CHAPTER 18

INTRODUCTION TO ECONOMIC GROWTH,

UNEMPLOYMENT AND INFLATION
ECONOMIC GROWTH

Economists define and measure economic growth as either (1) an increase in real GDP or
(2) an increase in real GDP per capita. Economic growth is calculated as a percentage
rate of growth per quarter or per year.

EXAMPLES
e.g. Real GDP in South Africa was e.g. Real GDP per capita is found by
R1 814 521 million in 2008 compared with dividing real GDP by the size of the
R1 782 262 million in 2009. population. In South Africa, the real GDP
Therefore, the rate of economic growth was R1 782 262 million in 2007 and the
was negative in South Africa for 2009 at population was estimated at 48,55 million.
-1.77%. The real GDP per capita for 2007 was
R36 045. The real GDP in 2008 rose slightly
new − old to R36 951. Therefore, the rate of growth of
X 100
old GDP per capita for 2008 was 2.5%.

1 782 262 − 1 814 521 36 951 − 36 045

𝑋 100 = −1.77% 𝑋 100 = 2.5%
1 814 521 36 045

Growth is a widely held economic growth. Why do economists pay so much attention to
small changes in the rate of economic growth? Because every little change matters!!!

RULE OF 70
Rule of 70 is a mathematical approximation that provides a quantitative grasp of the
effect of economic growth.

70
Approximate number of years required to double real GDP =
annual percentage rate of growth

MAIN SOURCES OF GROWTH GROWTH IN SOUTH AFRICA

Society can increase real output and The real GDP grew at an average annual
income by: rate of 2.8% between 1970 and 2008 in SA,
►increasing inputs of resources (such as while real GDP per capita increased by
land, labour, capital and entrepreneurial 0.7% over that time. This is as a result of:
skills) ►improved products and services
►increasing productivity (when health, ►added leisure
training, education and motivation of ►other impacts
workers improves, better equipment and
machinery)
 BUSINESS CYCLE

A business cycle refers to the alternating rising and declining of the level of economic
activity over several years. The twin problems that arise from the business cycle are
unemployment and inflation.

PHASE 1 PEAK ►business activity has reached a temporary maximum

►the economy is near or at full employment
►the level of real output is at or very close to the
economy’s capacity
►price level tends to rise causing inflation
PHASE 2 RECESSION ►a period of decline in total output, income and
employment
►decrease in business activity
►increase in unemployment
PHASE 3 TROUGH ►output and employment are at their lowest levels
PHASE 4 EXPANSION ►real GDP, income and employment rise

(1) UNEMPLOYMENT

Unemployment is the failure to use all available economic resources to produce desired
goods and services or the failure of the economy to fully employ its labour force.

MEASUREMENT OF UNEMPLOYMENT
Unemployment rate is the percentage of the labour force unemployed.

unemployed
Unemployment rate = X 100
labour force

Labour force consists of people who are able and willing to work and includes both
those who are employed and those who are unemployed but are actively seeking
work.
 TYPES OF UNEMPLOYMENT
FRICTIONAL is a type of search unemployment and wait unemployment where
workers are either voluntarily changing jobs or are between different
jobs or are fired and are looking for reemployment or have been laid
off temporarily because of seasonal demand
STRUCTURAL unemployment of workers whose skills are not demanded by
employers or who lack sufficient skills to obtain employment or who
cannot easily move to locations where jobs are available
CYCLICAL a type of unemployment caused by insufficient total spending and
typically begins in the recession phase of the business cycle

FULL EMPLOYMENT
FULL EMPLOYMENT:
(1) the use of all available resources to produce want-satisfying goods and services
(2) the situation in which the unemployment rate is equal to the full- employment
unemployment rate and there is frictional and structural but no cyclical unemployment
(3) the real GDP of the economy equals potential output
FULL-EMPLOYMENT RATE OF UNEMPLOYMENT/ NATURAL RATE OF UNEMPLOYMENT (NRU):
the unemployment rate at which there is no cyclical unemployment of the labour force
and where actual inflation equals expected inflation and the economy is achieving its
potential output

GDP gap = actual GDP – potential GDP

ECONOMIC COST OF UNEMPLOYMENT

Part of the burden of unemployment is that its cost is unequally distributed as a result of:
►occupation – workers in lower-skilled occupations have higher unemployment rates
than workers in higher-skilled occupations
►age – teenagers have much higher unemployment rates than adults as they have
lower skill levels, quit their jobs more frequently, are more frequently fired and have less
geographical mobility
►race and ethnicity – the unemployment rate for black South Africans is higher than
that of coloured, Indians and whites
►gender – the unemployment rates for women is higher than that of men
►province – the Free State has the highest unemployment rate (2012)

(2) INFLATION

Inflation is the general rise in price levels in an economy.

MEASUREMENT OF INFLATION
Consumer Price Index (CPI) is an index that measures the prices of a fixed “market
basket” of come 300 goods and services bought by a typical consumer. The three main
items are food, housing and transport.

price of the most recent market basket in the particular year

Consumer price index = X 100
price of the same market basket in1982−1984
 TYPES OF INFLATION
DEMAND-PULL is a type of inflation caused by the increase in the price level
(inflation) as a result from an increase in demand output at the
existing price level, caused by an increase in aggregate demand
COST-PUSH is a type of inflation caused by the increase in the price level
(inflation) as a result from an increase in resource costs and hence an
increase in per-unit production costs, caused by a decrease in
aggregate supply

REDISTRIBUTION EFFECTS OF INFLATION

NOMINAL INCOME is the number of rand received as wages, rent, interest or profits.

REAL INCOME is a measure of the amount of goods and services nominal income can
buy

nominal income
REAL INCOME =
price index

ANTICIPATIONS:
(1) Anticipated inflation – increases in the price level (inflation) that occur at the
expected rate
(2) Unanticipated inflation – increases in the price level (inflation) at a rate greater
than expected
WHO IS HURT BY INFLATION?
►fixed-income receivers – people whose incomes are fixed see their real incomes fall
when inflation occurs
►savers – as prices rise, the real value/ purchasing power of savings deteriorates
►creditors – due to inflation, the value of rand goes down, so the borrower pays back
less valuable rand than those received from the lender
WHO IS HELPED BY INFLATION?
►flexible-income receivers
►debtors
►the government

ANTICIPATED INFLATION
The redistribution effects of inflation are less severe or are eliminated if people
anticipate inflation and can adjust their nominal incomes to reflect the expected price-
level rises.

REAL INTEREST RATE is the percentage increase in purchasing power that the borrower
pays the lender.

NOMINAL INTEREST RATE is the percentage increase in money that the borrower pays
the lender

Nominal interest rate = real interest rate + inflation premium (the expected rate of inflation)
e.g. Suppose a lender, such as a bank, and a borrower, such as a household, both
agree that 5% is a fair rate of interest on a 1-year loan provided that the price level is
stable. But assume that inflation has been occurring and is expected to be 6% over the
next year.

Real interest rate = 5%

Nominal interest rate = 5% + 6% = 11%

INFLATION AND ITS EFFECTS ON OUTPUT

COST-PUSH INFLATION AND REAL OUTPUT
Cost-push inflation decrease real output. As prices rise, the quantity of goods and
services demanded falls. Firms respond by producing less output and unemployment
increases.
DEMAND-PULL INFLATION AND REAL OUTPUT
Demand-pull inflation increases real output. An increase aggregate demand results in
an increase in price level (inflation) and an increase in real output which decrease
unemployment.
HYPERINFLATION
Hyperinflation refers to extraordinary rapid inflation.

As prices shoot up sharply and unevenly during hyperinflation, people begin to

anticipate even more rapid inflation and normal economic relationships ae disrupted.
Businesses do not know what to charge for their products. Customers do not know what
to pay. Money eventually becomes almost worthless and ceases to do its job as a
medium of exchange. The result is economic collapse and political chaos.
e.g. Zimbabwe