CHAPTER 2: ECONOMIC GROWTH AND DEVELOPMENTCHAPTER 2:

ECONOMIC GROWTH AND DEVELOPMENT

ECONOMIC GROWTH
Economic growth:
- Sustained expansion of production possibilities.
- The increase in real GDP over a given period.
Economic growth rate is the rate of change of real GDP (percentage
per year).
To calculate this growth rate, we use the formula:

THE SOURCES OF ECONOMIC GROWTH

Labor productivity: the quantity of real GDP produced by 1 hour of
labor.
It is calculated by:

When labor productivity grows, real GDP per person grows, so the
growth in labor productivity is the basis of rising living standards.
The growth of labor productivity depends on three things:
o Saving and investment in physical capital
o Expansion of human capital
o Discovery of new technologies
ACHIEVING FASTER GROWTH
Preconditions for Economic Growth
Economic freedom is the fundamental precondition for creating the
incentives that lead to economic growth.
Economic freedom is a condition in which people are able to make
personal choices, their private property is protected, and they are free to
buy and sell in markets.
Policies to Achieve Faster Growth
Economic freedom requires the protection of private propertythe
factors of production and goods that people own.

 Property rights are the social arrangements that govern the

protection of private property.
Economic freedom also requires free markets.
Main actions governments can take to achieve these objectives are:
1. Create Incentive Mechanisms
Economic growth occurs when the incentive to save, invest, and
innovate is strong enough. These incentives exist only when
private property is protected.
2. Encourage Saving
Saving finances investment, which brings capital accumulation.
Tax incentives can encourage saving, increase the growth of
capital, and stimulate economic growth.
3. Encourage Research and Development
Everyone can use the fruits of basic research and development
efforts.
Because basic inventions can be copied, the inventors profit is
limited and so the market allocates too few resources to this
activity.
Governments can direct public funds toward financing basic
research, but it requires a mechanism for allocating public funds to
their highest-valued use.
4. Encourage International Trade
Free international trade stimulates economic growth by extracting
all the available gains from specialization and trade.
5. Improve the Quality of Education
By funding basic education and by ensuring high standards in skills
such as language, mathematics, and science, governments can
contribute enormously to a nations growth potential.
6. Financial Market Development
The more developed an economys financial market are, the more
efficient should be the allocation of resource and, therefore, the
greater the productivity.
A nation may have a high rate of saving and investment and a
sizable capital stock, but the key to efficient production is the
allocation of resources to their best use.
7. No corruption and political stability

BUSINESS CYCLES
Fluctuations in the economy between growth (rising real GDP) and
stagnation (falling real GDP).
Is the upward and downward movement of economic activity that
occurs around the growth trend.
Alternating periods of economic growth and contraction.
Macro theories, explain the business cycle; economic policies, control
it.
Before

1930s,

macroeconomists thought there could never be a Great Depression.

They believed a market-driven economy was inherently stable.
Laissez faire: The doctrine of leave it alone; of non-intervention by
government in the market mechanism seemed reasonable at the time.
THE MACRO THEORY

MACROECONOMIC PERFORMANCE
Determinants of macro performance include:
Internal market forces - Population growth, spending behavior,
intervention & innovation, etc.
External shocks - Wars, natural disasters, terrorist attacks, trade
disruptions...
Policy levers - Tax policies, government spending, changes in the
availability of money, and regulation.
Macroeconomic outcomes include:

 Output - Value of goods and services produced (real GDP).

Jobs - Levels of employment and unemployment.
Prices - Average price of goods and services.
Growth Yea3r-to-year expansion in production capacity.
International balances - International value of the dollar; trade and
payment
balances
with
other
countries.
CAUSES

BUSINESS CYCLES
Although the main interpretation of business cycles looks to changes in
AD, we may classify the different theories into two categories:
The external theories find the root of the business cycles in the
fluctuations of something outside the economic system (wars,
revolutions, elections, economic policy, migrations, discoveries of new
lands and resources).
The internal theories look for mechanism within the economic system
itself (self-generating business cycles).
PHASES BUSINESS CYCLES

A business cycle can be divided into four major phases:

Recession the downturn of a business cycle. This is a period in which
real GDP declines for at least 2 consecutive quarter-years.

 Through the lowest point of real GDP at the end of a recession.

Expansion (boom) is a period in which output increases and approaches
potential GDP or perhaps even overshoots it.
Peak the point at which recession begins, the highest point in real GDP
before a recession.
BUSINESS CYCLES INDICATORS
There are a number of variables that move in a fairly regular manner
over the business cycles.
These variables are classified into three categories depending on
whether the move up or down before, at the same time as, or following a
change in real GDP.
Leading indicators: generally change before real GDP changes.
Economists use them to forecast changes in output.
Average workweek.
Unemployment claims
Manufacturers new order.
Stock prices.
New building permits.
Delivery times of goods.
Interest rate spread.
Money supply.
Consumer expectations.
Coincident indicators: are economic variables that tend to change at
the same time as real GDP changes.
Payroll employment.
Personal Income.
Industrial Production.
Manufacturing and trade sales.
Lagging indicators: do not change in value until after the value of
real GDP has changed.
Labor cost per unit of output.
Inventories to sales ratio.
Unemployment duration.
Consumer credit to personal income ratio.
Outstanding commercial loans.
Interest rate.
Inflation rate for services.
CHAPTER 3: UNEMPLOYMENT
LABOR MARKET
Civilian population: people from 16 years and older.
Not in the labor force

 Persons (16 years and older) who are neither employed nor unemployed
(like retirees, students, homemakers, or disabled persons).
Persons in
the labor
force. (This group includes both the employed and unemployed).
Employed: A person is considered employed if he or she has
spent most of the previous week working at a paid job.
Unemployed
A person not currently employed who is
actively
seeking a job, or,
waiting
to begin a job, or,
on layoff,
waiting to return to a
previous job.

The labor-force participation rate is the percentage of the adult

population that is in the labor force.

LABOR MARKET INDICATORS

To be classified as unemployed, one must be actively seeking work,

waiting to begin a new job, or on layoff from a job.

Some argue the employment/population ratio is a better indicator of

job availability than the unemployment rate.

THREE TYPES OF UNEMPLOYMENT

Frictional Unemployment:
Caused by imperfect information.
Occurs because:
employers are not
aware of all
available workers
and their
qualifications,
and,

available workers are not fully aware of all the jobs being
offered by employers.

Structural

Unemployment:

Reflects
employee

an imperfect match of
skills to skill
requirements of the
available
jobs.
Also
reflects structural and
demographic characteristics of the labor market.
Cyclical Unemployment:
Reflects business cycle conditions.
When there is a general downturn in business activity, cyclical
unemployment increases.
THE CONCEPT OF FULL EMPLOYMENT
Full Employment: The level of employment that results when the rate of
unemployment is normal, considering both frictional and structural
factors.
Full employment is closely related to the concept of the natural rate of
unemployment.
Natural Rate of Unemployment: The level of unemployment that reflects
job shopping in an economy of imperfect information and dynamic
change.
CHAPTER 4: MONETARY POLICY
Monetary policy can be categorized by four characteristics

Monetary Policy goals address the central banks agenda in

general terms.
The Bank of China appears to have export driven growth as their primary
objective.
The European Central Bank (ECB) an explicit Inflation Target. Specifically,
the goal is to maintain 2% annual inflation.

The Federal Reserve follows policies of stable prices and maintenance of

full employment.
Instruments refer to the policy options a Central Bank has to
control the supply of money
Open market Operations.
Discount Window Loans. Altering the interest rate charged on loans
to commercial banks
Reserve Requirements: Reserve Requirements influence the ability of
banks to create new loans which affects the broader aggregates (M1, M2,
and M3)
Moneraty Policy
Expansionary monetary policy: when applied to increase the
amount of money. This would use one of the following mechanisms:
- Reduce the interest rate to make bank loans more
attractive.
- Reduce the cash reserve ratio (bank reserves), to pay more
money.
- Buy government debt, to contribute money to the market.
Restrictive monetary policy: When the market is a lot of money in
circulation, interested in reducing the amount of money, and for
this you can apply a restrictive monetary policy. It consists of the
expansive otherwise:
-Increase the rate of interest, so that borrowing more
expensive.
-Increase the cash reserve ratio (bank reserves), to leave
more money in the bank and less in circulation.
- Sell public debt, reduce money market securities changing
it.