UNIT 6: Economic growth, physical and human capital.

                             Economic Growth & Productivity

                     Economic Growth Defined

·         Sustained increase in Real GDP over time.

·         Sustained increase in Real GDP per Capita over time.

The question now is; why grow?

1.      Growth leads to greater prosperity for society.

2.      Lessens the burden of scarcity.

3.      Increases the general level of well-being.

                         Conditions for Growth

·           Rule of Law

·           Sound Legal and Economic Institutions

·          Economic Freedom

·          Respect for Private Property

·           Political & Economic Stability

·           Low Inflationary Expectations

·           Willingness to sacrifice current consumption in order to grow

·           Saving

·         Trade

                                 Physical Capital

§  Tools, machinery, factories, infrastructure

§  Physical Capital is the product of Investment.

§  Investment is sensitive to interest rates and expected rates of return.

§  It takes capital to make capital.

§  Capital must be maintained.

                               Technology & Productivity

§  Research and development, innovation and invention yield increases in available technology.

§  More technology in the hands of workers increases productivity.

§  Productivity is output per worker.

§  More Productivity = Economic Growth.

                                       Human Capital

§  People are a country’s most important resource. Therefore human capital must be developed.

§  Education

§  Economic Freedom

§  The right to acquire private property

§  Incentives

§  Clean Water

§  Stable Food Supply

§  Access to technology

Growth illustrated

Growth illustrated on a long run aggregate supply graph

                              Hindrances to Growth

Ø  Economic and Political Instability

Ø  High inflationary expectations

Ø  Absence of the rule of law

Ø  Diminished Private Property Rights

Ø  Negative Incentives

Ø  The welfare state

Ø  Lack of Savings

Ø  Excess current consumption

Ø  Failure to maintain existing capital

Ø  Crowding Out of Investment

Ø  Government deficits & debt increasing long term interest rates!

Ø  Increased income inequality à Populist policies

Ø  Restrictions on Free International Trade

UNIT 5: Supply side economics and the Laffer CURVE

                                         Supply side Economics

                                               Reagonomics

            Makes changes in AS but not AD and it determines the level of inflation, unemployment and economic growth.

-          Lower marginal tax rate induce more work this AS increases. It also makes leisure more expensive and work more attractive.

-           Supply side economist support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transferred payment such as unemployment compensation and welfare programs provide disincentives to work, invest, innovate and undertake entrepreneur inventions.

                                             Incentive to save and invest
        1.      High marginal tax rate can reduce the rewards for savings and investments.
        2.      Consumption might increase,but investment depend upon savings.
        3.      Lower marginal tax rates encourage saving and investment.

-         
                                                             Laffer Curve
    It depicts a theoretical relationship between tax rate and government revenue. As tax rate increase from zero, government revenues increase from zero to some maximum level and then decline.

                                              Criticisms of the Laffer curve.
        1.      Research suggests that the impact of tax rates on incentives to work, save and invest are small.
        2.      Tax cuts also increase demand which can fuel inflation, which causes demand to exceed supply.
        3.      Where the economy is actually located on the curve is difficult to determine.

UNIT 5: Philips Curve

                                          Philips curve

                                                   The long-run Philips curve (LRPC)

-          Because the long-run Philips curve exists of the natural rate of unemployment (Un), structural changes in  the economy that affect Un will also cause the LRPC to shift.

-          Increase in Un will shift LRPC o the right.

-          Decrease in Un will shift LRPC to the left.

                                                 Short run Philips curve (SRPC)

1.      There is a tradeoff between inflation and unemployment. As one increase the other decrease and vice versa.

                                             Long run Philips cure (LRPC)

1.      There is no tradeoff between inflation and unemployment.

2.      LRPC is represented by a vertical line.

3.      The LRPC occurs at the natural rate of unemployment.

4.      The LRPC only shifts if the LRAS shifts

NRU = frictional + structural + seasonal unemployment.

                                                       What changes LRPC

            The major LRPC assumption is that more worker benefits create higher natural rate of unemployment and fewer worker benefit creates lower natural rate.

                                                                      The misery index

                It is a combination of inflation and unemployment in a given year.

-          Single digit misery is good.

Inflation:

It is the general rise in the price level

Deflation:

A general decline in the price level

Disinflation:

Decrease in the rate of inflation over time

Stagflation:

Unemployment and inflation increasing at the same time.

UNIT 5: Extending the analysis of Aggregate Supply.

                        Extending the analysis of Aggregate Supply

                                                                 SRAS

In macroeconomics this is the period in which wages and other input prices remain fixed as price level increases or decreases. Remember how crucial worker salaries to a businesses  output to bottom line when considering effects of aggregate supply.

                                                                 LRAS
Period of time in which wages have become fully responsive to changes in price level. Remember how crucial worker salaries to a businesses output to bottom line when considering effects on AS.

                                             Effects over Short run

·         In the short run price level changes allow for companies to exceed normal Outputs and hire more workers because profits are increasing while wages remain constant.

·         in the long run wages will adjust to the price level and previous output levels will adjust accordingly.
                         Equilibrium in the extended model

·         The extended model means the inclusion of both the short run and AS curves.

·         The long AS curve is represented with a vertical line at full employment level of real GDP.

   Demand pull inflation in the AS model

-          Demand pull: prices increase based on increase in Aggregate demand.

-          In the short run, demand pull will drive up prices and increase production.

-          In the long run, increase in aggregate demand will eventually return to previous levels.

                                         Cost push and extended models

-          Cost-push arises from factors that will increase per unit costs such as increase in the price of a key resource.

                                    Dilemma for the government

-          In an effort to fight cost-push, the government can react in two different ways:

-          Action such as spending by the government could begin an inflationary spiral.

-          No action however could lead to recession. By keeping production and employment levels declining.

UNIT 4: Monetary Policy video-question #5