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Economics I
Economic Growth and Business Cycle Theory (4h)
Economic Growth.
Business Cycle Theory (4h)
•
The aim of the first lecture is to analyze the long-term productive capacity of the
economy, or to explore factors for economic growth (the growth of potential output).
We focus on the resources (factors) of economic growth. Various models of economic
growth within various economic streams will be outlined. The barriers of economic
growth will be discussed and also sustainable development concept and pro-growth
state policies will be defined.
•
The goal of second lecture is to characterize the economic cycle, which is an integral
part of the economic development of the national economy and in the economic
theory known as one of the fundamental macroeconomic instabilities. The lecture will
reflect the substance of the mechanism of the business cycle, lighting effects of the
economic cycle on the economy, the tools of macroeconomic policy aiming to reduce
fluctuations in economic activity and at last the question of the possibility of
predicting economic cycles will be answered.
Content
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introduction – defining the goals
•
definition of economic growth
•
resources (factors) of economic growth
•
economic growth and price stability (instability)
•
models of economic growth
•
constraints – economic growth barriers
•
pro-growth macroeconomic policy
•
definition of the business cycle and its characteristics
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mechanism of the business cycle
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the effects of business cycles and countercyclical economic policy
•
conjunctural indicators
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conclusion – summary, homework
Definition of economic growth
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GDP growth vs. economic growth, i.e. growth of potential output (the ability of the
economy to produce more output, PPF curve shifts to the right).
•
the growth rate of real GDP (GYt) and the growth rate of real GDP (gYt)
•
the growth rate of nominal GDP (GYNt) – roughly the sum of the growth rate of real
output and the rate of growth of the price level (inflation rate).
•
economic power, living standard and economic development.
•
HDI = Human Development Index
–
United Nations Development Programme – Development Programme of the United Nations
Organisation, http://hdr.undp.org/en/statistics/
Resources (factors) of economic growth
•
the production functions Q = (amount of inputs, the quality of inputs, level of
technology), it determines the production possibilities of the economy
•
there are two types of sources of economic growth:
– extensive (quantitative) sources of economic growth → extensive economic
growth
– intensive (qualitative) sources of economic growth → intensive economic
growth
•
in real economy there is mostly a combination of extensive and intensive
economic growth; it depends on which sources of economic growth prevail
Economic growth and price stability (instability)
•
ideal conditions: potential output growth in terms of price stability (enshrined in
the Act on the Czech National Bank)
•
price stability is not an accompanying effect of economic growth
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in terms of economic growth, the price level can increase, decrease, or may
remain constant
•
the new real product can fluctuate around the potential output in the short term
Economic growth in terms of price stability - ideal for the
economy
P
LRAS1
LRAS2
SRAS1
E1
SRAS2
But the price
stability is not a
phenomenon that
economic growth
would (always)
accompanied.
E2
P
AD2
AD1
Y1*
Y2*
Y
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Economic growth where aggregate supply is dropping
behind aggregate demand
P
LRAS1
LRAS2
The effect here is
higher price level and
lower output in
comparison with
potential output Y2*.
SRAS1 SRAS2
E2
P2
P1
AD2
E1
AD1
Y1*
Ya Y2*
Y
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Economic growth where aggregate demand is dropping
behind aggregate supply
P
LRAS1
LRAS2
SRAS1
P1
P2
E1
SRAS2
E2
AD1
Y1*
Ya Y2*
The effect here is
lower price level
and lower output
in comparison
with potential
output Y2*.
AD2
Y
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Models of economic growth
• classic “models”: T. R. Malthus, D. Ricardo
• Keynesian models
– New Keynesian models: R. F. Harrod, E. D. Domar - the first growth models
– Postkeynesianism (N. Kaldor, J. Robinson) - theory of income distribution
• Neoclassical models (theory of exogenous and endogenous growth
theory) - use the production function, growth accounting
• The School of growth limits – it emphasis on limited resources, there is a
respect for the environment, new variable called sustainable economic
development
Constraints – economic growth barriers
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the vicious circle of poverty: low income → low level of savings → insufficient
supply of capital goods → low capital-labor ratio (K/L) → low income and back to
the beginning
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demographic trends – population explosion
•
capital outflow “brain outflow” = escape of skilled workforce
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lack of political, legal and other institutional conditions
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inadequate infrastructure
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lack of natural resources, adverse weather conditions, natural disasters, wars.
Pro-growth macroeconomic policy
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stimulating the creation of new creative ideas, proposals on innovation, both,
in the private and government sector (endogenous growth theory)
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tax incentives for expenditures on research and development of new technologies
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encouraging investment in human capital
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reducing budget deficits that displace private investment, promotion of
investment tax incentives
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removing unnecessary regulation of economic processes
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investment in infrastructure
Definition of the business cycle and its characteristics
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business cycle = fluctuations in the actual product around the potential
product (we use the product adjusted for inflation – i.e. real product)
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there are two basic tendencies (phases) of the business cycle:
contraction and expansion (in some literature recession and
expansion)
•
turning points: peaks and throughs
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one business cycle and the cycle period
•
three basic types of cycles (per period):
I.
short term Kitchins ´ cycles
II.
medium term Juglars´ cycles
III. long term Kondratěvs´ cycles, Kuznets´cycles
The economic cycle
GAP
Ya,
boom
contraction
Y*
peak
expansion
trend, Y*
Ya
through
recovery
t (time)
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Mechanism of the business cycle
•
•
•
Economists only agree that there are shifts of SRAS and AD
different causes of economic activity changes → different theories of
the business cycle, different interpretation of certain terms
theory of business cycle:
–
–
–
–
–
–
–
–
Keynesian theory
Neokeynesian theory (principles of multiplier and accelerator)
theory of Monetarism
theory of School of Rational Expectations (New Classical Macroeconomics)
theory of economic-political cycle
innovation theory
real business cycle theory
other alternative theories
The link between movements in the economy and the
unemployment rate
• Arthur M. Okun (1928 - 1980): examined the relationship between
fluctuations in real output and the unemployment rate in the US
economy
• Okun's Law:
u = u * - σ [100. (Y - Y *) /Y *]
σ = coefficient of sensitivity changes in the unemployment rate to change
the coefficients of the product
„One of the most credible empirical regularities of macroeconomics“.
(cited by J. Tobin)
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Classical recession
P
LRAS
SRAS
Drop in AD
Y
P
P´
E´
Λ
P
E
AD
AD´
Y´
Y*
Y
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Slumpflation
P
LRAS
SRAS´
SRAS
Drop in SRAS
E´
P´
P
Y Λ
P
E
AD
Y´ Y*
Y
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Stagflation: output stagnation + inflation
P
LRAS
SRAS´
SRAS
P´
E´
P
E
Rise in AD and
drop in SRAS.
Yr const. Λ
AD´
AD
Y*
P
Stagflation can
occur even if the
output is lower than
the potential.
Y
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Keynesian interpretation of the business cycle
- multiplier principle and the principle of the accelerator
•
multiplier principle:
ΔY = α . ΔI
increase in investment → increase in output (income)
α = investment multiplier
•
principle of the accelerator:
Ii = a . ΔY
increase in output (income) → increase in investment
a = accelerator coefficient
Ii = induced investment, induced by the increasing output
Both, multiplier and accelerator, act in the same direction, the upper limit is the potential
output and the lower limit represents replacement investment.
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The effects of business cycles and countercyclical economic
policy
• the effects of business cycles:
I.
economic
II.
social
III.
political
• activist Keynesian macroeconomic policy vs. macroeconomic policy of
conservatism (conserv. - the effort to strengthen the ability of market selfregulation, not to support the growth of AD)
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Conjunctural indicators
• there is trying to predict the phase of the business cycle (but the future is
always uncertain)
• we distinguish the following types of business cycle indicators:
– leading (eg. numbers of contracts for investment)
– concurrent (eg. real GDP)
– delayed (eg. wage levels)
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Literature
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FRANK, R. H., BERNANKE, B. S. Principles of Macroeconomics. 3rd Edition. McGrawHill/Irwin: NY, 2007. ISBN 978-0-07-319397-7. 561 p.
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MANKIW, G. N. Principles of Macroeconomics. 4 th ed. USA: Thomson SouthWestern, 2007. 583 p. ISBN 978-0-324-23695-8.
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McCONNELL, C. R., BRUE, S. L. Economics: Principles, Problems, and Policies. 17th
ed. NY: McGraw/Irwin. 716 p. ISBN 978-0-07-312663-0.
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SAMUELSON, P. A., NORDHAUS, W. D. Economics. 15th ed. McGraw-Hill, 1995.
Internet sources
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Czech Statistical Office. Statistics. Macroeconomic data. Available at: WWW:
http://www.czso.cz.
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Ministry of Finance of the Czech Republic. Menu – Public Sector. Macroeconomic
prediction. Available at: WWW: http://www.mfcr.cz.
Homework
Exercise “Economic Growth”
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The share of employment in manufacturing on total employment was decreasing
from 30 % to 16 % between the years 1950 – 2000. However, production in
industry grew at a healthy pace, higher than the total production. What can say on
the basis of these facts about labor productivity in manufacturing? Was the
decline in the share of industrial employment on total employment worrisome?
•
Assume the share of capital cost on the product of 0.2 and the share of labor costs
on the product 0.8. Capital is growing by 10% rate and labor supply decreases by
4% rate. What rate does the potential product increase (decrease)? Consider the
absence of technological progress.
Homework
Exercise “Business Cycle Theory”
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Assume the natural rate of unemployment in an economy of 5 %. When the size of
the real product is 200 billion, the real unemployment rate rises up to 10 %. On
the basis of these data, calculate the estimated amount of potential output.
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Draw the growth rate development of real GDP of the Czech Republic from 1996 to
the present. Use data from the Czech Statistical Office and read the text about the
economic cycle on web pages of the Czech Ministry of Finance: http://www.czso.cz
(menu Statistics - Macroeconomic data); http://www.mfcr.cz - Macroeconomic
Forecast file (economic cycle).