Download Chapter 8 - Jacob Schulman

Jacob Schulman
AP Economics
June 27, 2017
Mr. Coggin
Chapter 8: Introduction to Economic Growth and Instability
I. Economic Growth:
A. Economic Growth: an increase in real GDP occurring over some time period or an increase
in real GDP per capita occurring over some time period
1. Economic growth is calculated as a percentage rate of growth per year
B. Growth as a Goal
- Expansion of total output relative 2 pop results in rising real wages & incomes & higher
standards of living
- Economies experiencing economic growth are better able 2 meet people’s wants & resolve
socioeconomic problems
- Growth lessens the burden of scarcity
- A growing economy can consume more today while increasing its capacity 2 produce more
in the future
C. Arithmetic of Growth
- Mathematical approximation called the rule of 70 provides a quantitative grasp of the effect
of economic growth.
- Approx # years required to double real GDP= 70/annual % rate of growth
D. Main Sources of Growth
1. 2 ways society can increase its real output & income:
- Can increase its inputs of resources
- Can increase the productivity of those inputs
2. Inc in land, labor, capital etc yield additional output
3. Economic growth occurs through increases in productivitymeasured broadly as real
output per unit of input.
- 1/3 of US growth comes from more inputsremaining 2/3 results from improved
productivity
E. Growth in the United States
- Improved products and services, added leisure
- Other impacts: measures of growth don’t account 4 any effects growth may have had on the
environment & quality of life
F. Relative Growth Rates
- US lagged behind Japan, Germany, Italy, Canada, & FranceBut in 1990s US growth rate
surged ahead of rates of other industrial nations
II. The Business Cycle:
A. Phases of the Business Cycle
- Business cycle refers 2 alternating rises & declines in the level of economic activity
- Individual cycles vary substantially in duration & intensity
1. Peak: business activity has reach a temporary maximum; economy is at full
employment & level of real output is very close 2 economy’s capacity
- The price level is likely 2 rise during this phase.
2. Recession: (a peak is followed by a recession) A period of decline in total output,
income, employment, & trade
- This downturn is marked by the widespread contraction of business activity in many
sectors of the economy
- The price level is likely to fall only if the recession is sever & prolonged.
3. Trough: in the trough of the recession or depression, output & employment “bottom out”
at their lowest levels
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4. Recovery: in expansion or recovery phase, output & employment rise toward full
employment
- As recovery intensifies, price level may begin to rise before full employment & fullcapacity production return
- Business cycles all pass thru the same phases (many eco prefer “fluctuations” in lieu of
cycles b/c cycles imply regularity while fluctuations don’t)
B. Causation: A First Glance
- Some eco see changes in productivity as cause of business cycles & others view as
monetary phenomenon
- Most eco believe that immediate cause of cyclical changes in levels of real output &
employment is changes in level of total spending
C. Cyclical Impact: Durables and Nondurables
- Firms & industries producing capital goods & consumer durables are affected most by the
business cycles
- Firms can postpone purchase of capital goods
- In contrast, service industries & industries that produce nondurable consumer goods are
somewhat insulated from most severe effects of recession
III. Unemployment:
A. Measurement of Unemployment
- To measure unemployment rate, must 1st determine who is eligible & available to work
- Divides US pop into diff groups: ppl less than 16 yrs of age & ppl who are institutionalized,
“Not in labor force,” and the labor force (50% total pop)
- Unemployment rate is percentage of the labor force unemployed
- US Bureau of Labor Statistics (BLS) conducts a nationwide random survey of 60,000
households each month to determine who is employed & who isn’t employed
1. Part-time employment: all part-time workers are listed as fully employed
2. Discouraged workers: must be actively seeking work in order 2 be counted as
unemployed-># of discouraged workers is larger during recession than during prosperity
B.Types of Unemployment
1. Frictional Unemployment
- Workers are “between jobs”; in addition 2 between jobs, many are searching for 1st jobs
- Other job seekers & laid-off workers will replace them in “unemployment pool”
- Frictional unemployment: consists of search unemployment & wait unemployment=for
workers who are either searching for jobs or waiting to take jobs in the near future
2. Structural Unemployment
- Frictional unemployment blurs into a category called structural unemployment
- Changes over time in consumer demand & tech alter structure of total demand for labor
- Key diff: frictionally unemployed workers have salable skills & either live in areas where
jobs exist or are able to move to areas where they do (frictional is short-term)
- Structurally unemployed workers find it hard to obtain new jobs w/o retraining, gaining
additional education, or relocating (more likely to be long-term & serious)
3. Cyclical Unemployment
- Caused by a decline in total spending & is likely to occur in the recession phase of the
business cycle
- As the demand for goods & services decreases, employment falls & unemployment rises
- Cyclical unemployment is sometimes called deficient-demand unemployment
C. Definition of Full Employment
- Economists say that the economy is “fully employed” when it is experiencing only frictional &
structural unemployment (full employment occurs when there is no cyclical unemployment)
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- The unemployment rate that is consistent w/ full employment as the full-employment rate of
unemployment, or natural rate of unemployment (NRU)
- At NRU, eco is said 2 be producing its potential output=this is the real GDP that occurs
when the eco is “fully employed”
- NRU occurs when # of job seekers equals the # of job vacancies
- When cyclical unemployment occurs, eco has much more unemployment than that which
would occur at the NRU
- The economy can operate for a while at unemployment rate below NRU
D. Economic Cost of Unemployment
1. GDP Gap and Okun’s Law
- When the eco fails to create enough jobs for all who are able & willing to work, potential
production of goods & services is irretrievably lost
- Measure the sacrificed output as the GDP gap=the amt by which actual GDP falls short
of potential GDP (determined by assuming that the natural rate of unemployment prevails)
- Okun’s law indicates that for every 1 percentage point by which the actual
unemployment rate exceeds the natural rate, a GDP gap of about 2 percent occurs
 With this info we can calculate the abs loss of output assoc w/ any above-natural
unemployment rate
2. Unequal Burdens
- Part of the burden of unemployment is that its cost is unequally distributed
1. Occupation: workers in lower-skilled occupations have higher unemployment rates
than workers in higher-skilled occupations
2. Age: teenagers have much higher unemployment rates than adults.
3. Race and ethnicity: unemployment rate for black & Hispanics is higher than whites
4. Gender: unemployment rates for men & women r very similar
5. Education: less educated workers, on avg, have higher unemployment rates than
workers w/ more edu
6. Duration: # of persons unemployed for long periods (15 wks or more) as a percentage
Of the labor force is much lower than overall unemployment rate
E. Noneconomic Costs
- History demonstrates that severe unemployment can lead to rapid & sometimes violent
social & political change
F. International Comparisons
- Unemployment rates differ greatly among nations at any given time b/c nations have diff
natural rates of unemployment & nations may be in diff phases of their business cycles
IV. Inflation:
A. Meaning of Inflation
- Inflation is a rise in the general level of prices=this means that not all prices are rising
- Even during periods of rapid inflation, some prices may be relatively constant while others
are falling
B. Measurement of Inflation
- Price-index numbers measure inflationprice index measures the general level of prices in
any year relative to prices in a base period
- Rate of inflation for any given year is found by subtracting the preceding year’s price index
from that year’s index, dividing by the preceding year’s index & multiplying by 100 to express
the result as a percentage
C. Facts of Inflation
- In recent years US inflation has been neither unusually high nor low relative to inflation in
several other industrial countries
- Some nations have had double-digit or even higher annual rates of inflation in recent yrs
D. Types of Inflation
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1. Demand-pull inflation: when resources are already fully employed, the business sector
cannot respond to this excess demand by expanding output-so the excess demand builds up
the prices of the limited real output, causing demand-pull inflation-“to much spending chasing
to few goods”
- Range 1: toward the left in range 1, output is very low relative 2 the eco’s fullyemployment output
- Range 2: as output continues to expand in response 2 further increases in total
spending, the economy enters range 2
- Range 3: as total spending increases into range 3, the eco simply cannot supply more
resources.
2. Cost-Push Inflation:
- Explains rising prices in terms of factors that raise per-unit production costs at each level of
spendinga per-unit production cost is the avg cost of a particular level of output
This avg cost is found by dividing the total cost of all resource inputs by the amount of
output produced
- Per-unit production cost= total input cost / Units of Output
- The major source of cost-push inflation has be so-called supply shocks; specifically, abrupt
increases in the costs of raw materials or energy inputs have on occasion driven up per-unit
production costs & thus product prices
E. Complexities
- Difficult to distinguish between demand-pull inflation & cost-push inflation
- Cost-push inflation & demand-pull inflation differ in their sustainability
- Demand-pull will continue as long as there is excess total spending
- Cost-push is automatically self limiting; it will die out by itself
V. Redistribution Effects of Inflation:
A. Nominal and Real Income
- Nominal income is the # of dollars received as wages, rent, interest, or profits
- Real income is a measure of the amount of goods & services nominal income can buy
It is the purchasing power of nominal income, or income adjusted for inflation
- Real income= nominal income / Price index (hundredths)
- The real income will remain the same when nominal income rises at the same percentage
as does the price indexinflation doesn’t alter an eco’s overall real income or purchasing
power)
- If the change in the price level differs from the change in a person’s nominal income, his or
her real income will b affected
- % change in real income= % change in nominal income / % change in price level
- Anticipations: redistribution effects of inflation depends on whether or not it is expected
- With fully expected or anticipated inflation, an income receiver may be able to avoid or
lessen the adverse effects of inflation on real income
- The generalizations that follow assumed unanticipated inflation-inflation whose full extent
was not expected
B. Who is hurt by inflation?
1. Unanticipated in hurts fixed-income recipients, savers, & creditors-it redistributes real
income away from them & toward others.
2. Fixed-Income Receivers: People whose incomes are fixed see their real incomes fall when
inflation occurs
3. Savers: Unanticipated inflation hurts savers (as prices rise, the real value, or purchasing
power, of an accumulation of savings deteriorates)
- Paper assets that were once adequate to meet contingencies or provide for comfortable
retirement decline in real value during inflation
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4. Creditors: unanticipated inflation harms creditors (the lenders of society)
C. Who is Unaffected or Helped by inflation?
1. Flexible-Income Receivers: People who have flexible incomes may escape the harm of
inflation or even benefit from it
- Some union workers get automatic cost-of-living adjustments in their pay when CPI rises
- Some flexible-income receivers & all borrowers are helped by unanticipated inflation
- Strong product demand & labor shortages implied by rapid demand-pull inflation may
cause some nominal incomes to spurt ahead of the price level & enhance real incomes
2. Debtors: Unanticipated inflation benefits debtors (borrowers)
D. Anticipated Inflation
1. Redistribution effects of inflation are less severe or are eliminated if people anticipate
inflation & can adjust their nominal incomes to reflect the expected price-level rises
2. If inflation is anticipated, the redistribution of income from lender to borrower may be
altered
3. The lender can avoid this subsidy by charging an inflation premium
- By raising the interest rate by 6%, the most of the anticipated inflation
4. Financial institutions have also dev variable-interest-rate mortgages to protect themselves
from adverse effects of income
5. Real interest rate is the percentage increase in purchasing power that the borrower pays
the lender
6. Nominal interest rate is the percentage increase in money that the borrower pays the
lender, including that resulting from built-in expectation of inflation
- Nominal interest rate= real interest rate + inflation premium(expected rate of inflation)
E. Addenda
1. Deflation: effects of unanticipated deflation-declines in price level-are the reverse of those
of inflation
2. Mixed effects: a person who is an income earner, and an owner of real assets
simultaneously will probably find that the redistribution impact of inflation is cushioned
3.Arbitrariness: redistribution effects of inflation occur regardless of society’s goals & values
VI. Effects of Inflation on Output
A. Cost-Push Inflation and Real Output
- As prices rise, the quantity of goods & services demanded falls (firms respond by producing
less output, & unemployment goes up)
- Eco events of the 1970s provide an example of how inflation can reduce real output
- Cost-push inflation reduces real outputit redistributes a decreased level of real income
B. Demand-Pull Inflation and Real Output
- 1 perspective: even low levels of inflation reduce real output, b/c inflation diverts time &
effort toward activities designed to hedge against inflation
- Even mild inflation is detrimental to eco growth
- Contrast: eco point tout that full employment & eco growth depends on strong levels of total
spending
- Moreover, a little inflation may have positive effects b/c it makes easier for firms to adjust
real wage downward when the demands 4 their products fall
- Defenders of mild inflation say that it is much better 4 an economy to err on the side of
strong spending, full employment, eco growth, & mild inflation than on the side of weak
spending, unemployment, recession, & deflation
C. Hyperinflation and Breakdown
- Nation’s policymakers must carefully monitor mild inflation so that is doesn’t snowball into
higher rates of inflation or hyperinflation (an extremely rapid inflation whose impact on real
output & employment usually is devastating)
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- Aside from its disruptive redistribution effects, hyperinflation may cause eco
collapsesevere inflation encourages speculative activity
- But restriction of availability of materials & products intensifies the inflationary pressure
- In the extreme, as prices shoot up sharply & unevenly, normal eco relationships r disrupted
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