Economic growthWhat is economic growth?

How can we get the economy to grow?

Is economic growth desirable?

Economic Growth and the AD-AS Model

Aggregate Supply

National Income / National Output

Price Level

AS

Classical Range

Intermediate RangeKeynesian Range

Aggregate Supply

National Income / National Output

Price Level AS

Keynesian Range

Y0

AD0AD1

Y1

P0

Intermediate Range

AD2

Y2

P2

Classical Range

AD3

AD4P3

P4

AS1

Yf1Yf

Economic Growth

Measurement of economic growth• % increase in real GDP (or GNP) in a year

How?

Short run • keep increasing AD as long as there are idle resources

(Keynesian range)

Long run• expansion in demand, if uncontrolled, may result in sharp

price increase (Classical range)• only way is to ensure AS shifts as well

Economic Growth

Definition

• expansion in the economy’s productive capacity over time

• sustained increase in the country’s real national income (GDP / GNP)

Economic Growth

Is economic growth a good thing?The fastest growing economy in the world…

Country Growth rate in 2004 (%)China 9.5Singapore 8.4India 7.3Vietnam 7.7Ireland 4.5

Economic Growth

The trail-blazing Chinese economyThe good it has done :)

Higher standard of living

Economic Growth

The trail-blazing Chinese economy

The damage it has caused :(

Environmental problems

(Externalities)

Economic Growth

Dislocation

Destruction of natural beauty

Economic Growth

Income disparity

Economic Growth

Loss of traditional way of life

Lecture take-away

Economic Growth

Short Run Growth

Graph

Long Run Growth

Graph

Definition

InflationWhat is inflation?

What is the Consumer Price Index (CPI)?

Why is inflation undesirable?

Inflation

Definition

• A sustained and inordinate increase in the general price level

Sharp increase

____ % ↑ in price levels

[mild inflation]

not considered a problem

One-off increase in prices (e.g. from the adjustment in GST rate)

does not count as inflation

Inflation

Definition

• A sustained and inordinate increase in the general price level

A basket (mix) of goods and services

Consumer Price Index (CPI)*

basket of goods and services that a typical family consumes in a year

include transportation, housing, food, insurance, electrical appliances and furnishing, etc.

Consumer Price Index

Interviewer Interviewee (consumer)

What goods and services do you buy in a year?

Consumer Price Index

Price

$1,500

$4,000

$2,000

Price

$1,800

$4,500

$2,200

2005 2006

Price Index

100

100

100

set as base year

Price Index

120

112.5

110

Consumer Price Index

Interviewer Interviewee (consumer)

How much of your income do you spend on the

goods?

40%

30%

30%

Consumer Price Index

2005 2006

Price Index

100

100

100

Price Index

120

112.5

110

Weight

40%

30%

30%

4

3

3

×

×

×

CPI = (400 + 300 + 300) ÷ (4 + 3 + 3)

= 100

CPI = ?

= 114.75

Inflation rate

= 14.75%

Causes of Inflation

National Income / National Output

Price Level

AD

P0

Y0

= ?= C + I + G + (X-M)

AS

AD1

P1

Demand-pull

inflation

Causes of Inflation

National Income / National Output

Price Level

AD

P0

Y0

= ?= C + I + G + (X-M)

AS

AS1

P1

Cost-push

inflation

Causes of Inflation

Demand-pull inflation• AD keeps rising

– govt policy– consumers / investors confidence– external demand

• BUT economy is unable to produce enough g&s to keep up with the rising AD due to

– full employment– structural rigidity / supply bottlenecks

• Shortages develop• Prices increase

Causes of Inflation

Article: China overheating"The overheating problems in some sectors have imposed pressure on coal, power, oil and transport supplies and resultingly brought about rises in prices for raw materials and other necessities, according to the meeting.“ (New York Times)

Causes of Inflation

Cost-push inflation• Rising cost of production

– essential fop e.g. oil– weakening exchange rate– Imported inflation

• Firms pass on the higher cost to consumers by raising prices of final g&s

Causes of Inflation

Case Study: Oil price rising

In addition to gasoline, crude oil is used to make rubber and plastics, asphalt, synthetic fibres and fuel for electrical power generators…. Some economists argue that oil price increases matter because they make it more costly to produce a variety of products. Consequently, prices increase. (New York Times)

Businesses pay more to transport their goods and heat their premises, and they pass the extra costs on to customers, many of whom are also paying more for their petrol. (The Guardian)

Causes of Inflation

Case Study: Labour cost

“There is increasing inflationary pressure from the tightening labor market and higher product prices,'' said Usara Wilaipich, an economist at Standard Chartered Bank in Bangkok. “The threat of an increase in wages will increase because of the labor situation, especially the

property and construction sectors.” (Bloomberg)

Effects of Inflation

Internal EffectsMay have SR benefits• Higher profits, may encourage greater production

Damaging effects in LR• Discourage investment• Discourage saving

External EffectsDamaging external effects• Reduce export competitiveness• Capital flight

INFLATION Effects

Causes Solutions

Demand

-pull

Cost

-push

? ?

Lecture take-away

INFLATIONEffects

Causes Solutions

Internal

External

?

?

Lecture take-away