CHAPTER 2: ECONOMIC GROWTH AND DEVELOPMENTCHAPTER 2: ECONOMIC GROWTH AND DEVELOPMENT

ECONOMIC GROWTH

• Economic growth:- Sustained expansion of production possibilities.- The increase in real GDP over a given period. – Economic growth rate is the rate of change of real GDP (percentage per year). – To calculate this growth rate, we use the formula:

THE SOURCES OF ECONOMIC GROWTH

– Labor productivity: the quantity of real GDP produced by 1 hour of labor.

– It is calculated by:

– When labor productivity grows, real GDP per person grows, so the growth in labor productivity is the basis of rising living standards.

– The growth of labor productivity depends on three things:

o Saving and investment in physical capital o Expansion of human capital o Discovery of new technologies

ACHIEVING FASTER GROWTH

Preconditions for Economic Growth

– Economic freedom is the fundamental precondition for creating the incentives that lead to economic growth.

– Economic freedom is a condition in which people are able to make personal choices, their private property is protected, and they are free to buy and sell in markets.

Policies to Achieve Faster Growth

– Economic freedom requires the protection of private property—the factors of production and goods that people own.

– Property rights are the social arrangements that govern the protection of private property.

– Economic freedom also requires free markets.

– Main actions governments can take to achieve these objectives are:

1. Create Incentive Mechanisms

Economic growth occurs when the incentive to save, invest, and innovate is strong enough. These incentives exist only when private property is protected.

2. Encourage Saving

Saving finances investment, which brings capital accumulation. Tax incentives can encourage saving, increase the growth of capital, and stimulate

economic growth.

3. Encourage Research and Development

Everyone can use the fruits of basic research and development efforts. Because basic inventions can be copied, the inventor’s profit is limited and so the

market allocates too few resources to this activity. Governments can direct public funds toward financing basic research, but it

requires a mechanism for allocating public funds to their highest-valued use.

4. Encourage International Trade

Free international trade stimulates economic growth by extracting all the available gains from specialization and trade.

5. Improve the Quality of Education

By funding basic education and by ensuring high standards in skills such as language, mathematics, and science, governments can contribute enormously to a nation’s growth potential.

6. Financial Market Development

The more developed an economy´s financial market are, the more efficient should be the allocation of resource and, therefore, the greater the productivity.

A nation may have a high rate of saving and investment and a sizable capital stock, but the key to efficient production is the allocation of resources to their best use.

7. No corruption and political stability

BUSINESS CYCLES

Fluctuations in the economy between growth (rising real GDP) and stagnation (falling real GDP).

• Is the upward and downward movement of economic activity that occurs around the growth trend.

• Alternating periods of economic growth and contraction.

• Macro theories, explain the business cycle; economic policies, control it.

• Before 1930s, macroeconomists thought there could never be a Great Depression.

– They believed a market-driven economy was inherently stable.

• Laissez faire: The doctrine of “leave it alone”; of non-intervention by government in the market mechanism seemed reasonable at the time.

THE MACRO THEORY

MACROECONOMIC PERFORMANCE

• Determinants of macro performance include:

– Internal market forces - Population growth, spending behavior, intervention & innovation, etc.

– External shocks - Wars, natural disasters, terrorist attacks, trade disruptions...

– Policy levers - Tax policies, government spending, changes in the availability of money, and regulation.

• Macroeconomic outcomes include:

– Output - Value of goods and services produced (real GDP).

– Jobs - Levels of employment and unemployment.

– Prices - Average price of goods and services.

– Growth – Yea3r-to-year expansion in production capacity.

– International balances - International value of the dollar; trade and payment balances with other countries.

CAUSES BUSINESS CYCLES

• Although the main interpretation of business cycles looks to changes in AD, we may classify the different theories into two categories:

– The external theories find the root of the business cycles in the fluctuations of something outside the economic system (wars, revolutions, elections, economic policy, migrations, discoveries of new lands and resources).

– The internal theories look for mechanism within the economic system itself (self-generating business cycles).

PHASES BUSINESS CYCLES

• A business cycle can be divided into four major phases:– Recession – the downturn of a business cycle. This is a period in which real GDP declines for at least 2 consecutive quarter-years.

– Through – the lowest point of real GDP at the end of a recession.

– Expansion (boom) is a period in which output increases and approaches potential GDP or perhaps even overshoots it.

– Peak – the point at which recession begins, the highest point in real GDP before a recession.

BUSINESS CYCLES INDICATORS

• There are a number of variables that move in a fairly regular manner over the business cycles.

• These variables are classified into three categories depending on whether the move up or down before, at the same time as, or following a change in real GDP.

Leading indicators: generally change before real GDP changes. Economists use them to forecast changes in output. Average workweek. Unemployment claims Manufacturers´ new order. Stock prices. New building permits. Delivery times of goods.

Interest rate spread. Money supply. Consumer expectations.

Coincident indicators: are economic variables that tend to change at the same time as real GDP changes. Payroll employment. Personal Income. Industrial Production. Manufacturing and trade sales. Lagging indicators: do not change in value until after the value of real GDP has

changed. Labor cost per unit of output. Inventories to sales ratio. Unemployment duration. Consumer credit to personal income ratio. Outstanding commercial loans. Interest rate. Inflation rate for services.

CHAPTER 3: UNEMPLOYMENT

LABOR MARKET

• Civilian population: people from 16 years and older.

Not in the labor force

– Persons (16 years and older) who are neither employed nor unemployed (like retirees, students, homemakers, or disabled persons).

Persons in the labor force. (This group includes both the employed and unemployed). Employed: A person is considered employed if he or she has spent most of the

previous week working at a paid job. Unemployed

– A person not currently employed who is actively seeking a job, or, waiting to begin a job, or, on layoff, waiting to return to a previous job.

The labor-force participation rate

is the percentage of the adult population that is in the labor force.

LABOR MARKET INDICATORS

To be classified as unemployed, one must be actively seeking work, waiting to begin a new job, or on layoff from a job.

Some argue the employment/population ratio

is a better indicator of job availability than the unemployment rate.

THREE TYPES OF UNEMPLOYMENT

• Frictional Unemployment:

Caused by imperfect information. Occurs because:

employers are not aware of all available workers and their qualifications, and, available workers are not fully aware of all the jobs being offered by employers.

• Structural Unemployment:

Reflects an imperfect match of employee skills to skill requirements of the available jobs.

Also reflects structural and demographic characteristics of the labor market.

• Cyclical Unemployment:

Reflects business cycle conditions. When there is a general downturn in business activity, cyclical unemployment

increases.

THE CONCEPT OF FULL EMPLOYMENT

Full Employment: The level of employment that results when the rate of unemployment is normal, considering both frictional and structural factors.

• Full employment is closely related to the concept of the natural rate of unemployment.

• Natural Rate of Unemployment: The level of unemployment that reflects “job shopping” in an economy of imperfect information and dynamic change.

CHAPTER 4: MONETARY POLICY

Monetary policy can be categorized by four characteristics

Monetary Policy goals address the central bank’s agenda in general terms.

The Bank of China appears to have export driven growth as their primary objective.

The European Central Bank (ECB) an explicit Inflation Target. Specifically, the goal is to maintain 2% annual inflation.

The Federal Reserve follows policies of stable prices and maintenance of full employment.

Instruments refer to the policy options a Central Bank has to control the supply of money…

• Open market Operations.

• Discount Window Loans. Altering the interest rate charged on loans to commercial banks

• Reserve Requirements: Reserve Requirements influence the ability of banks to create new loans which affects the broader aggregates (M1, M2, and M3)

Moneraty Policy

Expansionary monetary policy: when applied to increase the amount of money. This would use one of the following mechanisms:

- Reduce the interest rate to make bank loans more attractive.

- Reduce the cash reserve ratio (bank reserves), to pay more money.

- Buy government debt, to contribute money to the market.

Restrictive monetary policy: When the market is a lot of money in circulation, interested in reducing the amount of money, and for this you can apply a restrictive monetary policy. It consists of the expansive otherwise:

-Increase the rate of interest, so that borrowing more expensive.

-Increase the cash reserve ratio (bank reserves), to leave more money in the bank and less in circulation.

- Sell public debt, reduce money market securities changing it.