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Chapter 25 & 26 Introduction to Economic Growth and Instability Economic Growth Definitions of Economic Growth LO1 • Increase in real GDP over some time period, or • Increase real GDP per capita over some time period. • Economic Growth is a percentage rate of growth. Economic Growth Real GDP and Real GDP per Capita (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 LO1 Economic Growth • Countries determine economic growth as a goal. It is one of the most important economic goals - To raise total outputs relative to population - This will lead to raising real wages and income and standards of living: More goods and services, leisure, higher educations… • Growth can reduce the effect of scarcity Economic Growth • Why the rate of growth is important? Because it matters! • In the USA, a 1% growth rate increase means $100 billion more outputs. • We use the “rule of 70” : we can find the number of years for some measure to double: Arithmetic of growth: Rule of 70 Approximate number of years required to double real GDP LO1 70 = annual percentage rate of growth Economic Growth LO1 • An example for “rule of 70” ; i.e a 3% annual rate of growth will double real GDP in 23 years. How !! • Also, “rule of 70” can be used to compare 2 countries, How !! Economic Growth Main Sources of Growth Can increase real outputs in two main ways: A. Increasing inputs of resources B. Increasing the productivity of these resources Note: Productivity is the real output per unit of inputs and it increases when health, training, education, and motivation of workers are improved (technology). The Business Cycle Definition of Business Cycle : Alternating rises and declines in the level of economic activity over periods of times. Usually, level of outputs (Real GDP) increases to a peak then declines to a trough. There are four phases of the business cycle are identified over a several-year period. These includes a peak, a recession, a trough, and finally a recovery. The Business Cycle Peak Level of real output Peak Peak Trough Trough Time LO1 The Business Cycle 1. A peak is when business activity reaches a temporary maximum with full employment and near-capacity output. 2. A recession is a decline in total output, income, employment, and trade lasting six months or more. 3. The trough is the bottom of the recession period. 4. Recovery is when output and employment are expanding toward full-employment level. A. Unemployment • It is one of the problems that arise from economic instability. • Can be defined as the failure to use all available economic resources to produce desired goods and services; the failure of the economy to fully employ its labor force. A. Unemployment < 16 and or in institutions Not in labor force Total population Employed Labor force “People who are able and willing to work” Unemployed “People who are able and willing to work” A. Unemployment Thus Definition of Unemployment is: • The unemployment rate is defined as the percentage of the labor force that is not employed. (Note: Emphasize not the percentage of the population.). • Unemployment can be measured as; Unemployment Rate = (unemployed / Labor Force) x 100 A. 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) Unemployed (14.3 million) LO2 14,265,000 X 100 = 9.3% 154,142,000 Labor force (154.2 million) A. Unemployment Types of unemployment: • 1. Frictional unemployment: consists of those workers between jobs (searching for better job, fired, laid of b\c of seasonal demand, searching for the first job…) . • 2. Structural unemployment: due to changes in the structure of demand for labor; e.g., workers whose skills are not demanded, who lack sufficient skill to obtain employment, or who cannot move to locations where jobs are available. • 3. Cyclical unemployment: is caused by the recession phase of the business cycle as demand decreases, employment falls and unemployment increases. A. Unemployment Definition of Full Employment: • Full employment does not mean zero unemployment. • Therefore, we can say the economy is fully employed ( at Full Employment) even if we have both the structural and frictional unemployment. • Full employment occurs when there is no cyclical unemployment. A. Unemployment • Since we have unemployment even when we are at full employment. • The full-employment rate of unemployment is also referred to as the natural rate of unemployment. • The natural rate is achieved when labor markets are in balance; “the number of job seekers” equals “the number of job vacancies”. • The natural rate of unemployment is not fixed but depends on the demographic makeup of the labor force and the laws and customs of the nations. A. Unemployment Economic cost of unemployment: (1) • GDP gap and Okun’s Law: GDP gap is the difference between potential and actual GDP. • Economist Arthur Okun quantified the relationship between unemployment and GDP as follows: For every 1 percent of unemployment above the natural rate, a negative GDP gap of about 2 percent occurs. This is known as “Okun’s law”. • The forgone outputs in this case when the economy fails to create enough jobs for all who are able and willing to work, potential production of goods and services is lost. A. Unemployment (2) • Unequal Burden: Level of skill, nature of occupation, certain age and race and ethnicity, gender, and education. Noneconomic cost of unemployment: (1) • Noneconomic costs include loss of self-respect and social and political unrest. B. Inflation Definition of Inflation: • Inflation is a rising general level of prices (not all prices rise at the same rate, and some may fall). • Not necessary that all prices are increasing • In periods of inflation, some prices are rising while some are declining • The most important: general price level, and the increase to have an affect B. Inflation Measuring of Inflation: • The main index used to measure inflation is the Consumer Price Index (CPI). • Using CPI when price index measures the general level of prices in the economy as : CPIyear A=(basket yearA)/(basket in base year) X100 • Therefore, inflation rate2000 = CPI2000- CPI1999 CPI1999 X 100 B. Inflation Types of Inflation 1. Demand Pull Inflation: • Assume that the economy is at its full capacity of production. Then, Assume that total spending is greater than production level… what will happen to price level? • Since all resources are fully employed, production cannot respond to this increase in demand. • Therefore, outputs cannot be expanded to meet demand, This excess demand will bid up prices, causing “demand-pull inflation”. • “Too much spending for too few goods” B. Inflation 2. Cost-Push Inflation: • This is an increase in per-unit production costs. • Per-unit production cost = Total input cost / units of outputs • This will reduce profits and reduce outputs firms willing to produce. • Thus, the economy’s supply of goods and services declines and the price level rises. • Costs are pushing the price level upward • Sources: supply shocks: increase in costs or raw materials, energy inputs, wages… B. Inflation Redistribution Effects of Inflation • Inflation hurts some, leaves others unaffected • Inflation redistributes real income from some to others • Who benefits and who gets hurt? B. Inflation Redistribution Effects of Inflation Terminology; Recall; • Real income = nominal income/price index • Real wage: purchasing power of nominal wage (number of $$ received as wages, rent, interest, or profits) • Some people will be affected more than others as inflation occurs (redistribution effect). • The following rule tells us approximately by how much real income will change: %ΔReal in Income =%Δ nominal income - %Δ in price level B. Inflation Redistribution Effects of Inflation Who is affected by Inflation; Unanticipated inflation has stronger impacts; those expecting inflation may be able to adjust their work or spending activities to avoid or lessen the effects. 1. 2. 3. 1. 2. Unanticipated inflation hurts: Fixed income receivers Savers Creditors Unanticipated inflation is unaffected to: Flexible income receivers Debtors B. Inflation Anticipated inflation • The redistribution effects of inflation are less sever or can be eliminated when people can expect inflation (inflation is anticipated )and can adjust their nominal incomes to reflect the expected price-level increases. • The lender can avoid the anticipated inflation by charging inflation premium; Nominal interest rate = Real interest rate + Inflation Premium B. Inflation Hyperinflation; • Is an extremely high rate of inflation. • Individuals expect inflation rate to even gets higher, leading them to “spend now”. • Business owners do not know what to charge for their products. • May cause economic collapse • Uncertainty about future prices