OxfordAQA International AS and A-level Economics: Economic growth and the cycle (9640) – Revision Notes

Quick-recall notes on growth and the cycle from the OxfordAQA International AS and A-level Economics (9640) specification, section 3.2.3.1, version 1.2. This is International AS content. For full explanations, read the study guide, then test yourself with the practice questions. Course pages: the OxfordAQA Economics hub, the printable checklist and the free diagnostics. For indicators and index numbers, see the macroeconomic performance notes. All figures are invented and illustrative.

Key definitions

Term	Meaning
Economic growth	More real national output over time
Short-run growth	A rise in actual real GDP, usually from using spare capacity
Long-run growth	Rising productive capacity, measured by the underlying trend rate of real output growth
Potential output	The normal capacity level of output; the position of the vertical LRAS
Positive output gap	Actual output exceeds normal-capacity output
Negative output gap	Actual output falls short of normal-capacity output
Economic cycle	Fluctuation of real GDP around its trend, in phases
Demand-side shock	A sudden, unexpected shift in AD
Supply-side shock	A sudden, unexpected shift in SRAS (or LRAS if lasting)

Short run versus long run in one table

	Short-run growth	Long-run growth
PPD (production possibility diagram)	Point moves from inside the boundary towards it	Boundary shifts outwards
AD/AS	AD shifts right along SRAS	LRAS shifts right
Main drivers	Consumption, investment, government spending, net exports; falling costs	Capital stock, technology, working population, productivity, enterprise, incentives, factor mobility
Lasts	Until spare capacity is used up	Permanent rise in capacity

Determinants at a glance

Demand-side: confidence, interest rates, wealth, taxes, foreign incomes, exchange rate, government spending.

Supply-side (short-run costs): money wage rates, raw material prices, indirect taxes, productivity.

Supply-side (long-run capacity): capital stock, technology, size and skills of the workforce, attitudes, enterprise, factor mobility, incentives.

Chain to learn: lower interest rates, so cheaper borrowing, so investment and consumption rise, so AD shifts right. With spare capacity: more output, little price change. Near capacity: mostly higher prices. If the investment is lasting, capacity also rises, which lifts the trend rate.

Formulas

Quantity	Formula
Growth rate	(later real GDP - earlier real GDP) / earlier real GDP x 100
Real value	nominal value / price index x 100
Real growth (exact)	(1 + nominal growth) / (1 + inflation) - 1
Output gap (%)	(actual - potential) / potential x 100
Compound average growth	(end / start)^(1/n) - 1
Index number	value / base-year value x 100
Change in GDP from a shock	change in injection x multiplier

Method boxes

Output gap

1. Write the formula with the numbers in it.
2. Subtract potential from actual first, so the sign is right.
3. Divide by potential, not by actual.
4. State the sign: positive or negative gap, and what it means.

Identifying a phase

1. Check real GDP growth: positive, negative, above or below trend?
2. Check whether growth is rising or falling.
3. Add inflation, unemployment and investment as support.
4. Remember that unemployment lags.

Worked reminders

Output gap. Potential output is 560. Actual output is 551.6, so the gap is (551.6 - 560) / 560 = -1.5%. If actual output is 588, the gap is 28 / 560 = +5.0%.

Real growth. Nominal GDP is 3,150 and the price index is 105. Real GDP = 3,150 / 105 x 100 = 3,000. If last year’s real GDP was 2,900, growth is 100 / 2,900 = 3.4% (3.45% before rounding).

Index numbers. Real GDP is 250, 258 and 266 in three years. With the first year as base (100), the indices are 100, 103.2 and 106.4. Growth in year 3 is (266 - 258) / 258 = 3.1%. Do not treat an index-point change as a percentage change: the rise of 3.2 points in year 3 is 3.2 / 103.2 = 3.1% of the previous year’s level, and only equals a percentage when the starting index is 100.

Trend rate. Output rises from 200 to 236 over four years: 236 / 200 = 1.18, and 1.18^(1/4) - 1 = 4.2% a year.

Growth with a widening gap. Potential is 574 after growth of 2.5%. Actual output is 566, so the gap is (566 - 574) / 574 = -1.4%. Real GDP can rise and the gap can still widen if growth is below the trend.

The cycle: signals

Phase	Growth	Inflation	Unemployment	Investment
Boom	Strong, above trend	Rising	Low	Strong
Slowdown	Positive but falling	High, then easing	Lowest, about to turn	Slowing
Recession	Negative	Falling	Rising	Falling sharply
Recovery	Positive, rising	Low	High, then falling	Rising

Recession. A common definition is two consecutive quarters of falling real GDP.

Lags. Inflation and unemployment follow real GDP, so they can mislead if used alone.

Shocks table

Shock	AD/AS movement	Output	Price level
Negative demand	AD left	Falls	Falls
Positive demand	AD right	Rises	Rises
Negative supply	SRAS left	Falls	Rises
Positive supply	SRAS right	Rises	Falls

Global routes in: export demand, imported input prices, exchange rate, confidence.

Judgement words for evaluation: size and duration of the shock, openness, spare capacity, wage and price flexibility, policy response, and whether the effect is temporary or reduces capacity.

Must-know distinctions

• Short-run growth is a use of capacity. Long-run growth is more capacity.
• Slowdown (growth falling) is not recession (output falling).
• A negative gap and negative growth are different things.
• Real and nominal are different: always deflate first.
• Moving along SRAS (price level change) is not a shift of SRAS (cost change).

Evaluation frames to reuse

Demand stimulus or supply-side improvement? A demand stimulus works faster and suits a large negative gap, where output can rise without much inflation. It cannot raise the trend rate on its own. Supply-side measures raise capacity and the trend rate but take years and can be costly. Conclude by stating which fits the economy in the data, for example “demand stimulus if there is a large negative gap, supply-side measures once output is near potential”.

Is a shock temporary? Temporary if prices and wages adjust and capacity is intact. Lasting if firms close, skills are lost or investment stays weak. The Keynesian view in the specification is that output can stay below normal capacity for many years.

Shock worked reminder. Imported fuel prices rise. Costs rise, so SRAS shifts left: output falls and prices rise. If the same economy also loses export orders, AD shifts left too, so output falls further and the price effect is uncertain. State which shift is larger before concluding about prices.

Quick self-test

1. State what makes long-run growth different from short-run growth.
2. Real GDP goes from 400 to 412. Calculate growth.
3. Potential output is 1,200 and actual output is 1,170. Calculate the output gap and state its sign.
4. Nominal GDP rises 6.5% and prices rise 4%. Calculate real growth to one decimal place.
5. Explain why unemployment may still be rising when real GDP has started to grow.
6. Give one supply-side determinant of the trend rate and one demand-side determinant of short-run growth.
7. Exports are 20% of a GDP of 1,500. They fall 10% and the multiplier is 2.5. Calculate the fall in GDP.
8. State the effect on output and the price level of a rise in imported oil prices.
9. Real GDP index is 100 and then 108 over two years. Calculate the average annual growth to one decimal place.
10. Why might a deep recession reduce potential output?

Answers

1. Long-run growth increases productive capacity (the trend rate; LRAS or the boundary shifts right). Short-run growth is a rise in actual real GDP, which can come from using spare capacity.
2. (412 - 400) / 400 = 3.0%.
3. (1,170 - 1,200) / 1,200 = -2.5%, a negative gap.
4. 1.065 / 1.04 - 1 = 0.0240, so 2.4%.
5. Unemployment lags output. Firms are cautious about hiring until they are sure the recovery will last, and output may still be below potential.
6. For example, technology or the size of the working population (supply-side, trend); a fall in interest rates or higher consumer confidence (demand-side, short run).
7. Fall in exports = 10% x 300 = 30. Fall in GDP = 30 x 2.5 = 75, which is 5% of GDP.
8. Costs rise, so SRAS shifts left: output falls and the price level rises.
9. 1.08^(1/2) - 1 = 0.0392, so 3.9% a year. (Simple halving of 8% gives 4.0%, which is not exact.)
10. Firms close and scrap capital, and long-term unemployed workers lose skills, so capacity may shrink and LRAS may shift left.

Where marks are usually lost

• Working with money values when the question is about real growth.
• Dividing the output gap by actual output instead of potential output.
• Getting the sign wrong: actual minus potential, not potential minus actual.
• Drawing AD moving right and calling it long-run growth.
• Treating a slowdown as a recession.
• Naming indicators without linking each to a phase.
• Listing shocks without showing the shift, the new equilibrium and the change in output and prices.
• Giving a one-sided evaluation, with no condition such as spare capacity or the size of the shock.
• Leaving out units, signs or the word “illustrative” when quoting made-up data.

Official syllabus

OxfordAQA International AS and A-level Economics (9640), specification version 1.2, section 3.2.3.1, first teaching September 2020, published by OxfordAQA.