7 Introduction to Economic Growth and Instability

Chapter Objectives The Business Cycle and its Primary Phases How Economic Growth is Measured and Why is it Important How Unemployment and Inflation are Measured The Types of Unemployment and Inflation and their Various Economic Impacts

annual percentage rate Economic Growth Increase in Real GDP Increase in Real GDP Per Capita Growth as a Goal Arithmetic of Growth Rule of 70 W 7.1 Approximate number of years required to double real GDP 70 = annual percentage rate of growth

Economic Growth Main Sources of Growth Increases in Inputs Increases in Resource Productivity Productivity Defined Productivity in the United States Improved Products and Services Added Leisure Other Impacts

Selected Growth Rates GLOBAL PERSPECTIVE U.S. France Germany U.K. Percentage Change (annual rate) Japan Italy 1997 1999 2001 2003 2005 Source: Economic Report of the President, 2006

The Business Cycle Phases of the Business Cycle Cyclical Impact: Peak Peak Trend Peak Expansion Growth Level of Real Output Recession Expansion Trough Recession Trough Time Cyclical Impact: Durables and Nondurables

Unemployment Twin Problems of the Business Cycle Inflation Measurement of Unemployment Labor Force Unemployment Rate Part-Time Employment Discouraged Workers W 7.2 Unemployment Rate Unemployed Labor Force = x 100

Unemployment Labor Force, Employment, and Unemployment, 2005 Under 16 And/or Institutionalized (70.5 Million) Not in Labor Force (76.8 Million) Total Population (296.6 Million) Employed (141.7 Million) Labor Force (149.3 Million) Unemployed (7.6 Million)

Unemployment Types of Unemployment Full Employment Defined Frictional Unemployment Structural Unemployment Cyclical Unemployment Full Employment Defined Full-Employment Rate of Unemployment Natural Rate of Unemployment (NRU)

Unemployment Economic Cost of Unemployment Potential Output GDP Gap and Okun’s Law W 7.3 GDP Gap Actual GDP Potential GDP = -

Unemployment Actual and Potential GDP and the Unemployment Rate 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 The GDP Gap 12,000 11,000 10,000 9,000 8,000 7,000 6,000 5,000 GDP (billions of 1996 dollars) GDP gap (positive) Potential GDP GDP gap (negative) Actual GDP 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 The Unemployment Rate 10 8 6 4 2 (percent of civilian Unemployment Labor force) Source: Congressional Budget Office & Bureau of Economic Analysis

Unemployment Unequal Burdens Noneconomic Costs Occupation Age Race and Ethnicity Gender Education Duration Noneconomic Costs

Unemployment GLOBAL PERSPECTIVE Unemployment Rates in Five Industrial Nations, 1995-2005 France Italy Unemployment Rate (percent) Germany U.S. Japan 1995 2000 2005 Source: Bureau of Labor Statistics

Inflation Inflation Defined Measurement of Inflation CPI = x Consumer Price Index CPI Price of the Most Recent Market Basket in the Particular Year Price of the Same Market Basket in 1982-1984 = x 100

Inflation Annual Inflation Rates in the United States, 1960-2005 Inflation Rate (percent) Source: Bureau of Labor Statistics

Inflation GLOBAL PERSPECTIVE Inflation Rates in Five Industrial Nations, 1995-2005 Italy U.S. Inflation Rate (percent) France Germany Japan 1995 2000 2005 Source: Bureau of Labor Statistics

Inflation Types of Inflation Redistributive Effects Demand Pull Inflation Cost-Push Inflation Per Unit Production Costs Redistributive Effects Nominal and Real Income Anticipations Anticipated Inflation Unanticipated Inflation

Inflation Who is Hurt by Inflation? Fixed-Income Receivers Savers Creditors Who is Unaffected or Hurt by Inflation? Flexible-Income Receivers Cost-of-Living Adjustments (COLAs) Debtors W 7.4

Inflation Anticipated Inflation = + Nominal Interest Rate Real Interest Rate Inflation Premium O 7.2 11% 6% = + 5% Inflation Premium Nominal Interest Rate Real Interest Rate

Inflation Deflation Mixed Effects Arbitrariness Cost-Push Inflation and Real Output Demand-Pull Inflation and Real Output Hyperinflation

The Stock Market and the Economy Last Word Do Stock Prices Affect Macroeconomic Instability? Supply and Demand in the Stock Market Collective Expectations of Future Profits and Losses Dow Jones Industrial Average (DJIA) Volatility of the Stock Market Wealth Effect Investment Effect Studies Show Consumption and Investment Unaffected Little Impact on Macroeconomy Stock Market Bubbles Do Have an Impact Stock Price Cycle Predictions Index of Leading Indicators Stock Prices Not a Reliable Predictor Alone

Key Terms economic growth real GDP per capita rule of 70 productivity business cycle peak recession trough expansion labor force unemployment rate discouraged workers frictional unemployment structural unemployment cyclical unemployment full-employment rate of unemployment natural rate of unemployment (NRU) potential output GDP gap Okun’s law inflation Consumer Price Index (CPI) demand-pull inflation cost-push inflation per-unit production costs nominal income real income anticipated inflation unanticipated inflation cost-of-living adjustments (COLAs) real interest rate nominal interest rate deflation hyperinflation

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