Outline

1. Outline Chapter 12 – Aggregate Supply, Aggregate Demand and Inflation Section 4 – Competing Theories Section 5 – Stabilization vs. Sustainability Macroeconomic Issues and Applications Ch 14 – How Economies Grow and Develop Section 1 – Standard Theory of Economic Growth (1.1 only) Section 2 – Patterns of Growth and Development Section 3 – What Explains the Variety in Growth Experiences

2. Competing Theories So far – tried to understand the dynamics using ADE/ASR model. Fluctuations coupled with and informed by interventions – e.g. expansionary fiscal policies of 1960s to get out of slump, inflation targeting in 1980s etc. Remember – classical vs. keynesian perspectives as two poles in assessing the role of government intervention Contoversial in relation to ADE/ASR framework

3. Competing Theories Classicals – self-adjusting free market system Labour markets clear at eqm wage, market for loanable funds equate S&I at an eqm i => FE ASR curve – output would always be at FE level, level of AD determines only inflation rate At FE, all agents are optimizing their choices; if deviate from FE, smooth and quick restoration Classical ASR Inflation rate (π) ADE Output (Y ) Y*

4. Competing Theories Classicals – self-adjusting free market system Effect of AD management policies? No effect on Y* • Expansionary fiscal policies: crowding out priv. I • Expansionary monetary policy: lead to only inflation! CB should choose a target inflation rate or interest rate and not concern about Y or UN. Politically conservative policies – small governments, strict rules on monetary policies

5. Competing Theories Keynesians – market economies are inherently unsustainable Animal spirits of the investors – tendency of private agents to get over-optimistic and create booms in I and thus Y. Perpetual business cycles - ADE moving back and forth (peaks : A; troughs: B)

6. Competing Theories Keynesians – market economies are inherently unsustainable Impossible to have “settling down” at a FE eqm. No assumption of rationality but rather optimism/pessimism; societal determinants. Traditional model unable to cope with supply shocks or sustainability issues – need to have more flexible models so as to incorporate new issues and variety of forces as well

7. Stabilization vs. Sustainability Remember the goals of macroeconomic policies: maintain living standards, stabilization and sustainability. Up to now, talking about first two, sustainability? Stabilization and ecological sustainability are in direct conflict Have been assuming: • More employment is better – high levels of output are necessary to keep employment high • Levels of C, II, G and NX are important rather than composition or production methods

8. Stabilization vs. Sustainability Need to focus on the quality, types and intensity of employment rather than the level only. Also composition of output is important – need to shift towards producing goods and services that are environmentally less destructive; investments in energy saving infrastructure Transition towards more sustainable macroeconomy is essential Policy examples – subsidies, investment tax credits

9. Standard Theory of Economic Growth Economic Growth: increases in aggregate levels of production and income; measured as the percentage change in GDP or GDP per capita from year to year Use real GDP (GDP adjusted for inflation) Growth Rate = 100* (real GDPt - real GDPt-1 )/ real GDPt-1 Focus on GDP per capita (output per person) GDP per capita = GDP / population GDP Growth = population growth + GDP per capita growth

10. Standard Theory of Economic Growth GDP per capita indicates the actual increase in GDP experienced Economic growth is the rightward shift ot ASR – increasing maximum capacity In general growth is accompanied with increase in AD Output ↑but overall impact on inflation is ambiguous

11. Patterns of Growth and Development Industrial Revolution – important not just as a historical episode but because the pattern of economic development it established became a model for worldwide. A process of social and economic change starting in early 18th C, that developed and applied new methods of production and work organization resulting in substantial increases in output per worker

12. Patterns of Growth and Development Industrial Revolution • Agriculture: new techniques, increases in productivity • Mechanization: new sources of power, inventions + railroads and other advances in transportation (Manchester : Cottonopolis) • Colonies serving as both supplier of raw materials and markets for finished goods

13. Global Economic Growth Industrial revolution began in England but then spread to much of Western Europe in 19th and 20th C – “early industrializing countries” Rapid growth in 20th C; much came in the aftermath of 1960s – golden era of capitalism

14. Global Economic Growth Though rapid, growth does not translate into even/equitable distribution across countries as well as among people in the countries

15. Global Economic Growth Growth experience of developed countries (US, Japan, Europe) – GDP increase due to a combination of factors: growth in AD, labour productivity, technological innovation, investment in manufactured K etc. + trade opportunities. Variety in patterns of growth Japan – economic miracle (1950-80) East Asian tigers – S. Korea, Taiwan, Singapore, Hong Kong (at least until 1997 crisis) Virtuous cycles – high S & I lead to greater productivity, competitive X and growth of domestic industries

16. Global Economic Growth No single/unique recipe to be applied to all!! Also need to consider human capital – educational attainment Japan – I in technology intensive industries+X favourable policies = world leader in technology goods! (complemented by tariffs + channeling I to favoured industries) Can we talk about “convergence”?? Underlying economic forces will cause poorer countries and regions to catch up with richer ones!

17. Global Economic Growth Uneven pattern of economic growth = small portion of world’s population benefits disproportionately from production Convergence is not occuring in the majority of developing countries. Only valid for China, less valid for India!

18. What Explains the Variety? Striking differences between countries Why? S&I: some of output not spent may be set aside or spent on assets that would increase productivity Size of spheres proportional to population

19. What Explains the Variety? I may take different forms: industrial capital, agriculture, human capital. Technological Innovation – by adopting new tech. developed elsewhere, R&D activities etc. China and India – counterexamples for std. economic theory (L-int cou but high-tech X) Gov. policies encouraging organizational innovation, enterpreneurship, selective industrial support (e.g. Japan)

20. What Explains the Variety? Macroeconomic policies – stabilization of AD (prevent or aid recovery from recession); access to international markets for inputs and for finished goods; infant industry protection Natural resources – important assets but overuse may lead to environmental degradation and economic distortion Foreign capital – in the form of FDI, development assistance (aids or loans) Institutions – regulation, monitoring, “governance”, effective systems of IPR and contract enforcement