1. Introduction to Economic Growth and Instability 8 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 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 Approximate number of years required to double real GDP = 70 annual percentage rate of growth LO1 25-2

3. 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

4. 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

5. 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

6. 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 32,1812.3 France 9,347 29,6632.5 Ireland 6,666 41,6254.0 Japan 5,473 30,5853.7 Singapore 4,149 44,6195.2 Hong Kong 3,849 43,1215.3 South Korea 1,765 23,8505.7 Figures are in 2005 dollars Source: Penn World Table version 6.3, pwt.econ.upenn.edu LO2 25-6

7. Modern Economic Growth LO3 25-7

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. Global Perspective LO5 25-14

15. The Business Cycle Alternating increases and decreases in economic activity over time Phases of the business cycle Peak Recession Trough Expansion LO1 26-15

16. The Business Cycle Level of real output Time Peak Recession Expansion Trough Growth Trend LO1 26-16

17. 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

18. Unemployment Under 16 and/or Institutionalized (71.4 million) Not in labor force (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

19. 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

20. 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

21. 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

22. 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

23. 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

24. Economic Cost of Unemployment LO3 26-24

25. 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

26. 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

28. LO3 26-28

29. Inflation General rise in the price level Inflation reduces the “purchasing power” of money Consumer Price Index (CPI) LO3 CPI Price of the Most Recent Market Basket in the Particular Year Price estimate of the Market Basket in 1982-1984 = x 100 CPI 207.3 - 201.6 201.6 = x 100 = 2.8% 26-29

30. 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

32. 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

33. 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

34. 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

35. 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