Introduction to Economic Growth and Instability Chapter 7

Revision Economic growth Rule of 70 Sources of growth Business Cycle Unemployment Types of unemployment Economic costs Okun’s Law

Inflation Rise in the general level of prices Each dollar buys fewer goods and services Reduces the purchasing power of money

Measuring inflation Price indices Consumer price index Each month or each year Market basket of some 300 consumer goods and services CPI Price of the Most Recent Market Basket in the Particular Year Price of the Same Market Basket in = x 100

Quantity in Basket (kg or litre) Price Cost of basket Price Cost of basket Price Cost of basket Flour6Rs Rs. 300Rs. 150 Oil1.5Rs Rs. 150Rs. 50 Milk1Rs. 4040Rs. 55Rs. 30 Rice3Rs Rs. 250 Total cost2260 Price index 100 Consumer Price Index

Types of Inflation Demand-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-push Supply or cost side of economy Rising per-unit production costs Reduces profits and thus reduces output Prices rise Also known as supply shocks

Redistributive Effects Inflation hurt some people, leaves others unaffected, and actually helps still others Anticipations Anticipated Inflation, avoid or lesson effects of inflation Unanticipated Inflation( not expected)

Nominal vs. Real income Nominal income is the number of dollars received as wages, rent, interest, profits Real 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

Inflation Who is Hurt by Inflation? Fixed-Income Receivers Savers Creditors Who is Unaffected or Hurt by Inflation? Flexible-Income Receivers Cost-of-Living Adjustments (COLAs) Business Debtors

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

Households 113 million households One or more person occupying a housing unit Supplier of economic resources Major spenders in economy Income received can be categorized as How its earned How it distributed by households

Functional distribution of Income Indicates how nations income is apportioned among wages, rents, profits etc According to the function performed by the income receivers

Personal Distribution of Income Indicates how money is divided among individual households Divided into groups, height of bar shows how much of total income is received by each group

Household as Spenders Personal Taxes Personal Savings Security Speculation Dis-save Personal consumption Relation of income with S and C ??

The business population A 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 role Providing 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