Introduction to Economic Growth and Instability

Chapter 7

RevisionEconomic growthRule of 70Sources of growthBusiness CycleUnemploymentTypes of unemploymentEconomic costsOkun’s Law

InflationRise in the general level of pricesEach dollar buys fewer goods and

servicesReduces the purchasing power of

money

Measuring inflation

Price indicesConsumer price index

Each month or each yearMarket basket of some 300

consumer goods and services

CPIPrice of the Most Recent Market

Basket in the Particular Year

Price of the Same MarketBasket in 1982-1984

= x 100

Quanti

ty in

Basket

2006 2007 2008

(kg or

litre)Price

Cost of

basketPrice

Cost of

basketPrice

Cost of

basket

Flour 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

cost2260

Price

index100

Consumer Price Index

Types of InflationDemand-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-pushSupply or cost side of economyRising per-unit production costsReduces profits and thus reduces output Prices riseAlso known as supply shocks

Redistributive Effects

Inflation hurt some people , leaves others unaffected, and actually helps still others

AnticipationsAnticipated Inflation, avoid or lesson effects

of inflationUnanticipated Inflation( not expected)

Nominal vs. Real income Nominal income is the number of dollars received

as wages, rent, interest, profitsReal 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

Redistribution Effects of Inflation

InflationWho is Hurt by Inflation?

Fixed-Income ReceiversSaversCreditors

Who is Unaffected or Hurt by Inflation?Flexible-Income Receivers

Cost-of-Living Adjustments (COLAs)BusinessDebtors

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

Public and Private Sectors- M&B Ch. 5

Households, Businesses, the Public Sector/Government

The US Economy: Private and Public sectors

Households113 million householdsOne or more person occupying a housing

unitSupplier of economic resourcesMajor spenders in economy

Income received can be categorized asHow its earnedHow it distributed by households

Functional distribution of IncomeIndicates how nations income is

apportioned among wages, rents , profits etc

According to the function performed by the income receivers

Personal Distribution of IncomeIndicates how money is divided among

individual householdsDivided into groups , height of bar shows

how much of total income is received by each group

Household as SpendersPersonal TaxesPersonal Savings

SecuritySpeculationDis-save

Personal consumption Relation of income with S and C ??

The business populationA 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

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.

Legal Forms of Businesses

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

The Principal-Agent Problem

Government’s roleProviding 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)

Public Sector