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08 Economic Growth McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Economic Growth • Increase in real GDP or real GDP per • • • capita over some time period Percentage rate of growth Growth as a goal Arithmetic of growth: Rule of 70 Approximate number of years required to double real GDP LO1 70 = annual percentage rate of growth 8-2 Economic Growth • Growth in U.S. real GDP 1950-2009 • Increased 6 fold • 3.2% per year • Growth in U.S. real GDP per capita • Increased more than 3 fold • 2% per year • Qualifications • Improved products and services • Added leisure • Other impacts LO1 8-3 Economic Growth Real GDP and Real GDP per Capita LO1 (4) Real GDP, Per Capita, 2005$ (2) ÷ (3) (1) Year (2) Real GDP, Billions of 2 2005$ 1950 $ 2006 152 $12,197 1960 2831 181 15,640 1970 4270 205 20,829 1980 5839 228 25,610 1990 8034 250 32,136 2000 11,226 282 39,809 2009 12,987 307 42,303 (3) Population, Millions Source: Bureau of Economic Analysis, http://www.bea.gov and U.S. Census Bureau, http://www.census.gov 8-4 Modern Economic Growth • Began with the Industrial Revolution in late • • • • • LO2 1700s Ongoing increases in living standards Time for leisure Social change Democracy Human lifespan doubled 8-5 Modern Economic Growth • Began in Britain • Has spread slowly • Starting date main cause of worldwide • LO2 differences in living standards Catching up is possible • Leader countries invent technology • Follower countries adopt technology • Can grow faster 8-7 Modern Economic Growth Country Real GDP per capita, 1960 United States $ 14,766 United Kingdom 11,257 France 9,347 Ireland 6,666 Japan 5,473 Singapore 4,149 Hong Kong 3,849 South Korea 1,765 Real GDP per capita, 2007 $42,887 32,181 29,663 41,625 30,585 44,619 43,121 23,850 Average annual growth rate, 1960-2007 2.3% 2.3 2.5 4.0 3.7 5.2 5.3 5.7 Figures are in 2005 dollars Source: Penn World Table version 6.3, pwt.econ.upenn.edu LO2 8-8 Modern Economic Growth LO3 8-10 Institutional Structures of Growth • Strong property rights • Patents and copyrights • Efficient financial institutions • Literacy and widespread education • Free trade • Competitive market system LO3 8-11 Determinants of Growth • Supply factors • Increases in quantity and quality of natural resources • Increases in quality and quantity of human resources • Increases in the supply (or stock) of capital goods • Improvements in technology LO3 8-13 Determinants of Growth • Demand factor • Households, businesses, and • LO3 government must purchase the economy’s expanding output Efficiency factor • Must achieve economic efficiency and full employment 8-14 Production Possibilities Capital Goods C A Economic Growth c b a B D Consumer Goods LO3 8-15 Labor and Productivity Real GDP = hours of work x labor productivity • Size of employed labor force Labor Inputs (hours of work) • Average hours of work x • Technological advance • Quantity of capital • Education and training • Allocative efficiency • Other LO3 = Real GDP Labor Productivity (average output per hour) 8-16 U.S. Economic Growth Accounting for the Growth of U.S. Real GDP, 1953-2007, Plus Projection from 2009-2020 Item 1953 Q2 To 1973 Q4 Increase in real GDP 1973 Q4 To 1995 Q4 1995 Q4 To 2001 Q1 2001 Q1 To 2007 Q3 Projected 2009 Q1 To 2020 Q4 3.6 2.8 3.8 2.6 2.5 Increase in quantity of labor 1.1 1.3 1.4 -0.1 0.2 Increase in labor productivity 2.5 1.5 2.4 2.7 2.3 (Average Percent Changes) Source: Derived from Economic Report of the President, 2008, p. 45; and Economic Report of the President, 2010, p. 76 LO3 8-17 Accounting for Growth • Factors affecting productivity growth • Technological advance (40%) • Quantity of capital (30%) • Education and training (15%) • Economies of scale and resource allocation (15%) LO3 8-18 Productivity Growth • Average rate of growth • 1.5% per year 1973-1995 • 2.8% per year 1995-2009 • Affects real output, real income, and real • LO4 wages Pay higher wages without lowering profit 8-20 Productivity Growth LO5 8-21 Economic Growth in China • Growth averages past 25 years: • 9% annual growth output • 8% annual growth output per capita • Labor more productive • More international trade • Transition to market economy • Joined WTO 2001 • Financial system remains weak • Income inequality across areas LO5 8-22 09 Business Cycles, Unemployment, and Inflation McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. The Business Cycle • • Alternating increases and decreases in economic activity over time Phases of the business cycle • • • • LO1 Peak Recession Trough Expansion 9-24 The Business Cycle Peak Level of real output Peak Peak Trough Trough Time LO1 9-25 The Business Cycle U.S. Recessions since 1950 Period Duration, Months Depth (Decline in Real Output) 1953-54 10 -2.6% 1957-58 8 -3.7 1960-61 10 -1.1 1969-70 11 -0.2 1973-75 16 -3.2 1980 6 -2.2 1981-82 16 -2.9 1990-91 8 -1.4 2001 8 -0.4 2007-09 18 -3.7 Source: National Bureau of Economic Research, http://www.nber.org and Minneapolis Federal Reserve Bank, http://www.minneapolisfed.org Output data are in 2000 dollars LO1 9-26 Causation: A First Glance • Business cycle fluctuations • Economic shocks • Prices are “sticky” downwards • Economic response entails decreases in output and employment LO1 9-27 Causation: A First Glance • Causes of shocks • Irregular innovation • Productivity changes • Monetary factors • Political events • Financial instability • Recession of 2007 LO1 9-28 Unemployment Total population (307.3 million) Under 16 and/or Institutionalized (71.4 million) Unemployment rate = # of unemployed X 100 labor force Not in labor force (81.7 million) Unemployment rate = Employed (139.9 million) 14,265,000 X 100 = 9.3% 154,142,000 Labor force (154.2 million) Unemployed (14.3 million) LO2 9-31 Unemployment • Criticisms of unemployment • Involuntary part-time workers counted as if full-time • Discouraged workers are not counted as unemployed LO2 9-32 Types of Unemployment • Frictional unemployment • • Structural unemployment • • Occurs due to changes in the structure of the demand for labor Cyclical unemployment • LO3 Individuals searching for jobs or waiting to take jobs soon Caused by the recession phase of the business cycle 9-33 Definition of Full Employment • Natural Rate of Unemployment (NRU) • • 6% Can vary over time • Demographic changes • Changing job search methods • Public policy changes • LO3 Actual unemployment can be above or below the natural rate 9-34 Economic Cost of Unemployment • GDP Gap • GDP gap = actual GDP – potential GDP • Can be negative or positive • Okun’s Law • LO3 Every 1% of cyclical unemployment creates a 2% GDP gap 9-35 Economic Cost of Unemployment Economic Cost of Unemployment LO3 9-36 Economic Cost of Unemployment LO3 9-37 Unequal Burdens • Occupation • Age • Race and ethnicity • Gender • Education • Duration LO3 9-38 Unequal Burdens Unemployment Rates by Demographic Group: Full Employment Year (2007) and Recession Year (2009)* Unemployment Rate Demographic Group Overall Occupation: Managerial and professional Construction and extraction Age: 16-19 African American, 16-19 White, 16-19 Male, 20+ Female, 20+ Race and ethnicity: African American Hispanic White Gender: Women Men ** Education: Less than high school diploma High school diploma only College degree or more Duration: 15 or more weeks LO3 2007 2009 4.6% 9.3% 2.1 4.6 7.6 19.7 15.7 24.3 29.4 39.5 13.9 21.8 4.1 9.6 4.0 7.5 8.3 14.8 5.6 12.1 4.1 8.5 4.5 8.1 4.7 10.3 7.1 14.6 4.4 9.7 2.0 4.6 1.5 4.7 9-39 Noneconomic Costs • Loss of skills and loss of self-respect • Plummeting morale • Family disintegration • Poverty and reduced hope • Heightened racial and ethnic tensions • Suicide, homicide, fatal heart attacks, • LO3 mental illness Can lead to violent social and political change 9-40 Global Perspective LO3 9-41 U.S. Manufacturing Employment 1920-1940 Inflation • • • General rise in the price level Inflation reduces the “purchasing power” of money Consumer Price Index (CPI) CPI = CPI = LO2 Price of the Most Recent Market Basket in the Particular Year Price estimate of the Market Basket in 1982-1984 207.3 - 201.6 x 100 x 100 = 2.8% 201.6 9-43 Inflation Inflation Rates in Five Industrial Nations LO2 9-45 Inflation LO2 9-47 Types of Inflation • Demand-Pull inflation • • • Excess spending relative to output Central bank issues too much money Cost-Push inflation • Due to a rise in per-unit input costs • Supply shocks LO3 9-49 Inflation • • Difficult to distinguish inflation types Types differ in sustainability • • • Core inflation • • LO3 Demand-pull continues as long as the excess spending continues Cost-push ends in a recession Without food and energy goods Focuses on more stable prices 9-50 Who is Hurt by Inflation? • Fixed-income receivers • • Savers • • Real incomes fall Value of accumulated savings deteriorates Creditors • Lenders get paid back in “cheaper dollars” LO3 9-51 Who is Unaffected by Inflation? • Flexible-income receivers • COLAs • Social Security recipients • Union members • Debtors • LO3 Pay back the loan with “cheaper dollars” 9-52 Anticipated Inflation 6% 11% = + 5% Nominal Interest Rate LO3 Inflation Premium Real Interest Rate 9-53 Does Inflation Affect Output? • Cost-Push inflation • • • Reduces real output Redistributes a decreased level of real income Demand-Pull inflation • One view is that zero inflation is best • Another view is that mild inflation is best • Demand-pull inflation causes recessions LO3 9-54 Hyperinflation • • • • • • LO3 Extraordinarily rapid inflation Devastates an economy Businesses don’t know what to charge Consumers don’t know what to pay Money becomes worthless Zimbabwe’s 14.9 billion percent inflation in 2008 9-56 The Stock Market and the Economy • Stock prices changing • Wealth effect • Investment effect • Typical changes lead to weak effects • Stock market bubbles • • • Huge unwarranted rises in stock prices Excessive optimism and frenzied buying Can be detrimental to an economy 9-57