Ch 7.Ch 7. Intro to Economic Intro to Economic Growth & InstabilityGrowth & Instability

Why d

o we w

ant

economic

growth??

A.A. Economic Growth – Economic Growth – in either real in either real GDP or Real GDP per capita over time.GDP or Real GDP per capita over time.

-- The time period is calculated as a quarter (3-months) or year.-- Real GDP is GDP adjusted for inflation.-- Real GDP per capita = dividingreal GDP by the size of thepopulation.

In 2001, China’s GDP was1,1131 Billion compared to

Denmark’s 166 Billion.

However, Denmark’s GDPper capita was $31,090

compared to China’s $890.

1.1. “Rule of 70.”“Rule of 70.”

2.2. Sources of growth.Sources of growth.

Rule of 70

Approx # of Years required = 70to double the annual % rateReal GDP of growth

A 3% annual rate of growth will double Real GDP in about 23 (= 70 divided by .03)

-- Rule of 70 tells us the number of years it will take for some measure to double,given its annual percentage increase, by dividing that % increase into 70.

-- Sources of growth: increasing inputs of resources or increasing productivity.

B.B. Business cycle - Business cycle - & & levels of levels of economic activity.economic activity.

1.1. PeakPeak

2.2. RecessionRecession

3.3. TroughTrough

4.4. RecoveryRecovery

-- Trough is where a recession or depression bottoms out.-- Causes in fluctuations: changes in production, supply, demand, spending, policies.

The 4 Seasons = Business cycle

Summer(Boom)

Fall(Recession)

Winter(Depression)

Spring(Recovery)

IU

The Business CycleThe Business CycleL

evel

of

Rea

l Ou

tpu

t

Time

Peak

Peak

Peak

Recession

Recession

Expa

nsio

n Exp

ansi

on

Trough

Trough

Growth

Trend

Phases of the Business Cycle

Cyclical Impact:Durables and Nondurables

C.C. UnemploymentUnemployment

1.1. FrictionalFrictional

2.2. StructuralStructural

3.3. CyclicalCyclical

-- Frictional – between jobs.-- Structural – skills not needed or possess no skills.-- Cyclical – caused by a decline on spending (recession).

Does not include those under 16 years old and/or

institutionalized.

Unequal Burden: -- Occupation -- Age -- Race & ethnicity -- Gender (similar) -- Education

UnemploymentUnemploymentUnder 16And/or

Institutionalized(70.5 Million)

Labor Force, Employment, and Unemployment, 2005

TotalPopulation

(296.6 Million)

Not inLabor Force(76.8 Million)

Employed(141.7 Million)

LaborForce(149.3 Million)

Unemployed(7.6 Million)

7,591,000 149,320,000 X 100 = 5.1% unemployment rate

D.D. Full employment: # of job seekers = Full employment: # of job seekers = # # of job vacancies. No cyclical of job vacancies. No cyclical unemploymentunemployment

-- Full employment, or the natural rate of employment (NRU) fluctuates over timedue to fewer workers after the baby boomers, growth of temp workers, anddoubling of the prison population since 1985.

E.E. Okun’s Law – for every 1% point the Okun’s Law – for every 1% point the unemployment rate exceeds the unemployment rate exceeds the

natural natural rate (full employment), a rate (full employment), a negative GDP negative GDP gap of 2% point occurs.gap of 2% point occurs.

-- Macroeconomist Arthur Okun discovered the relationship between the unemployment rate and the GDP gap.

Okun’s LawOkun’s Law Actual and potential Actual and potential GDP and the GDP and the unemployment.unemployment. (a) Difference between (a) Difference between actual & potential GDP actual & potential GDP is the GDP gap. A is the GDP gap. A negative gap measures negative gap measures the output the economy the output the economy sacrifices when actual sacrifices when actual GDP falls short of GDP falls short of potential GDP. A potential GDP. A positive GDP gap positive GDP gap shows the opposite.shows the opposite. (b) A high (b) A high unemployment rate unemployment rate means a large GDP gap means a large GDP gap (negative), and a low (negative), and a low unemployment rate unemployment rate means a small or even means a small or even positive GDP gap.positive GDP gap.

F.F. Inflation – Inflation – in level of prices. in level of prices.

1.1. Consumer Price Index (CPI) – Consumer Price Index (CPI) – main measure of inflation.main measure of inflation.

-- When inflation occurs, each dollar of income will buy fewer goods & services than before (reduces ‘purchasing power’).

-- CPI is compiled by the Bureau of Labor Statistics (BLS).-- The BLS arbitrarily sets the CPA equal to 100 for 1982-84 (start point).-- The gov’t uses the index for monthly reports on inflation rates.

Rate of inflation = 179.9 – 177.1 x 100 = 1.6% 177.1

The CPI was 179.9 in 2002, up from 177.1 in 2001.

Rule of 70:A 1.6% annual rate of inflation willdouble the price level in about 43 years.

Value of $declines

i = Δ in CPI X 100 current CPI

-- CPI reports the price of a ‘market basket’ of 300 consumer goods/services.-- The BLS updates the composition of the market basket every 2 years.-- Will take 6 years to double the inflation rate at 12%.

Two Types of InflationTwo Types of Inflation

Demand-Pull InflationDemand-Pull Inflation – Caused by an – Caused by an excess of total spending beyond the excess of total spending beyond the economy’s ability to produce. When economy’s ability to produce. When inflation is rapid and sustained, it may be inflation is rapid and sustained, it may be due to an overissuance of money by the due to an overissuance of money by the central bank (the U.S. Federal Reserve).central bank (the U.S. Federal Reserve).

Cost-Push InflationCost-Push Inflation – Results from an – Results from an increase in resource costs.increase in resource costs.

Who’s hurt / helped by Inflation?Who’s hurt / helped by Inflation?

HURTHURT

Fixed-income Fixed-income receivers receivers

Savers (less Savers (less purchasing purchasing power)power)

Creditors Creditors (lenders)(lenders)

HELPEDHELPED

Flexible-income Flexible-income receivers receivers (COLAs) (COLAs)

Debtors (home Debtors (home loans)loans)

G.G. HyperinflationHyperinflation

H.H. Deflation.Deflation.

I.I. Nominal income Nominal income (money) vs. real (money) vs. real income.income.

The German Weimar Republic printed so much money to pay Its bills after WWI that

prices rose 1.3 trillion times.A German woman in 1923 burning

Deutsche Marks because it was cheaper than buying wood to burn.

-- Nominal Income: # of dollars in wages, rent, income, or profits.

-- Real Income: amount of goods/servicesthat nominal income can buy.