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Chapter 7
Introduction to Economic Growth and
Instability
Revision
 Economic growth
 Rule of 70
 Sources of growth
 Business Cycle
 Unemployment
 Types of unemployment
 Economic costs
 Okun’s Law
Inflation
 Rise in the general level of prices
 Each dollar buys fewer goods and services
 Reduces the purchasing power of money
Measuring inflation
Price indices
 Consumer price index
 Each month or each year
 Market basket of some 300 consumer goods and
services
CPI =
Price of the Most Recent Market
Basket in the Particular Year
Price of the Same Market
Basket in 1982-1984
x
100
Consumer Price Index
Quantity
in
2006
2007
2008
Basket
(kg or
Price
litre)
Flour
Cost of
basket
Price
Cost of
basket
Price
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
Price
index
2260
100
Cost of
basket
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 economy
 Rising per-unit production costs
 Reduces profits and thus reduces output
 Prices rise
 Also 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)
Redistribution Effects of Inflation
 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
Inflation
 Who is Hurt by Inflation?
 Fixed-Income Receivers
 Savers
 Creditors
 Who is Unaffected or Hurt by Inflation?
 Flexible-Income Receivers
 Cost-of-Living Adjustments (COLAs)
 Business
 Debtors
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
The US Economy: Private and Public
sectors
Public and Private Sectors- M&B Ch. 5
Households, Businesses, the Public
Sector/Government
Households
 113 million households
 One or more person occupying a housing unit
 Supplier of economic resources
 Major spenders in economy
 Income received can be categorized as
 How its earned
 How it distributed by households
Functional distribution of Income
 Indicates how nations income is apportioned among wages,
rents , profits etc
 According to the function performed by the income
receivers
Personal Distribution of Income
 Indicates how money is divided among individual households
 Divided into groups , height of bar shows how much of total
income is received by each group
Household as Spenders
 Personal Taxes
 Personal Savings
 Security
 Speculation
 Dis-save
 Personal consumption
 Relation of income with S and C ??
The business population
 A plant is a physical establishment, that performs one or
more function in fabricating a good or serivce
 A firm is a business organization that owns and operates plant
 An industry is a grp of firms that produce the same, or
similar products
 Multiplant
Legal Forms of Businesses
 Sole-proprietorship: is a business owned and operated by
one person
 Partnership: two or more individuals agree to own and
operate a business together
 Corporation: is a legal creation that can acquire resources,
own assts, produce and sell products, incur debts, extend
credit etc...perform the functions of any other type of
enterprise.
The Principal-Agent Problem
 Principals (stockholders)- want maximum company
profit and stock price.
 Agents (managers) –may want the power, prestige and
pay that often accompany control over a large
enterprise, independent of profitability and stock
price. For example, executives may build expensive
office buildings, enjoy the use of corporate jets, pay
too much to acquire other corporations.
 Differences in objectives (profits vs. salary) –so a
conflict of interest may exist between the principal and
the agent
Public Sector
 Government’s role
 Providing legal structure: government establishes rules of the game
that control relationships among businesses, resource suppliers and
consumers. Optimum amount of regulation is established so that the
MB and MC are equal
 Maintaining competition: in most markets, efficient production can
be best attained with a high degree of competition.
 Redistributing income
 Transfer payments (to the poor)
 Market intervention (minimum prices, wages)
 Taxation (Higher taxes applied on rich and lower taxes on the poor to narrow
income gaps)