26 introduction to economic growth and instability
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26Introduction to Economic Growth and Instability
CHAPTER OBJECTIVES
The Business Cycle and its Primary Phases
How Economic Growth is Measured and Why is it Important
How Unemployment and Inflation are Measured
The Types of Unemployment and Inflation and their Various Economic Impacts
ECONOMIC GROWTH Increase in Real GDP Increase in Real GDP Per Capita Growth as a Goal
GROWTH LESSENS THE BURDEN OF SCARCITY What is scarcity? How can growth help overcome it ? An economy experiencing economic
growth is better able to meet people’s wants and resolve socioeconomic problems
A growing economic, unlike a static economy, can consume more today while increasing its capacity to produce more in the future!!!
RULE OF 70 Mathematical approximation of the
effect of growth
Approximate number of years required to double GDP = 70/ (annual percentage rate of growth)
SOURCES OF GROWTH 1. Increasing its inputs of resources2. Increasing productivity of inputs
Productivity (real output per unit of input) rises by increasing health, sanitation, training, education, motivation etc
THE BUSINESS CYCLE Does growth take place persistently?
Case of Pakistan: episodic growth between 2000-2005
Now?
Phases of economic growth/ activity are characterized as business cycles
THE BUSINESS CYCLE Business cycle is the alternate rise and
decline in the level of economic activity, sometimes over several years
PHASES OF BUSINESS CYCLE Peak: temporary maximum in activity.
Economy is near or at full employment, and the level of real output is at or very close to the economy’s capacity. Price level is likely to rise
Recession: a period of decline in total output, employment, trade, income.
Trough: bottom lowest in the temporary cycle
Recovery: rise in output and employment towards full employment. A recession is usually followed by a recovery and expansion
THE BUSINESS CYCLE
Level of
Real O
utp
ut
Time
Peak
Peak
Peak
Recession
Recession
Expa
nsio
n
Expan
sion
Trough
Trough
Growth
Trend
Phases of the Business Cycle
Cyclical Impact:Durables and Nondurables
WHY BUSINESS CYCLES Causes of business cycles Shocks to the economy
Changes in productivity changes in spending levels
Growth trend is the overall trend of the business cycles Expansionary Contractionary
CYCLICAL IMPACTS Who is affected the most through a
cycle?Capital goods/ consumer durables can be
put off to a later date e.g. car industry in the US
Whereas, Non-durable consumer goods (services)
harder to remove oneself from e.g. medical, legal services
Twin Problems of the Business CycleUnemployment Inflation
UNEMPLOYMENTUnder 16
And/orInstitutionalized
(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)
UNEMPLOYMENT Measurement of Unemployment Labor Force Unemployment Rate
Part-Time EmploymentDiscouraged Workers
Unemployment RateUnemployed
Labor Force= x100
UNEMPLOYMENT Those part of the labor force which are
not employed must be actively seeking work to be
considered unemployed
Unemployment rate = unemployed * 100
labor force
TYPES OF UNEMPLOYMENT1. Frictional
In search of employment In between jobs, fresh graduates
2. Structural Changes in consumer preferences, consumer
demand and in technology e.g hand made products
Structurally unemployed find hard to obtain new jobs without retraining, additional education or relocating
3. Cyclical Caused by changes in spending , less demand
and less income causes higher unemployment e.g. Credit Crunch 2008. Typically begins in the recession phase of the business cycle
FULL EMPLOYMENT The maximum population that can be
employed at a time (considering only structural and frictional unemployment)
Natural Rate of Unemployment (NRU)unemployment rate at full employment
level. When number of job seekers equal the number of job vacancies. This is always a positive percentage.
UNEMPLOYMENT
Economic Cost of Unemployment Potential Output GDP Gap and Okun’s Law
GDPGap Actual GDPPotential GDP= -
ECONOMIC COST OF UNEMPLOYMENT Large unemployment has costs
Causes a GDP gap The amount by which actual GDP falls short of
potential GDP (at full employment levels) Okun’s law: for every 1percentage point
unemployment rises above NRU a GDP gap of 2 percent occurs
Cost of unemployment is unequally distributedDifferent groups experience different
unemployment rates
NONECONOMIC COSTS Unemployment varies by
Occupation Age Race and ethnicity Gender Education Duration
Non-economic costs: depression, socio-political unrest, lowering
morale, poverty, ethnic and racial tension
INFLATION Rise in the general level of prices Each dollar buys fewer goods and
services Reduces the purchasing power of
money
MEASURING INFLATION
Price indicesConsumer price index
Each month or each yearMarket basket of some 300
consumer goods and services
CPIPrice of the Most Recent Market
Basket in the Particular Year
Price of the Same MarketBasket in 1982-1984
= x 100
Quantit
y in
Basket
2006 2007 2008
(kg or
litre) PriceCost of
basketPrice
Cost of
basketPrice
Cost of
basket
Flour 6 Rs. 200 1200 Rs. 300 Rs. 150
Oil 1.5 Rs. 80 120 Rs. 150 Rs. 50
Milk 1 Rs. 40 40 Rs. 55 Rs. 30
Rice 3 Rs. 300 900 Rs. 250 Rs. 250
Total cost 2260
Price
index100
CONSUMER PRICE INDEX
TYPES OF INFLATION Demand-pull
Excess of total spending beyond the economy’s capacity to produce
Excess demand for goods, can push up prices
“too much spending chasing too few goods” Cost-push
Supply or cost side of economyRising per-unit production costsReduces profits and thus reduces output Prices riseAlso known as supply shocks
REDISTRIBUTIVE EFFECTS
Inflation hurt some people , leaves others unaffected, and actually helps still others
Anticipations Anticipated Inflation, avoid or lesson effects of
inflation Unanticipated Inflation( not expected)
Nominal vs. Real income Nominal income is the number of dollars
received as wages, rent, interest, profits Real income = Nominal income / price
index
Real income is measures the amount of goods & services nominal income can buy. It is the purchasing power of nominal income
% change in real income = % change in nominal income - % change in price level
REDISTRIBUTION EFFECTS OF INFLATION
INFLATION Who is Hurt by Inflation?
Fixed-Income ReceiversSaversCreditors
Who is Unaffected or Hurt by Inflation?Flexible-Income Receivers
Cost-of-Living Adjustments (COLAs)BusinessDebtors
INFLATION Deflation: the effects of unanticipated
declines in the price level. People with fixed nominal incomes will benefit. Creditors and Savers will benefit.
Hyperinflation is extraordinarily rapid inflation. Money loses its value and status as medium of exchange
INFLATION Anticipated Inflation
Nominal Interest Rate Real Interest Rate Inflation Premium
NominalInterest
Rate
RealInterest
Rate
InflationPremium
11%
5%
6%
= +
BasicMacroeconomicRelationships
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