Introduction to Economic Growth and Stability CHAPTER 8 Introduction to Economic Growth and Stability Economic Growth means an increase in real GDP has occurred or there has been an increase in real GDP per capita. There are two ways to grow: An increase in real GDP over time An increase in real GDP per capita over time

ECONOMIC GROWTH Growth as a Goal Arithmetic of Growth Rule of 70 Main Sources of Growth Increases in Resources Increases in Productivity

Productivity is real output per unit of input. Long-run economic growth in all capitalist societies has been interrupted by periods of economic instability. This instability takes the form of upturns and downturns in the business cycle. The Business Cycle refers to alternating rises and declines in the level of economic activity.

THE BUSINESS CYCLE Phases of the Business Cycle GROWTH TREND Time PEAK RECESSION TROUGH RECOVERY GROWTH TREND Level of business activity Time

There are many causes of the business cycle: innovations, changes in productivity, too little money in the banks, and the level of total spending (C+Ig+G+Xn). Durable goods are more likely affected by the swings in the business cycle. The problem with the business cycle is that unemployment follows the business cycle. Unemployment rate=(unemployed/labor force)*100 This rate may be too low because it does not include part-time employment or discouraged workers.

Types of unemployment: Frictional: people between jobs Structural: the demand for the products in certain industries has declined Cyclical: general decline in demand Full employment rate of unemployment or natural rate = frictional and structural. Anything over this is cyclical unemployment. The economic cost of unemployment: Okun’s Law indicates that for every 1 percentage point by which the actual unemployment rate exceeds the natural rate, there will be a GDP gap of 2 percent.

UNEMPLOYMENT Noneconomic Costs:Suicide,Crime,Abuse Unequal Burdens of Unemployment Occupation Age Race and Ethnicity Gender Education Duration Noneconomic Costs:Suicide,Crime,Abuse International Comparisons

GLOBAL PERSPECTIVE Unemployment Rates 5 Industrial Nations 1992 - 2002 15 10 5 France U.K. Germany U.S. Japan 1992 1997 2002 Source: Economic Report of the President, 2003

INFLATION = CPI x 100 Defined and Measurement Consumer Price Index A rising general level of prices Rate of inflation calculated using index numbers Consumer Price Index = Price of the same market basket in 1982-1984 x 100 CPI Price of most recent market basket in the particular year

INFLATION Rule of 70 - Applied Facts of Inflation U.S. Double-Digit Inflation in Late 70s and Early 80s Currently Relatively Mild Other Nations in 2002 Romania – 23% Belarus – 43% Turkey – 45% Myanmar – 57%

INFLATION Types of Inflation DEMAND-PULL INFLATION Results from any situation that increases demand beyond the capacity of the economy to meet the demand COST-PUSH INFLATION Rising Per-Unit Production Costs Supply-Side Inflation Supply Shocks

REDISTRIBUTIVE EFFECTS OF INFLATION Nominal Income: Number of $ received Real Income:Nominal Income/Price Index Who is Hurt? Fixed Incomes, Savers, Creditors Effect Depends Upon Anticipations Anticipated Inflation Unanticipated Inflation

ANTICIPATED INFLATION 11% 6% = + 5% Inflation Premium Nominal Interest Rate Real Interest Rate

REDISTRIBUTIVE EFFECTS OF INFLATION Who is Unaffected or Helped by Inflation? Flexible-Income Receivers Cost of Living Adjustments (COLAs) Debtors

Inflation affects output Inflation affects output. When oil prices increase, that input now is more expensive for firms that use oil, so their prices increase and higher prices are associated with reduced output. Hyperinflation has occurred in some economies. This means that the prices increase so fast and that people may return to a barter economy to cope. It can cause economic collapse.