Ch 3 Long Run Economic Growth Long Run Economic Growth is defined as a persistent increase in the economy s po tential for producing goods and services Distinction between actual production of g s and potential for producing g s Position of frontier depends on the quantity and quality of a nation s primary factors of production and available technologies Constraints of growth Strategies for growth a Increase quantity of primary factors of production b Improve quality of primary factors of production c Invent and employ new production technology Labor L Capital K Land T Primary Factors of Production L K are far more important to process of growth Growth in labor force Labor Supply is single most important contributor to growth in nation s total Income Y Increasing Capital K is key to increasing economic output per person K Plant Equipment in private businesses and government buildings Investment in physical and human capital is the key to economic growth because it simultane ously pursues and increase in the quality of Labor education quantity of K which both lead to more advanced production technology Opportunity cost of growth is that more investment comes at the expense of sumption The sacrifice of consumption is too costly for poorer countries making the process difficult to start con growth Ch 6 The Macro Policy Goals Long Run Economic Growth and Full Employ ment Three Fundamental Questions of Macroeconomics 1 What factors determine the circular flow of economic activity 2 How does the circular flow of economic activity relate to the four economic policy goals LREG Full Employment Price Stability and Stability in economic relations w foreign countries 3 How can government effect composition of circular flow with its fiscal monetary pol Long Run Economic Growth is the most important factor in determining the overall eco nomic health of a nation over the long haul Outer limit of growth in U S 4 icy Full Employment Low Unemployment Labor Force Employed Works at least 1hr wk Unemployed Actively seeking realistic jobs UTotal UCyclical USearch Frictional UStructural sponsive 1 Cyclical unemployment is the only category of unemployment that is highly re to the performance of the economy and therefore to fiscal and monetary policy Cyclical unemployment inversely related to booms busts of economy It exists because wages are sticky workers prefer lay offs and recalls rather than flexible wages Cyclical unemployment is concentrated amongst job losers 2 Frictional Unemployment refers to the unemployment resulting from the natural frictions of the economy as new jobs are created and others destroyed Search Unemployment job leavers re entrants and new entrants who are searching for the best job opportunity Natural and beneficial to laborer and employer 3 Structural Unemployment refers to severe mismatches between the unemployed jobs that are available Skill or geographical and UNair Non accelerating inflationary rate of unemployment is the sum of frictional search unem ployment and structural unemployment Natural rate of unemployment is when UCyclical 0 Ch 7 The Macro Policy Goals Price Stability and Stable Int l Economic Rela tions Inflation refers to a process of continuing increases in the level of prices generally Generally prices of most g s must be increasing simultaneously Continuing A one time excise tax is not considered inflation Something has to shift up the supply curve and or the demand curve continuously over time to cause an inflation so that prices are continuously rising CPI P P CPI 2011 2012 CPI2011 CMB Annual rate of inflation is the increase in the cost of the market basket during the year Consumer Price Index CPI is based on CMB and is used to adjust for inflation in wage and pension contracts and to protect government transfer payments Inflation does not effect the purchasing power of an individual because the circular flow is equally affected at all points Inflationary trends are difficult to stop and may lead to hyperinflation Inefficiencies and redistributions caused by inflation depends on the extent to which a The inflation is unbalanced Prices of individual g s are rising at different rates High inflation markets tend to be in excess supply low inflation markets tend to have excess demand b The inflation is unadjusted to People who favor the high inflation g s lose purchasing power relative to others Economic contracts and tax systems must be indexed to rate of inflation Inefficiency results when not indexed to CPI c The inflation is unexpected The only costs to a balanced fully adjusted to and expected inflation is shoe leather cost of managing money more closely and menu costs of having to change prices Debtors borrowers gain at the expense of creditors lenders when inflation is unexpected Producer Price Index A price index that is designed to track changes in the cost of produc tion over time Its three 3 components are i Raw Materials ii Intermediate Materials iii Fin ished manufactured goods Fisher Equation Observed interest rate on a financial security equals the real interest rate plus the expected rate of inflation iobserved is the interest rate that appears on the loan iobserved rreal P P Stable International Economic Relations Imports are the ends of trade Countries import to gain access to goods that are produced better or more cheaply in foreign countries Exports are the means to the end Countries have to export in order to import Most counties are forced to have a zero balance of trade Imports Exports Imports Exports means balance of trade deficit U S A has large deficit Depreciation of a currency is when its value falls relative to other currencies ex 1 60 1 80 Bad for consumers Good for exporters and import competing firms Appreciation of a currency is when its value rises relative to other currencies ex 1 60 1 40 Good for consumers Bad for exporters and import competing firms Negative balance of trade causes currency to depreciate Ch 8 The National Income and Product Accounts National Income and National Product accounts measure the circular flow of economic activity National Income Value of L K T National Product Value of G S Saving Investment The value of sales National Product always equals the costs of goods sold National Income National Income fn workers comp rental income interest paid profits proprietors inc Value Added is the difference between the sales and the costs of intermediate goods It mea sures the top of the circular flow g s