Cambridge IGCSE and O Level Economics

Chapter 29: Economic growth

Suggested answers to individual and group activities
Group activities
1 a 
The taxi driver would not pay tax on her/his earnings and may not follow government
regulations.
b A business may find it easier to get a loan from a commercial bank and may be able to receive
a government subsidy.
A worker may be able to gain employment rights and more secure income.
A government will gain higher tax revenue and will have more accurate information on which
to base their macroeconomic policy measures.
2 a The cut in the rate of interest.
b An increase in lending will increase consumer expenditure and investment. The resulting rise
in total demand will cause economic growth if previously unemployed resources were used
to produce more to match the higher demand.
c Spending on infrastructure, such as railways and roads, may reduce firms’ costs of
production. This may result in them expanding and investing in new technology that could
further increase productivity.

Individual activities
1
100
1 a Real GDP = $500 bn × = $400 bn.
125
$25 bn
Rise in real GDP = × 100 = 6.67%.
$375 bn
b Year Read GDP per head ($)
2016 5 000
2017 5 000
2018 6 000

2 a T
 he economic growth was unstable. It fluctuated quite significantly – positive at first, and
then becoming negative.
b Output rose but at a slower rate than in 2012.

Suggested answers to multiple choice questions and

four-part question
Multiple choice questions
1 C
A definition question. D is inflation.
2 B
More was produced each year so that output must have been highest at the end of the period.
The economic growth rate, not the output, was highest in 2014. Output did not fall at any time.
Output rose in both 2012 and 2013 – it was the economic growth rate that remained unchanged.

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Cambridge IGCSE and O Level Economics

3 A
GDP is C + I + G + (X − M), i.e., $30 bn + $10 bn + $20 bn + $16 b − $20 bn.
4 B
An increase in education and training is likely to increase labour productivity. This may raise
productive capacity. A, C and D are all likely to reduce output – A would reduce the quantity of
capital goods. C would reduce total demand and D is likely to reduce the number of people who
are employed.

Four-part question
a Real GDP is the value of a country’s total output adjusted for inflation.
b One consequence of a recession is very likely to be an increase in unemployment. With less
output being produced, fewer workers will be needed and so firms are likely to dismiss some of
their workers.
Another possible consequence is a fall in the price level. If the recession has been caused by a fall
in total demand, firms may lower their prices in a bid to increase demand.
c Economic growth would be expected to reduce a budget deficit or increase a budget surplus.
This is because higher output and so higher incomes and more employment would increase
income tax revenue. Higher incomes are usually accompanied by higher expenditure and so a
rise in indirect taxes. Economic growth may also generate higher profits and so increase revenue
from corporation tax.
As well as increasing tax revenue, economic growth may reduce government spending. With
lower unemployment, less will be spent on unemployment benefit and other benefits associated
with low income. With higher incomes, people may also be healthier due to better nutrition and
housing conditions. A healthier population may reduce government spending on healthcare.
2
d An increase in government spending may lead to economic growth. If a government spends
more on, for example, defence, it will directly increase aggregate (total) demand. If it increases
benefits, it will allow the recipients to spend. In the case where an economy is operating below
its productive capacity, an increase in total demand can result in an increase in output. More
demand will encourage firms to produce more and to do so they will use previously unemployed
resources. Figure 1 shows this outcome using both an AD/AS diagram and a PPC diagram. Total
demand and the production point are moving closer to full capacity. As a result, actual economic
growth is achieved.

Capital Price
goods AD AD1 AS
level

y P1
x P
AD1
AD
0 Consumer
0 Y Y1 Real GDP
goods
Figure 1

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Cambridge IGCSE and O Level Economics

Higher government spending may also increase real GDP by raising both total demand and total
supply. For example, an increase in government spending on training will raise total demand and
will increase total supply if the workers become more productive. Figure 2 shows both actual and
productive economic growth being achieved.

Capital Price AD1 AS AS1

goods level AD

y
P
x
AD1
AD

0 A B Consumer
0 Y Y1 Real GDP
goods
Figure 2

A rise in government spending will not, however, cause economic growth if it just increases total
demand and the economy is initially operating at full capacity. If, for example, a government
increases state benefits, the unemployed, for example, may spend more. There will, however, not
be resources available to produce the extra output they want. In this case, total output does not
rise. It is just the price level that rises as shown in Figure 3.

Price 3
AD1
level AD AS

P1

P AD1

AD

0 Y Real GDP
Figure 3

There is also the possibility that an increase in government spending may be offset by a fall in
another component of total demand. If, for example, the government increases its tax revenue
more than the rise in its spending, consumer expenditure and investment may fall.

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