Introduction to Economic Growth and Instability

1. 7 Introduction to Economic Growth and Instability

2. 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

3. Economic Growth • Increase in real GDP over some time period (Gross Domestic Product): used to measure military or political strength • Increase in real GDP per capita over some time period: used to measure SOL • Real GDP per capita: GDP divided by size of population

4. Growth as a Goal • Widely held goal, helps lessen burden of scarcity • Arithmetic of growth: rule of 70 • Approx # years required to double real GDP=70/annual % rate of growth (RULE OF 70)

5. Sources of Growth • Increasing inputs of resources • Increasing productivity of inputs (productivity measured as real output per unit of input)

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

7. O 7.1 The Business Cycle Phases of the Business Cycle Peak Peak Trend Peak Expansion Growth Level of Real Output Recession Expansion Trough Recession Trough Time Cyclical Impact: Durables and Nondurables

8. What is the business cycle? • Series of growing & shrinking periods of economic activity by increasing & decreasing real GDP • Periods of expanding and contracting economic activity • 4 Phases: • Expansion – increase in real GDP , jobs plentiful & prices rise slightly • Length varies 1991-2001 longest in US history • Avg. last 48 months • Peak – high point where real GDP stops increasing

9. 4 phases of business cycle cont’d • Contraction (Recession) – decrease in real GDP, producers cut back, prices stabilize or fall, & unemployment increases • Recession = contraction in real GDP for at least 6 consecutive months (avg. last 15 months) • Depression = severe recession; extended period of high unemployment and limited business activity • Stagflation = prices rise at the same time business activity slows down • Trough – real GDP & unemployment stop declining; turnaround point

10. Causes of Business Cycle Fluctuations • Major innovations (Ex. Internet, car, synthetic fibers) • Productivity changes • Changes in the level of total spending

11. Cyclical Impact on Different Industries • Which industries suffer more during recession?? • Those producing capital goods (machinery, housing, commercial building) and consumer durables (cars, computers, refrigerators) Service industries and nondurable consumer good industries suffer less

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

13. 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)

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

15. Types of Unemployment • Frictional – workers who are searching for work or waiting to take jobs in near future • Ex. young worker searching for first job • Structural – changes in consumer demand over time alter the structure of the demand for labor • Demand for certain skills may decline, while demand for other skills increases (Ex. sewing)

16. Types of Unemployment • Cyclical unemployment – caused by a decline in total spending (recession) • Ex. worker loses job during downturn

17. Definition of Full Employment • Full-employment rate of unemployment (natural rate of unemployment) • Economy is producing its potential output • Rate 4-5%

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

19. GDP Gap and Okun’s Law • Basic economic cost of unempl is forgone output • GDP gap – difference between actual and potential GDP • Okun’s law – for every 1 percentage point by which actual unemployment rate exceeds the natural rate, a negative GDP gap of 2 percent occurs

20. 12,000 11,000 10,000 9,000 8,000 7,000 6,000 5,000 The GDP Gap GDP (billions of 1996 dollars) 10 8 6 4 2 0 The Unemployment Rate 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Unemployment (percent of civilian Labor force) 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Unemployment Actual and Potential GDP and the Unemployment Rate GDP gap (positive) Potential GDP GDP gap (negative) Actual GDP Source: Congressional Budget Office & Bureau of Economic Analysis

21. Unemployment • Unequal Burdens • Occupation – lower-skilled workers have higher unempl rates • Age – teens have higher rates than adults • Race and Ethnicity – African-Americans and Hispanic rates higher than whites • Gender – similar both genders • Education – less educated have hiigher rates • Duration

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

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

24. Inflation • Rise in the general level of prices • Reduces purchasing power of $$ • Measurement of Inflation: • Primary measure is Consumer Price Index (CPI) – compiled by BLS • CPI reports the price of a “market basket” of approx 300 g/s presumably purchased by the avg consumer

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

26. GLOBAL PERSPECTIVE Inflation 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

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

28. Types of Inflation • Demand-pull – excess demand bids up price of ltd output • Overissuanceof $$ by central bank • Cost-push – increase in the per-unit production costs at each level of spending • Per-unit production costs = total input cost/unit of output

29. Redistribution Effects of Inflation • Nominal and real income • Nominal income - # of dollars received as wages, rent, interest, profit • Real income – measure of the amt of g/s nominal income can buy; purchasing power of nominal income • Real income = nominal income/price index

30. W 7.4 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

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

32. Anticipated Inflation • Redistribution effects less severe if inflation is anticipated • Lenders can charge inflation premiums • Real interest rate - % increase in purchasing power that the borrower pays the lender • Nominal interest rate - % increase in money that the borrower pays the lender

33. Nominal interest rate = real interest rate + inflation premium (The expected rate of inflation)

34. Inflation • Deflation –decline in price level • Mixed Effects • Arbitrariness • Cost-Push Inflation and Real Output • Demand-Pull Inflation and Real Output • Hyperinflation – extraordinarily rapid inflation; effects are devastating

35. 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

36. 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 Key Terms

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