Definition of economic growth

Government and the Macro‑economy (Cambridge IGCSE 0455)

1. The Basic Economic Problem

• Scarcity – resources are limited but human wants are unlimited.
• Opportunity cost – the value of the next best alternative fore‑gone when a choice is made.
• Production Possibility Curve (PPC)
  • Shows the maximum combinations of two goods that can be produced with existing resources and technology.
  • Points on the curve = efficient use of resources; inside the curve = under‑utilisation; outside the curve = unattainable.
  • Shift of the PPC outward = economic growth (more resources, better technology, higher quality of resources).
• Factors of Production
  • Land (natural resources)
  • Labour (human effort)
  • Capital (machinery, buildings, infrastructure)
  • Entrepreneurship (organisation, risk‑taking)
• Factor‑reward relationships
  • Land → rent
  • Labour → wages
  • Capital → interest
  • Entrepreneurship → profit

2. Allocation of Resources

2.1 Demand‑supply model

• Law of demand – quantity demanded falls as price rises (downward‑sloping demand curve).
• Law of supply – quantity supplied rises as price rises (upward‑sloping supply curve).
• Market equilibrium – point where demand = supply; determines price and output.
• Diagram notes: label axes (Price, Quantity), show shifts of D or S and resulting changes in equilibrium.

2.2 Price elasticity of demand (PED) and supply (PES)

• Factors affecting PED: availability of substitutes, proportion of income spent, definition of the market, time‑period.
• Factors affecting PES: spare capacity, time to adjust production, mobility of factors, input prices.

2.3 Market systems

• Market (price) economy – decisions made by households and firms through the price mechanism.
• Command economy – central government decides what, how and for whom to produce.
• Mixed economy – features of both market and command systems; government intervenes to correct market failure.

2.4 Market failure and government intervention

3. Micro‑economic Decision‑makers

3.1 Households

• Goal: maximise utility (satisfaction) subject to income and prices.
• Key concepts: marginal utility, budget constraint, indifference curves (optional for IGCSE).

3.2 Workers (Labour market)

• Supply of labour determined by wages, working conditions, education, population.
• Demand for labour derived from firms’ marginal product of labour (MPL) and the price of the output.
• Equilibrium wage = where labour supply = labour demand.

3.3 Firms

• Goal: maximise profit = total revenue – total cost.
• Revenue: \(TR = P \times Q\).
• Cost concepts: fixed cost (FC), variable cost (VC), total cost (TC = FC + VC), average cost (AC = TC/Q), marginal cost (MC = ΔTC/ΔQ).
• Market structures (relevant for IGCSE):
  • Perfect competition – many sellers, identical product, price taker.
  • Monopoly – single seller, price maker, barriers to entry.
  • Oligopoly & monopolistic competition – briefly noted but not examined in depth.
• Economies of scale – average cost falls as output rises (e.g., bulk buying, specialised machinery).

3.4 Money & Banking (brief)

• Functions of money: medium of exchange, unit of account, store of value, standard of deferred payment.
• Banking system creates money through deposits and loans (fractional‑reserve banking).
• Central bank (e.g., Bank of England) controls the money supply using open‑market operations, reserve requirements and the policy interest rate.

4. Government and the Macro‑economy

4.1 Macro‑economic aims (the “six aims”)

1. Economic growth
2. Low unemployment (full employment)
3. Price stability (low inflation)
4. External balance (stable balance of payments)
5. Equitable distribution of income
6. Environmental sustainability (green growth)

4.2 Definition of Economic Growth

Economic growth is a sustained increase in the amount of goods and services produced by an economy over a period of time. It is measured by the rise in real Gross Domestic Product (GDP) or Gross National Product (GNP) and expressed as a percentage change.

4.3 Measuring Economic Growth

• Nominal GDP – measured at current prices; includes inflation.
• Real GDP – adjusted for inflation using a constant price base; allows comparison of output volumes.
• Growth rate of real GDP (the standard syllabus indicator): \[ \text{Growth Rate}_t = \frac{\text{Real GDP}_t-\text{Real GDP}_{t-1}}{\text{Real GDP}_{t-1}}\times100 \]
• Real GDP per capita – real GDP ÷ population; shows average standard of living and is useful for cross‑country comparisons.

4.4 Causes of Economic Growth

4.5 Consequences of Economic Growth

4.5.1 Advantages (linked to macro‑economic aims)

4.5.2 Disadvantages (conflicts with other aims)

4.6 Recession – Definition, Causes & Consequences

• Definition: A period of falling real GDP (usually two consecutive quarters) accompanied by lower output, income and employment.
• Typical causes
  • Drop in aggregate demand (e.g., fall in consumer confidence, reduced government spending).
  • Reduction in the quantity or quality of resources (labour shortages, loss of capital, negative supply shocks).
• Consequences
  • Higher unemployment → lower household incomes.
  • Reduced tax revenue → pressure on public budgets.
  • Possible short‑term improvement in the balance of payments (lower import demand).
  • Risk of deflation if demand falls sharply.

4.7 Policy Tools to Promote Economic Growth

Cambridge expects students to know the three main policy groups and give at least one example of each.

4.7.1 Fiscal‑policy sub‑topics (syllabus detail)

• Budget balance: surplus** (revenues > expenditure) vs. **deficit** (expenditure > revenues).
• Tax classifications:
  • Direct taxes (income tax, corporation tax) – paid directly by individuals or firms.
  • Indirect taxes (VAT, excise duties) – paid on consumption.
• Government borrowing – issuance of bonds to finance deficits; impact on interest rates and future tax burden.