Transcript Aggregate Supply and Growth

AGGREGATE DEMAND AND SUPPLY
•
Just as the intersection of demand and supply for a product determines price in a
single market, the intersection of aggregate demand and aggregate supply
determines the overall price level in the economy
•
The AD curve slopes down from left to right due to:
- international substitution effect: if prices in economy fall people will be
encouraged to buy more domestically produced goods (and less imports)
- the inter-temporal substitution effect: if prices fall people will need less
money leading to lower interest rates and higher levels of expenditure
- the real balance effect: if prices fall people’s real savings will increase
leading to further expenditure
•
The AS curve slopes up from left to right due to:
- greater profits to be made at higher prices (while real wage rates remain the
same; however the curve tend to eventually become inelastic due to
diminishing returns and growing shortages (as economy nears full production)
Aggregate demand and aggregate supply
Price level
AS
If the price level is initially P2,
the excess demand will
cause price level to rise to Pe
Pe
P2
b
a
AD
O
National output
ECONOMIC GROWTH AND THE BUSINESS CYCLE
• Distinction between actual and potential growth
- Actual growth is the percentage increase in national output:
the rate of growth in actual output.
- Potential growth is the rate at which an economy could grow if
working at full capacity.
An economy can easily under perform. Thus for example in a
recession the actual rate of growth may be well below the
potential level.
Short-run concerns in economies often relate to the actual rate
of growth (and the desire to maintain it at a high level).
Long run concerns are more with factors of production in the
economy that can potentially influence the rate of growth.
Good X
Growth and the production possibility curve
b
Growth in
actual output
Growth in
potential
output
a
I
O
Good Y
II
ECONOMIC GROWTH AND THE BUSINESS CYCLE
• There are four phases that are identified in terms of the business
cycle
1 The upturn
2. The expansion
3. the peaking out
4. The slowdown
- In practice this are not fully regular as diagrams would
suggest. For example sometimes the expansion phase
(boom) might be very short. In other cases the slowdown
(recession) might extend over a decade..
- Also a recession could vary significantly from mild to
extremely severe.
- Fluctuations in output are usually caused in the short-term by
variations in the overall level of aggregate demand (i.e. the total
expenditure in the economy).
- In the long-run changes in the potential of the economy to
produce output are more important.
Real GDP in France and the UK
500
France
UK
Real GDP, 1960 = 100 ..
450
400
350
300
250
200
150
100
1960
1965
1970
1975
1980
1985
1990
1995
Source: AMECO database (European Commission) and OECD Economic Outlook (OECD)
Note: 2009 and 2010 figures based on forecasts
2000
2005
2010
Economic growth in the UK
400
300
250
Quarterly growth rate
GDP
5.0
4.0
3.0
2.0
200
1.0
150
100
50
0.0
-1.0
-2.0
0
-3.0
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Source: National Statistics times series data
% change
£ billions (in 2005 prices) .
350
6.0
The business cycle
National output
Potential output
3
2
3
4
2
1
1
O
Time
4
Actual
output
POTENTIAL CONTRIBUTION TO GROWTH
Increases in Quantity of Resources
• Capital
- Output depends on stock of capital invested in economy e.g. roads,
factories, machinery, buildings etc.
- A major factor in the growth of the Celtic Tiger (1994 - 2001) was a
huge increase in multinational investment in Ireland (especially by US
firms).
- By contrast very poor nations (as in Africa) are unable to set aside
sufficient resources for investment and therefore find it hard to achieve
economic growth.
- Investment needs to be financed out of savings (or borrowing) and
understandably poor countries find it hard to save.
POTENTIAL CONTRIBUTION TO GROWTH (con)
• Labour
- Clearly if the numbers working increases, the level of output
should also increase.
This was also a major factor in the boom in the Irish economies
in the late 90's. the work force effectively doubled in 10 years
enabling a very large increase in output.
- However as well as the numbers working, the quality of labour
employed (e.g. in terms of education and skills is very
important).
- Ireland can no longer compete with lower cost countries (such
as in Eastern Europe) in terms of unskilled production. Thus it
makes greater sense for us to concentrate on more skilled areas
such as information technology.
POTENTIAL CONTRIBUTION TO GROWTH (con)
•
Land and Raw Materials
Ireland is well endowed with agricultural land (with agriculture and
the food industry important sectors of the economy).
Unfortunately we are not well endowed with important raw materials
such as oil and gas.
- However though helpful these are not vital for economic growth (as
the success of Japan after the 2nd World War demonstrated).
•
Enterprise
- This is the 4th factor of production. If an economy is to thrive, people
must be willing to undertake the risks of setting up business.
In the past there was a great lack of an enterprise culture in Ireland
which inhibited growth.
This is why we began to rely so much on importing enterprise from
abroad by attracting multinational companies through tax breaks and
grants.
POTENTIAL CONTRIBUTION TO GROWTH (con)
• Increases in Productivity
- Changes in technology are very important to prevent the law of
diminishing returns setting in with respect to investment.
So for example the rise of computer and internet technology has
greatly increased the possibilities for new types of investment
thus enhancing growth prospects.
• Policies to achieve Growth
- The policies of the Government can greatly affect the capacity
of an economy to grow.
During the 1980's there was very little growth in the Irish
economy largely because of the past effects of reckless
Government borrowing. In recent years the determination of the
Government to reduce income tax initially contributed
considerably to our growth prospects. However subsequent
reliance on a massive property bubble has created much of our
present problems
Explanations of Long-term Growth
• Neoclassical or ‘Solow’ growth model
– diminishing returns to capital
– need for replacement investment
– steady-state national income
– effect of an increase in the saving rate
– human capital and education
– technological progress
CAPITAL ACCUMULATION
•
The rate of growth of capital accumulation depends on two factors:
1. the marginal capital output ratio; this is the amount of extra capital
ΔK divided by the extra amount of output that it produces divided ΔY
So k = ΔK/ΔY
The lower the value of k the higher is the productivity of capital
2. the proportion of national income that is invested (i) which assuming that
all savings are invested is the proportion that is saved (s)
The formula for growth becomes
g = i/k (or g = s/k)
Thus if 20% of national income went into new investment with the marginal
capital output ratio k = 4, then the growth rate = 20/4 = 5
Output (Y), Investment (I), Depreciation (D)
Steady-state output
Output (Y)
f
Y1
Y0
a
Depreciation (D)
Investment (I)
g
I0
D0
O
b
c
K0
Equilibrium
at point g
K1
Capital stock (K)
Output (Y), Investment (I), Depreciation (D)
Effect of an increase in the rate of saving and investment
m
Y2
Y1
Y
f
D
n
h
g
I2
I1
Initial equilibrium New equilibrium
K1
Capital stock (K)
K2
Output (Y), Investment (I), Depreciation (D)
Effect of a technological advance
p
Y2
Y2
Y1
Y1
f
D
h
g
K1
Capital stock (K)
n
I2
I1
K2
Explanations of Long-term Growth (con)
• Endogenous growth theory
– when technological progress is not a ‘given’
– determinants of technological progress
• importance of institutional factors & policies
• research and development
• training and education
• incentives
– impact on production function?
• move upwards over time
• become steeper
REASONS FOR IRELAND’S BOOM
•
Continued investment in education since 1960’s with more emphasis in recent years
on technical education
•
Considerable foreign direct investment (FDI) - especially from US - in Ireland due
to following reasons
- generous grant support and tax concessions by Government
- Ireland a member of EU since 1973
- only English speaking country in Eurozone
- availability of skilled labour
- political stability
•
Generous structural funding by EU during late 80’s and 90’s providing funds for
infrastructural development
•
Availability of labour supply both in quantitative and qualitative terms through
- unemployed, significant increase in female participation, open approach to
immigration etc.
REASONS FOR IRELAND’S BOOM (con)
• Government Policy
- promotion of a more enterprise oriented approach
- responsible management of fiscal policy
- emphasis on continuing tax reductions as a way of stimulating
incentives
• Pay Constraints
- in view of the high productivity levels attained, growth in incomes
were very moderate during the 90’s
- significant improvement in industrial relationships
• International Conditions
- as Ireland is a very open economy, favourable conditions in major
markets are very important (with rapid increase in exports up till
2001)
REASONS FOR IRELAND’S BOOM (con)
•
After temporary downturn in’01 and ’02 return to substantial economic growth
(03 -07) though at a lower rate than in first phase
•
However a significant change in the reasons for growth was at work:
- continued foreign investment in Ireland under threat from cheaper
countries in Eastern Europe and elsewhere
- exports which had grown very rapidly until 2001 had been stagnant since
2001
- later boom very much driven by massive growth in construction
- demand for property largely dependent on the extension of increased credit
So in a sense we were borrowing from future to pay for today’s activities
- wage rates and other expenses had risen considerably making Ireland an
increasingly expensive country within which to do business
PRESENT SITUATION
• A sharp downturn in Irish economy has taken place due to a number of
reasons
- substantial drop in activity in construction sector (which had been
the recent engine of growth)
- continuing fall in stock markets around the world (and especially in
Ireland) further damaging business confidence
- severe worldwide financial crisis directly impacting on construction
activity and on economy in general
- reckless lending by Irish banking sector has damaged our credit
worthiness abroad
- recession in US and other markets (of great importance to Irish
economy)
- despite recent fall in inflation, cost basis still very high in Ireland
making us vulnerable to competition and movement of multinational
firms elsewhere
GROWTH IN CHINA
• Capital
- high savings rate is then efficiently channelled by government into
key infrastructure projects
- clever concentration on showcase investment in key areas which
helps to attract foreign investment
- creation of specific investment zones, free trade and tax incentives
- quick approval of investment projects
- strong industrial tradition with China now seen as the world’s
leading manufacturing base
• Labour
- China benefits from a vast pool of potential cheap labour with many
of the 40% of the population still working for very low returns in
agriculture eager to move to other sectors
- benefit from a vast diaspora abroad who increasingly are being
encouraged home to aid the economic effort
- increasing emphasis on educational and technical skills with many
going abroad to achieve their objectives
GROWTH IN CHINA (con)
•
Land and Raw Materials
- China has an abundance of natural resources e.g. coal, iron ore,
oil, natural gas and minerals (such as lead aluminium and zinc)
- because of the demands of domestic growth, China has invested
heavily in Africa and other countries with a view to exploiting its rich
natural resources such as oil and copper
•
Enterprise
- liberalisation measures by ruling party has greatly increased
opportunities for domestic enterprise
- multinational investment - which is at present welcomed – increases
access to enterprise in the higher tech industries
•
Other
- huge domestic market
- strong business attitude
- authoritarian government (preserving political and social cohesion) with a
desire to promote growth
COSTS OF ECONOMIC GROWTH
• The benefits of economic growth are obvious. The standard of
living increases with people in general having more money to
spend on consumer goods and services. Also it enables the
Government to improve services such as health and education
and spend more on improving the infrastructure e.g. roads.
However there are costs
• Higher growth in the short run could require more investment
thus lessening resources for consumption. This happened in a
dramatic fashion in the Soviet Union under Stalin!
• Growth can generate extra demands and social pressures to
keep up so that people still feel that they have too little.
• There may be adverse social effects as people become more
materialistic and less caring in society.
• There can also be environmental consequences e.g. terrible
traffic congestion in major cities.
• Non-renewable resources e.g. oil and gas can be run down and
finally the benefits may not be distributed equally.
UNEMPLOYMENT
• Meaning of Unemployment
- measurement by live register
- QNHS measurement by ILO and PES methods
• Standardised Unemployment
- ILO measurement which requires that no payment for
even I hrs work in previous week made, or that no search
was made in previous four weeks or that person not
available to take up employment in next two weeks
• Labour force made up of those in employment or seeking employment;
excludes many students still in full-time education and married women
who opt to stay at home
Unemployment rates in selected industrial economies
12
Unemployment (% of workforce)
UK
EU-15
USA
Japan
10
8
6
4
2
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
Notes: 2011 and 2012 based on forecasts; EU-15 = the member countries of the European Union prior to 1 May 2004
Source: based on data in AMECO Database, European Commission, DGECFIN
2010
Average unemployment rates by decade (%)
1960s
1970s
1980s
1990s
2000s
Australia
1.7
3.8
7.6
9.0
5.5
Canada
5.0
6.7
9.4
9.7
6.8
France
4.9
5.9
8.4
10.4
7.9
Germany
0.7
2.0
5.8
7.6
8.6
Greece
5.1
2.3
6.1
9.3
9.7
Ireland
5.3
7.5
14.2
11.9
5.3
Japan
1.3
1.7
2.5
3.2
4.7
Spain
2.4
4.5
15.4
16.2
11.0
UK
1.6
3.5
9.5
8.1
5.4
USA
4.8
6.2
7.3
5.7
5.6
EU-15
2.2
3.7
8.3
9.2
7.8
Standardised unemployment rates:
(December 2010)
All ages
Total
Male
Under 25
Female
Total
Male
Female
Belgium
8.1
8.1
8.1
20.3
20.6
20.3
Germany
6.6
7.1
6.0
8.5
9.5
7.5
Ireland
13.7
16.6
10.2
28.9
32.7
25.2
Spain
20.4
20.0
20.8
43.0
44.5
41.2
France
9.7
9.5
9.9
24.2
24.2
24.2
Netherlands
4.3
4.2
4.4
8.2
7.9
8.5
11.2
10.3
12.3
21.5
19.0
24.4
UK
7.9
8.5
7.1
20.2
21.7
18.6
USA
9.4
10.1
8.7
18.1
19.9
16.1
EU-15
9.5
9.5
9.5
20.0
20.7
19.1
Portugal
Source: Statistics Database, Eurostat, European Commission
TYPES OF UNEMPLOYMENT
•
Classical - arises from artificial restrictions on market forces e.g. by trade
unions
•
Involuntary (Keynesian) - due to business cycle e.g. a fall in aggregate demand
leading to recession
•
Structural - applies to special groups of workers or regions of the economy;
requires special measures
•
Frictional (short-term) - can reflect a healthy jobs market leading to
considerable job mobility
•
Cyclical - due to variations in economic activity
•
Technological e.g. application of IT systems
•
Seasonal e.g. changing availability of work in tourist sector
•
Wholetime, part-time and temporary
•
Hidden
•
Discouraged and marginalised workers
Classical unemployment
Average (real) wage rate
ASL
B
A
W2
We
ADL
O
Q
2
Q
1
No. of workers
Equilibrium and disequilibrium unemployment
Average (real) wage rate
ASL
Disequilibrium
unemployment
b
a
W2
N
c
e
We
Equilibrium
unemployment
ADL
O
No. of workers
COSTS OF UNEMPLOYMENT
• Losses to unemployed themselves in terms of lower earnings than
possible from social welfare payments
• Losses to economy and economic growth through waste of valuable
productive resource
• Costs to government and tax payers (less tax raised and higher social
spending required)
• Workers who stay unemployed for long periods may lose valuable
skills
• Other costs - higher rates of crime and domestic problems
• Can be very demoralising for those affected and community as a whole
MEASURES TO DEAL WITH UNEMPLOYMENT
• Achieving and maintaining higher levels of economic growth in
economy
• Adopting specific measures to deal with problem areas - e.g. retraining
for workers made unemployed, special job schemes for young
workers, infrastructural investment in disadvantaged regions etc.
• Improving job information services
• Matching educational programmes to future job needs in economy
• Job sharing schemes
• Incentives for those with enterprising ideas
• Lower tax rates on employed
INFLATION
• Inflation refers to the general rise in prices in economy
• Main measurement is Consumer Price Index (CPI) which is perhaps the
best known of all indices. It is now measured on a monthly basis in
Ireland
• Level of inflation in Ireland had been higher than other EU countries
prior to the recession but fell from 4.1% for 2008 to – 4.5% for 2009
• The degree of inflation can vary as between
- mild
- creeping
- rampant
- hyper
• Fast rising inflation undermines the value of money
CAUSES OF INFLATION
• Demand pull
- when overall demand exceeds supply (e.g. in a boom)
• Cost push
- when costs push up demand e.g. wages through trade union pressure,
- profits of monopoly firms and imported inflation
• Sectoral inflation
- e.g. when excess demand in certain labour markets pushes up price
• Monetarism
- where inflation is due to excess money supply
Demand-pull inflation
Price level
AS
P2
P1
AD2
AD1
O
Q1 Q2
National output
Cost-push inflation
Price level
AS2
AS1
P2
P1
AD
O
Q2
Q1
National output
Inflation rates for selected countries
(average % per annum)
Country
1971–80
1981–90
1991–2000
2001–10
Belgium
6.8
4.2
1.8
2.1
France
9.8
6.4
1.4
1.6
Germany
5.2
2.6
1.8
1.3
14.8
10.0
4.2
2.3
Japan
8.8
1.8
0.5
–0.9
Netherlands
7.3
2.1
2.6
2.0
15.0
9.2
4.2
2.8
9.6
8.0
3.0
1.7
13.4
6.2
3.2
2.2
7.0
4.5
2.2
2.1
10.0
6.3
2.8
1.9
Italy
Spain
Sweden
UK
USA
EU-15
Source: based on data in European Economy Statistical Annex (European Commission)
Inflation in Zimbabwe
2000
2001
2002
2003
2004
2005
2006 Q1
2006 Q2
2006 Q3
2006 Q4
2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
2008 Q4
2009
2010
2011
Rate of consumer price
inflation (% annual rate)
57
105
174
585
158
503
773
1 147
1 071
1 164
1 883
5 394
7 415
40 911
165 000
11 250 000
231 000 000
108
6.5  10
6
3
5
EFFECTS OF INFLATION
• Reduces the value of money creating a wage price spiral
• Can redistribute money away from those on fixed incomes
• Encourages speculation in the economy
- property market in Ireland during Celtic Tiger
- investments in stock market
• Penalises savers and rewards borrowers
- higher inflation in Ireland than EU contributed to credit boom
• Causes uncertainty which is bad for planning
• Can have damaging effect on international confidence affecting
exchange rates, interest rates, foreign investment etc.