Introduction to Economic Growth and Instability

8

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Economic Growth• Increase in real GDP or real GDP per

capita over some time period• Percentage rate of growth• Growth as a goal• Arithmetic of growth: Rule of 70

Approximatenumber of yearsrequired to doublereal GDP

=70

annual percentage rateof growth

LO1 25-2

Economic Growth• Growth in U.S. real GDP 1950-2009

–Increased 6 fold

–3.2% per year • Growth in U.S. real GDP per capita

–Increased more than 3 fold–2% per year

• Qualifications –Improved products and services–Added leisure–Other impacts

LO1 25-3

Modern Economic Growth

• Began with the Industrial Revolution in late 1700s

• Ongoing increases in living standards

• Time for leisure

• Social change

• Democracy

• Human lifespan doubled

LO2 25-4

Modern Economic Growth• Began in Britain

• Has spread slowly

• Starting date main cause of worldwide differences in living standards

• Catching up is possible

–Leader countries invent technology

–Follower countries adopt technology

–Can grow faster

LO2 25-5

Modern Economic Growth Real GDP Real GDP Average annual per capita, per capita, growth rate,

Country 1960 2007 1960-2007

United States $ 14,766 $42,887 2.3%United Kingdom 11,257 32,181 2.3France 9,347 29,663 2.5Ireland 6,666 41,625 4.0Japan 5,473 30,585 3.7Singapore 4,149 44,619 5.2Hong Kong 3,849 43,121 5.3South Korea 1,765 23,850 5.7

Figures are in 2005 dollars

Source: Penn World Table version 6.3, pwt.econ.upenn.edu

LO2 25-6

Modern Economic Growth

LO3 25-7

Institutional Structures of Growth–Strong property rights

–Patents and copyrights

–Efficient financial institutions

–Literacy and widespread education

–Free trade

–Competitive market system

LO3 25-8

Determinants of Growth

LO3

Supply factors• Increases in quantity and quality of natural resources • Increases in quality and quantity of human resources• Increases in the supply (or stock) of capital goods• Improvements in technology

Demand factor• Households, businesses, and government must purchase the economy’s expanding output

Efficiency factor• Must achieve economic efficiency and full employment

25-9

Accounting for Growth

• Factors affecting productivity growth

–Technological advance (40%)

–Quantity of capital (30%)

–Education and training (15%)

–Economies of scale and resource allocation (15%)

LO3 25-10

Productivity Growth• Average rate of growth

–1.5% per year 1973-1995

–2.8% per year 1995-2009

• Affects real output, real income, and real wages

• Pay higher wages without lowering profit

LO4 25-11

Economic Growth• Is economic growth desirable and

sustainable?

• The antigrowth view

–Environmental and resource issues

• In defense of economic growth

–Higher standard of living

–Human imagination can solve environmental and resource issues

LO5 25-12

Economic Growth• Growth is the path to greater material

abundance

• Results in higher standards of living

• Increases leisure time

• Allows for the expansion and application of human knowledge

LO5 25-13

Global Perspective

LO5 25-14

The Business Cycle

• Alternating increases and decreases in economic activity over time

• Phases of the business cycle

• Peak

• Recession

• Trough

• Expansion

LO1 26-15

The Business CycleL

evel

of

real

ou

tpu

t

Time

Peak

Peak

Peak

Recession

Recession

Expansion Expansion

Trough

Trough

Growth

Trend

LO1 26-16

Causation: A First Glance

• Business cycle fluctuations Primary causation is total spending

(probably) Affects both capital goods and consumer

durables but services and nondurables are somewhat shielded Economic shocks

Prices are “sticky” downwards Economic response entails decreases in

output and employment

LO1 26-17

Unemployment

Under 16and/or

Institutionalized (71.4 million)

Not inlaborforce

(81.7 million)

Employed(139.9 million)

Unemployed(14.3 million)

Total population (307.3 million)

Labor force (154.2 million)

Unemployment rate =

14,265,000

154,142,000

X 100 = 9.3%

Unemployment rate =

# of unemployed

labor force

X 100

LO2 26-18

Unemployment• Unemployment – labor force equals about 50% of the

total population– Unemployment rate =unemployed/ civilian labor force x

100• Bureau of the Census

– Monthly survey• 60,000 households• Unemployed = people available for work who made a

specific effort to find a job during the past month and who, during the most recent survey week, worked less than 1 hour for pay or profit

• Bureau of Labor Statistic determines the unemployment rate

Unemployment

• Criticisms of unemployment

• Involuntary part-time workers counted as if full-time (these people are partially employed and partially unemployed)

• Discouraged “frustrated” workers are not counted as unemployed

LO2 26-20

Types of Unemployment

– Frictional Unemployment = workers who are “between jobs”– Cyclical Unemployment = unemployment directly related to

swings in the business cycle– “Deficient-demand” unemployment – Effected by recession– Often mixed with other types of unemployment– Affected workers usually get their jobs back

» Seasonal Unemployment = resulting from changes in the weather or demand for certain products

– Structural Unemployment = fundamental change in the economy reduces the demand for workers and their skills (usually need to be “retrained”)

– Consumer taste changes– Industrial operation changes, automation– Geographical changes

LO3 26-21

Definition of Full Employment

–“Full Employment”--Not Zero employment

• Natural Rate of Unemployment (NRU)

• Full employment level of unemployment

• Can vary over time• Demographic changes

• Changing job search methods

• Public policy changes

• Actual unemployment can be above or fall below the NRU

LO3 26-22

Economic Cost of Unemployment

• When the economy fails to crate enough jobs for all who are able and willing to work potential production of goods and services is irretrievably lost

• GDP Gap

• GDP gap = actual GDP – potential GDP

• Can be negative or positive

• Okun’s Law

• Every 1% of cyclical unemployment creates a 2% GDP gap

LO3 26-23

Economic Cost of Unemployment

LO3 26-24

Unequal Burdens

• Occupation-low skill = high unemployment

• Age-Teenage = high unemployment

• Race and ethnicity-minority = high unemployment

• Gender-men and women very similar

• Education-less educated =high unemployment

• Duration-unemployed over 15 wks very small %

LO3 26-25

Noneconomic Costs

LO3

• Loss of skills and loss of self-respect

• Plummeting morale

• Family disintegration

• Poverty and reduced hope

• Heightened racial and ethnic tensions

• Suicide, homicide, fatal heart attacks, mental illness

• Can lead to violent social and political change

26-26

LO3 26-28

Inflation

• General rise in the price level

• Inflation reduces the “purchasing power” of money

• Consumer Price Index (CPI)

LO3

CPIPrice of the Most Recent Market

Basket in the Particular Year

Price estimate of the MarketBasket in 1982-1984

= x 100

CPI207.3 - 201.6

201.6= x 100= 2.8%

26-29

Types of Inflation

• Demand-Pull inflation

• Excess spending relative to output

• Central bank issues too much money

• Cost-Push inflation

• Due to a rise in per-unit input costs

• Supply shocks

LO3 26-30

Redistribution Effects of Inflation• Nominal income

• Unadjusted for inflation

• Real income = measure of the amount of goods/services nominal income can buy

• Purchasing power• Real income=nominal income/PI (in hundredths)• Inflation may redistribute real income• Anticipation inflation/unanticipated inflation

•Nominal income adjusted for inflation

• Anticipated vs. unanticipated income

• “Inflation premium”

•Real interest rate = nominal rate – inflation premium

LO3 26-32

Who is Hurt by Inflation?

• Fixed-income receivers

• Real incomes fall (nominal income doesn’t rise with prices)

• Savers

• Value of accumulated savings deteriorates

• Creditors

• Lenders get paid back in “cheaper dollars”

LO3 26-33

Who is Unaffected or Helped by Inflation?

• Flexible-income receivers

• COLAs (cost-of-living adjustments)

• Social Security recipients

• Union members

• Debtors

• Pay back the loan with “cheaper dollars”

LO3 26-34

Does Inflation Affect Output?

• Cost-push inflation

• Reduces real output

• Redistributes a decreased level of real income

• Demand-pull inflation

• One view is that zero inflation is best

• Another view is that mild inflation is best

LO3 26-35