Essay: Economic theories

Sample Essay

Economic theories will be used in order to support the study. It will be shown that there are three possible relationships: positive, negative and no relationship between output variability and economic growth. According to these views three broad schools of these thoughts will be discussed.

Two theories refer to the positive relationship between economic output growth and volatility. Sandmo (1970) indicates that higher savings rate depends on income uncertainty whilst Mirman (1972) states that ‘according to neoclassical growth theory it leads to higher equilibrium rate of economic growth’. Further explanation is given by Black (1987). His hypothesis for positive relationship states that investments will be taken only if expected return compensates for taking a risk in that investment. More risk taken, more expected return which depends on covariance of its return with the market as a whole. Also results for positive relationship were obtained by both Caporale and McKiernan (1996) using UK data for the period 1948-1991 and Blackburn (1999) who used endogenous growth model. It was shown that permanent effects might be caused by temporary shocks such that the cyclical and secular properties of output are related. ‘In particular, smoother cyclical fluctuations may be associated with flatter secular trends, implying a trade-off between short-term stabilisation and long-term growth’.

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