growth, statements 1 to 3.