Monday, July 30, 2018

IB Economics: a 101 on growth (by Krugman)

Paul Krugman is a heavyweight in Economics.  No doubt about that. He was the winner of the John Bates Clark in 1993 (while at MIT '...given biannually by the American Economic Association to the economist under 40 who has made the most important contributions to economics'; see MIT on Krugman's award) and the winner of the 2008 Nobel Prize in economics (while at Princeton, '...for insights into international trade patterns that overturned longheld theories about the global economy'; see Princeton on Krugman's Nobel prize).  He is also a 'media columnist and commentator' writing for the NYT and, of course in this respect, you may agree or disagree with him.

In this latest column he discusses the recent strong 2nd quarter US growth rate.  I will not focus on the 'politics' of this opinion, but on some simple analytics that all IB Economics students should be aware of.

Quoting Krugman:
The key point when you look at real GDP is that the economy’s actual output depends both on its capacity – the amount it is capable of producing on a sustained basis – and the rate at which it is using that capacity. That is,

Output = capacity * capacity utilization

An estimate of 'capacity' is “potential GDP” (which in the US is published by the CBO, the Congressional Budget Office).

He continues... can look at the ratio of actual GDP to potential, which is an indication of how hot the economy is running
...Why does capacity utilization fluctuate? Mainly because the economy sometimes suffers from periods of inadequate demand, as it did after the 2008 financial crisis. Sometimes, also, the economy overheats, reaching levels of capacity utilization that will lead to rising inflation.
The equation above is a slightly stylized (and more compact) version of what the IB syllabus states, namely that growth can result from greater use of existing resources (=capacity utilization) and from more / better resources becoming available (=capacity). 

And another point Krugman makes (read the whole article if interested) also ties well with this LO from the IB Economics syllabus: 'Evaluate the view that increased investment is essential to achieve economic growth'.  What is missing, according to Krugman, to determine whether high growth rates are sustainable, is an 'investment surge'.

The other point he makes that 'wage gains' are also missing, ties in well with our discussion on income distribution (this fall for candidates 2019 at a theater near you: 901 in Athens).  The point relates to how a satisfactory growth rate number should be evaluated.  If curious, see Emmanuel Saez Berkely lecture here.

Lastly, I was curious about the word 'nothingburger', so had to check dictionaries.  Did so.  I think I will use this word as a comment when marking some (few, I hope) school essays, instead of the standard IB: 'NAQ'...

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