Macroeconomic Objective:

Economic Growth
 What is Economic Growth?
Economic growth is an increase in real GDP over time.

Ecuadorian GDP 1960 - 2015

(in USD millions)

$100,000.00

$90,000.00

$80,000.00

$70,000.00

$60,000.00

$50,000.00

$40,000.00

$30,000.00

$20,000.00

$10,000.00

$-
1988

2010
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986

1990
1992
1994
1996
1998
2000
2002
2004
2006
2008

2012
2014
2016
 Ecuadorian GDP 2000 - 2015
(in USD millions)

$100,000.00

$90,000.00

$80,000.00

$70,000.00

$60,000.00

$50,000.00

$40,000.00

$30,000.00

$20,000.00

$10,000.00

$-
What are the Economic Growth types?

Utilization of
unemployed resources
Short term
in actual Increase in productive
GDP(r) efficiency
ECONOMIC
GROWTH
Long term Increases in the
quantity and quality
in potential of resources
GDP(r) in the long term

How can Economic Growth be shown in a diagram?

 Economic Growth Short Run

Price By an in AD Price By an in SRAS

Level Level SRAS
LRAS
LRAS SRAS SRAS1

PL1

PL1 PL
Deflation
PL
Inflation1

AD1 AD
AD
Y Y1 GDP (r) Y Y1 GDP (r)
Economic Economic
growth growth

Its caused by changes in the Its caused by a Decrease in the cost

determinants of AD, resulting in an of production factors, resulting in an
increase in AD. Increase in SRAS.
HOW IS INFLATION MEASURED?
Inflation is measured The Basket of goods
mostly using the CPI and services is a
Consumer Price Index. collection of products,
raw materials
and services typically
The CPI measures the
consumed by the
changes in prices of a
average household
Basket of goods and
in a country.
services consumed by
an average household. Are you an Average
Household?
Do you consume
these products?
All of them?
Some of them?
How many?

Research Homework
Inflation data from last
10 years, 5 countries
But, what is in this of your choice
basket? (include Ecuador).
 Consequences of High inflation
1) Greater uncertainty 5) Shoe-leather costs
that could lead to falling (costo de suela de zapato)
investment and consumption The cost of searching for a
lower price. Time consuming.
2) Loss of purchasing power
Less products can be bought 6) Menu costs
with the same amount of money. Cost of constantly changing
your goods/services prices
3) Redistributive effect
For savers (in banks), high
inflation means they will get
smaller real interest rates
on their savings account.

4) Export more expensive

Making national products
less competitive.
 Typ e s o f I n f l a t i o n
Price Demand-pull inflation Price Cost-push inflation
Level Level SRAS1
LRAS SRAS LRAS SRAS
BAD

BAD
PL2
PL1
Inflation2 BAD
PL1 PL
PL
Inflation1
Inflation
BAD
AD1 AD2 AD
AD
Y Y1 Y2 GDP (r) Y1 Y GDP (r)
Econ. Econ.
growth1 growth2 Recession!

Its caused by changes in the determinants
of AD, resulting in an increase in AD.
Negative ONLY when AD grows beyond
the F.E.L. Otherwise, it is desirable.
Its caused by an increases in the cost
of production factors, resulting in a
decrease in SRAS.
Inflation + Recession = STAGFLATION
Worst economic situation for a country.
 Inflation - Ecuador and Venezuela

121.74
130
120
110
100
90

62.17
80
70

40.64
60

31.44
31.09

28.19
27.08
50

26.09
22.43

21.75

21.07
18.70
40

15.95

13.66
12.48

30
7.93

5.16

4.47

3.97
3.57
3.56
8.4
3.03
2.74

2.74
2.41

2.28
20

5.1
10
0

Ecuador Venezuela

Why does Venezuela have such a high rate of inflation?

For many reasons, but one of the most important ones is:
High costs of production for firms.
The Venezuelan government has:
Increased minimum wages, several times
Increased taxes for firms (corporate taxes).
Increased tariffs (import taxes), which makes imported materials more expensive.
Destroyed the Business Confidence and future expectations of firms.
These and many other economic policies have led Venezuela to the most dangerous
type of inflation: Cost-push inflation, which leads to STAGFLATION (Inflation + Recession)
 Typ e s o f D E F L AT I O N ( 2 )
Price Supply-side DEFLATION
Level SRAS
LRAS SRAS 1
GOOD
Consequences of
GOOD
Supply-side Deflation
PL
GOOD Lower prices
PL1
Deflation
More production
GOOD More employment
Economic growth
AD

Y Y1 GDP (r)
Recessionary gap
Economic Growth!

Its caused by a Decrease in the cost

of production factors, resulting in an
Increase in SRAS.
Best economic situation for a country.
Lower prices + economic growth.
How to cure Inflation? Demand-Pull inflation
It depends on the type of inflation. In the case of Demand-Pull inflation, governments need to
decrease the AD, for which they can use:
Contractionary Fiscal Policy
Contractionary monetary policy AD = C + I + G + Xn
Fiscal policy Contractionary Fiscal policy
Manipulation of T To contract (decrease) AD (aggregate demand) by:
and G in order to 1. T (increasing taxes), and/or
influence AD.
2. G (decreasing government spending).

1. By T, the Yd (disposable income) of households

How does it
and firms is reduced, hence decreasing C and I.
work?
2. By G the AD is reduced too.

Monetary policy Contractionary Monetary policy

Manipulation of Sm To contract (decrease) AD (aggregate demand) by:
and i in order to 1. Decreasing the Sm (supply of money), and/or
influence AD. 2. Increasing i (interest rates).

1.+ 2. By Sm (supply of money), the currency itself gets

How does it more expensive so its price i (the interest rate) gets higher.
work? This makes banking credit more expensive, decreasing
Investment, hence decreasing AD.
 How to cure Inflation? Cost-Push inflation
It depends on the type of inflation. In the case of Cost-Push inflation, the governments need to
expand or increase the SRAS, for which they will need to use:
Expansionary Supply-side Policies
The idea is to decrease the production costs for firms, so they can produce more, expanding
(increasing) their supply.

Supply-side Expansionary Supply-side Policies

Policies
Examples of Expansionary Supply-side Policies:
Measures that
seek to change the
1. T
production costs 2. minimum wage (decreasing the cost of labor)
for firms in an 3. Tariffs for capital goods (so imports for producers get cheaper)
economy 4. the cost of energy (gas, electricity, oil, etc.)

All these economic policies reduce the costs of production, increasing

the output (production level) of firms, SRAS.
1. By T, the Yd (disposable income) for firms is increased, so they
can increase production.
How does it 2. By minimum wage, the cost of labor is lowered. Firms save
work? money to invest in production.
3. By Tariffs for capital goods, imports for production processes
get cheaper, leaving more money for I.
4. By the cost of energy (gas, electricity, oil, etc.), the Yd for firms
increase.
Summarizing
The appropriate policy depends on the cause of inflation
If the cause is the price of imported products (for example oil) then this is an
external factor which is out of governments control
If it is demand pull inflation government can try to slow down demand using
deflationary/contractionary fiscal or monetary policy
If it is cost push inflation government can try to decrease production costs for firms

Evaluation notes
There are often problems with
contractionary policies.
T, G or i are not popular
measures among people.
This is one of the reasons that many
developed countries have monetary
policy managed by their central bank
(which is an independent institution)
and not the central government.

There are lags with both fiscal and
monetary policy of 1 to 2 years.
Government spending budgets are
developed over a long period of time
and may need long legislative
procedures to make any changes.
Monetary policy will harm some
people in the economy more than
others
Anyone that has a loan or
mortgage, and businesses that
want to invest.

Any government that is looking to be

re-elected will try to avoid using these
measures
 IB Questions
1. Distinguish between inflation, 1. Using diagram (s), Discuss the
disinflation and deflation. (30 marks) possible consequences of a high
inflation rate. (100 marks)
2. Explain the way of calculating the
rate of inflation. (30 marks) 6. Using diagram (s), Discuss possible
consequences of deflation. (100 marks)
3. Explain why the rate of inflation
experienced by different income 7. While both inflation and deflation are
groups may be different from the rate undesirable, deflation poses greater
of inflation calculated by use of the risks for an economy compared to
consumer price index (CPI). (40 marks) inflation. Discuss this statement. (100
marks)

4. Using diagrams, distinguish

between cost-push and demand-pull 8. Since inflation has negative
inflation. (50 marks)
consequences for an economy,
policy-makers should aim toward
achieving deflation. Discuss this
5. Using diagrams, distinguish
view. (100 marks)
between demand-side and supply-
side deflation. (50 marks)
9. Evaluate government policies to deal
with the different types of inflation.
(100 marks)