Macro Econ 220 - Unit 6 - Economic Growth and Business Cycles

Downsides of growth:

1. Environmental issues. 2. Economic growth does not resolve socioeconomic problems such as an unequal distribution of income and wealth. 3. Sustainability of growth is a problem as natural resources are limited.

Uneconomic Growth

Continuing to grow the economy when the costs are higher than the benefits is actually uneconomic growth. The United Nations has classified five types of uneconomic growth: 1. jobless growth, where the economy grows, but does not expand opportunities for employment; 2. ruthless growth, where the proceeds of economic growth mostly benefit the rich; 3. voiceless growth, where economic growth is not accompanied by an extension of democracy or empowerment; 4. rootless growth, where economic growth squashes people's cultural identity; and 5. futureless growth, where the present generation squanders resources needed by future generations. The downsides of economic growth can be avoided by maintaining an optimal scale of the economy.

Quality of labor

Measured as labor productivity (average real GDP per hour of work). Labor productivity depends on: 1. Technological advances, which have accounted for the largest increase in the productivity of labor in the United States. 2. Quantity of capital resources per worker 3. Education and training facilities 4. Economies of scale (scale of production or firm size) 5. Improved resource allocation: Workers over time moving from lower productivity employment to higher productivity employment. For instance, the shift of labor out of agriculture to industry in the United States has led to an increase in labor productivity.

Quantity of labor

Measured as the total number of hours of work available in the economy from all the workers. Hours of works depend on: (i) Size of the labor force (ii) Labor force participation rate (iii) Length of the workweek.

Based on the quantity and quality of human resources real GDP can be redefined as:

Real GDP = Labor quality x Labor quantity OR Real GDP = Labor productivity x number of hours of work.

Real GDP per capita formula

Real GDP per capita = Real GDP / Population Real GDP per capita measures the standard of living.

Real GDP per capita growth rate formula

Real GDP per capita growth rate = Real GDP per Capita / Initial Real GDP per capita x 100 This method accounts for the change in the size of the population. So it is easier to compare across countries or time periods. An increase in per capita growth rate leads to an increase in the standard of living and vice versa.

Real GDP growth rate formula

Real GDP/Initial Real GDP x 100 The real GDP growth rate does not account for the change in the size of the population.

Supply factors

Changes in the physical and technical agents of production that enables growth such as: (a) increase in quantity and quality of natural resources; (b) increase in quantity and quality of human resources (labor); (c) increase in the number of capital resources; and (d) improvements in technology.

The arithmetic of growth

Rule of 70 The growth rate of a rich (leader) country's real GDP is lower as compared to the growth rate of poorer (follower) nations. Approximate numbers of years to double real GDP = 70/Annual percentage growth rate. Reasons: For rich (leader) nations to increase the growth rate, they need to invest and apply new technologies. On the other hand, poor nations can increase the growth rate by simply adopting the technologies that were already developed.

Demand factors

The purchasing power of households, businesses, and government. Expansion of purchasing of goods and services by households, businesses, and the government is needed to provide a market for all the new output that can potentially be produced. The optimal expansion of purchasing power guarantees that there will be no unplanned increases in inventories and resources will remain fully employed.

Real GDP growth rate

The real GDP growth rate does not account for the change in the size of the population.

The newer measure of economic growth

Measured as an increase in the real GDP per capita or GDP per capita growth rate. The real GDP per capita growth rate is measured as a percentage change in real GDP per capita over a period of time.

Measuring Economic Growth

-Annual percent change in real GDP -annual change in real per capita GDP (standard of living measurement) Real GDP growth rate is the most commonly used method of measuring economic growth. The real GDP growth rate is measured as a percentage change in real GDP over a period of time.

Phases of business cycles

peak, recession, trough, expansion 1. Peak: Reaching a temporary maximum in real GDP. Reaching near or full employment. 2. Trough: Reaching a temporary minimum in real GDP and employment. 3. Recession: Phase of business cycle moving from peak to trough. Phase in which output and employment are declining. 4. Expansion: Phase of recovering from the recession. Phase in which output and employment are increasing.

According to the Center for the Advancement of the Steady State Economy, there is a conflict between economic growth and:

(1) Environmental Protection A growing economy consumes natural resources and produces wastes. It results in biodiversity loss, air and water pollution, climate destabilization, and other major environmental threats. (2) Economic Sustainability A healthy environment is the foundation of a healthy economy. We need healthy soils for agriculture, healthy forests for timber, and healthy oceans for fisheries. Along with clean air for breathing and clean water for drinking, these are the building blocks of a prosperous economy and a good life. (3) National Security and International Stability When economic growth threatens the environment and economic sustainability, social unrest is the result, and national security is compromised. Economic growth was once used for building military power, but in an overgrown global economy, economic sustainability is more conducive to diplomacy and stability among nations.

The following list provides growth-promoting institutional structures:

(a) Strong property rights both tangible and intellectual property rights (patents and copyrights) encourage investment as it reassure investors that they can reap their expected returns on investment. (b) Funding sources such as a well-established financial institutions to convert savings into investment. These are essential institutional structures to channel savings generated by the households towards the businesses, entrepreneurs, and inventors that do most of society's investing and inventing. (c) Educational facilities in increase the quality of the workforce. Without highly educated inventors, new technologies don't get developed. In addition, without a highly educated workforce, it is not possible to implement those technologies and put them to productive use. (d) Free trade promotes economic growth by allowing nations to specialize such that goods will be produced in the nation where the opportunity cost is the lowest. In addition, free trade promotes the rapid spread of new ideas so that innovations made in one nation quickly spreads to other nations. (e) Competitive market system signals firms to what to make and how much to make. (f) The overall social-cultural-political environment of the nation also plays an important role in promoting growth.

Business Cycles

Business cycles are alternating rises and declines in the level of economic activity, sometimes over several years.

Reasons for business cycles:

Demand and/or supply shock with price stickiness resulting from: -Irregular innovations -Changes in the productivity of the resources. -Monetary factors such as changes in the money supply. -Political factors such as wars, 9/11 kind of incidents. -Financial instability such as a rapid increase or decrease in the value of assets. Individual cycles vary substantially in terms of duration and intensity. So, the impact of the business cycle on the economy depends on (a) duration; (b) intensity or depth.

Effect of business cycles on different goods:

Firms: Reduce the purchase of capital goods in the recession phase. Households: Reduce the purchase of durable goods during the recession. The effect on non-durable goods and services is limited.

External Factors

Institutional structure that promotes modern economic growth. Some of the institutional structures increase the savings and investments that are needed to fund the construction and maintenance of infrastructure required to run modern economies. Other institutional structures promote the development of new technologies. Some act to ensure flow of resources efficiently to their most productive use.

Internal Factors

Production and consumption factor that influence growth. There are three important types of internal factors influencing growth; demand factors, supply factors, and efficiency factors.

Evidence of the Conflict

The conflict between economic growth and environmental protection is becoming more apparent as the oversized economy bumps up against limits. From depletion of ocean fisheries to a loss of pollinators, from groundwater drawdown to deforestation, from climate change to increasing concentrations of toxic pollution (not to mention increasing childhood cancer rates), from massive urban slums to degraded rural lands, the consequences of too much economic growth are observable all around us. Ecological footprint analysis also reveals that the economy has become overgrown. The footprint measures how much land and water area a human population requires to produce the resources it consumes and to absorb its wastes under prevailing technology. According to data from the Global Footprint Network (Links to an external site.), the footprint of all nations exceeded the biological capacity of the planet in the mid- to late 1980s. We find ourselves in a global state of overshoot, accumulating ecological debt by depleting natural capital to keep the economy growing.

Efficiency factors

To reach full production potential, the economy needs to use the resources in the most efficient way. It can be assured through two ways: (a) Productive efficiency: producing goods and services in a least-cost way; (b) Allocative efficiency: using the resources to produce the best possible goods that will increase real GDP. The main supply factor of the GDP growth rate is Labor (quantity and quality of human resources).

Marginal Cost (MC)

the extra cost incurred by producing one more unit of a product. refers to the cost of producing one more unit of a good or service. Marginal benefit is the benefit gained from one more unit. This graph shows the marginal costs and benefits of GDP growth. Costs tend to rise and benefits tend to decrease for each additional unit of growth. We should stop growing GDP, therefore, when marginal costs are exactly equal to marginal benefits. If costs are less than benefits, then GDP growth is economic (the green part of the graph). When costs rise above benefits, GDP growth is uneconomic (the brown part).