Unit 6 - Economic Growth and Productivity

Economic Growth

• Sustained increase in real GDP over time
• Sustained increase in real GDP per Capita over time

Why Grow?

• Leads to greater prosperity for society
• Lessens burden of scarity
• Increases the general level of well being

Conditions for Growth

• Rule of Law
• Sound legal and Economic Institution
• Economic freedom
• Respect for private property
• Political and Economic Stability
• Low inflationary expectation
• Willingness to sacrifice current consumption in order to grow
• Saving
• Trade

Physical Capital

• Tools, machinery, factories, infrastructure
• Physical capital is the product of invesment
• Investment is sensitive to interest rate and expected rate of return

Rate of Return

• It take capital to make capital
• Capital must be maintained.

Unit 5 - Laffer Curve

Definition

• A trade off between tax rate and government revenue.
• Used to support the supply side economic.
• As tax increase from 0 to some max level then decline

*Criticism of Laffer Curve

• Research suggest that impact of tax rate on incentive to work, save and invest are small.
• Tax cut also create demand, which can fill inflation -> demand exceeds supply.
• Where the economy is actually located on the curve is difficult to determine. 

Reaganomics:
Lower marginal tax rate -> deficit

Unit 5 - Supply-SIde Economics (Reaganomics)

• Tend to believe AS curve will determine level of inflation, unemployment and economic growth.
• To increase the economy, you take action to shift AS curve to the right. Always benefiting companies first.
• Focus on marginal tax rate.

              +The amount paid on the last dollar earned or on each additional dollar.

• If they reduce marginal tax rate, you encourage more people will work longer, which they will forgo their time for income.
• Lower taxes are incentives for businesses to invest
• Lower taxes are incentives for people to increase saving -> create lower interest rate for increases in business investment.

Unit 5 - Long Run Phillips Curve

Because the LRPC exist at the natural rate of unemployment, structural changes in the economy that affect unemployment will also cause LRPC to shift

• +Increase in unemployment: LRPC ->
• +Decrease in unemployment: LRPC <-

Changes in the AS/AD model can also be seen in the Philips Curve
Think of changes in AS/AD affects the PC like 2 sets as mirror image
Note:

• The 2 models are not equivalent. AS/AD model is static. PC includes changes over time. Whereas AS/AD shows one time changes in price level as inflation or deflation.
• Phillips Curve illustrate continuous changes in price level as either increased inflation or disinflation.

Disinflation

• Reduction in inflation rate from year to year, usually displayed in LRPC
• Also occurs when AD declines
• In short run, profits fall and unemployment increase

Deflation
Actual drop in price level.

Unit 5 - Phillips Curve

Definition:

• Inverse relationship between inflation and unemployment
• Only occur in the short run

+Long Run Phillips Curve

• Occurs at natural rate of unemployment
• No trade off between unemployment and inflation
• It only shifts if the LRAS curve shifts
• Major LRPC assumption is that more worker benefit create higher natural rate and fewer benefit create lower natural rate.
•  

+Short Run Phillips Curve

• Has relevant to Okun Law
• Inverse relationship between inflation and unemployment
• Since wages are sticky, inflation changes move the point on SRPC
• If inflation persist, and the expected rate of inflation increases, the entire SRPC moves upward, create stagflation. 
• If inflation expectation drop due to new technology, SRPC will move downward.

 

Stagflation
High unemployment and high inflation simultaneously

Misery Index
Combination of inflation and unemployment in given year
Single digit misery is good 

Natural Rate of Unemployment
Frictional, Structural and seasonal unemployments