Chapter 8
Introduction to Economic Growth & Instability
Economic growth: is defined and measured as
 An increase in real GDP occurring over some time period
 An increase in real GDP per capita occurring over some time
period.
Growth is a widely held economic goal. The expansion of total output
relative to population results in rising real wages and incomes and thus
higher standards of living.
An economy that is experiencing economic growth is better able to meet
people’s wants and resolve socioeconomic problems.
Growth lessens the burden of scarcity
Rule of 70
Approximate # of years to required to double real GDP
= 70/annual percentage rate of growth
Main sources of Growth:
 By increasing its inputs of resources
 By increasing the productivity of those inputs
 Other thing equal, increases in land, labor, capital and
entrepreneurial resources yield additional output.
 Economic growth also occurs through increases in productivity
– measured broadly as real output per unit of input.
Growth in the United States
 Real GDP grew 3.5% and real GDP per capita about 2.3%.
 But remember:
o Improved products and services
o Added leisure – which causes a reduction in GDP
The Business Cycle
 Refers to alternating rises and declines in the level of
economic activity some times extending over several
years.
 Peak: business activity has reached a temporary
maximum
 Economy is at full employment
 The level of real output is at or very close to the
economy’s capacity
 Recession: a period of decline in total output, income,
employment and trade.
 Lasts 6 months or more
 Widespread contraction of business activity in
many sectors of the economy
 Firms and industries producing capital goods or
consumer durables are affected most by the
business cycle.
 Nondurables and service industries are somewhat
isolated from business fluctuations
 Trough: output and employment bottom out.
 Recovery: the expansion phase of the economy
 Output and employment rise toward full
employment
 Price level may begin to rise
Unemployment:
 Measurement of Unemployment:
o Total population:
 Under 16 and/or institutionalized
 Not in the labor force
 Employed
o Labor force:
 Employed + Unemployed
 Consists of people who are able and willing to work
 Actively seeking employment
o Unemployment rate:
Rate = Unemployed X 100
Labor force
o The data is collected by the Us Bureau of Labor Statistics
o Criticisms
 Part time employees counted as full time
 Discouraged workers
 Types of Unemployment:
o Frictional unemployment
 Workers moving voluntarily from one job to another
 The workers have the necessary skills for the jobs
available
 Search unemployment or wait unemployment
 Implies that the labor market does not operate perfectly
and instantaneously in matching workers and jobs
 Frictional unemployment is inevitable and, at least in part
desirable.
o Structural unemployment
 Changes over time in consumer demand and in
technology alter the structure of the total demand for
labor
 Workers do not have the necessary skills for the jobs
available
 Unemployment results because the composition of the
labor force does not respond immediately or completely
to the new structure of job opportunities
 Workers who find that their skills and experience have
become obsolete or unneeded thus find that they have no
marketable talents.
 They are unemployed until they adapt or develop skills
that employers want
 They find hard to obtain new jobs
o Cyclical unemployment:
 Caused by a decline in total spending likely to occur in
the recession phase of the business cycle.
 Full Employment
o Is less than 100% employment
 Due to frictional and structural unemployment being
largely unavoidable in a dynamic economy.
 Occurs when there is no cyclical unemployment
 Natural rate of unemployment – when there is no cyclical
unemployment
 Occurs when the number of job seekers equals the
number of job vacancies
 It is 4%
 Economic Cost of Unemployment
o The basic economic cost of unemployment is forgone output
o When the economy fails to create enough jobs for all who are
able and willing to work, potential production of goods and
services is irretrievably lost.
o Economy operating inside the production possibilities curve
o The sacrificed output is the GDP GAP
 GDP GAP – the amount by which actual GDP falls short
of potential GDP
 Potential GDP is determined by assuming that the natural
rate of unemployment prevails.
 The growth of potential GDP is simply projected forward
on the basis of economy’s normal growth rate of real
GDP
 Okun’s Law: indicates that for every 1% by which the
actual unemployment rate exceeds the natural rate, a
GDP gap of about 2% occurs.
 Unequal burden: higher levels of unemployment occurs in several
groups
o Occupation
o Age
o Race and ethnicity
o Gender
o Education
o Duration
Labor force participation of men and women in the US economy
 Women’s role in American society has changed dramatically over the
past century.
 The change in women’s role is also partly attributable to changing
political and social attitudes.
 World War II - 33% of women worked, 87% of men
 1995 - 59% of women and 75% of men.
 The increase in women’s labor force participation is easy to
understand but the fall in men’s may seem puzzling. There are
several reasons for this decline.
1. Young men now stay in school longer than their fathers and
grandfathers did
2. Older men now retire earlier and live longer.
3. With more women employed, more fathers now stay at home to
raise children.
Inflation
 Is a rise in the general level of prices
 Measurement of Inflation
o Rate of inflation is by price indexes such as CPI
Types of Inflation
o Demand Pull Inflation
 An excess of total spending beyond the economy’s
capacity to produce causes changes in the price level.
 Too many dollars chasing too few goods
o Cost Push Inflation
 Occurs when factors such as excessive wage increases
and rapid increases in raw material prices drive up per
unit production costs at each level of output higher costs
push the price level upward
 Redistribution Effects of Inflation
o Nominal income – is the number of dollars received as wages,
rents, interest or profits
o Real income – is a measure of the amount of goods and services
nominal income can buy
o But when inflation occurs, not everyone’s nominal income rises
at the same pace as the price level
o Causing a redistribution of real income from some to others
o This depends on whether inflation is anticipated or
unanticipated
 Anticipated inflation
o Fully expected by the recipient
o The redistribution effects of inflation are less severe or are
eliminated altogether if people anticipate inflation and can
adjust their nominal incomes to reflect the expected price level
rises.
 Unanticipated Inflation
o Inflation whose full extent was not expected
o Whom does Unanticipated Inflation hurt?
 Fixed income receivers
 Savers
 Creditors
o Whom does Unanticipated Inflation help?
 Flexible income receivers
 COLAs – cost of living adjustments
 Benefits increase when cost of living increases
 Debtors
Deflation – the effects of unanticipated declines the price level are reverse
of those of inflation.
Effects of Inflation on Output
 The direction and significance of the effect of inflation on output
depends on the type of inflation and its severity
 Cost Push Inflation
o Abrupt and unexpected rises in resource prices can sufficiently
drive up overall production costs to cause cost-push inflation.
o Cost-push inflation reduces real output. It redistributes a
decreased level of real income
 Demand Pull Inflation
o Economists do not fully agree on the effects of mild inflation on
real output.
Hyperinflation
 Extremely rapid inflation whose impact on real output
and employment usually is devastating.
 When inflation begins to escalate, consumers, workers,
and business assume that it will rise even further.
Consumers spend now to beat the price increase
Causation: the changes in the levels of real output and employment is
caused by the changes in the level of total spending