E & S Chapter 2 Political Economy of Economic Growth, Schools of Thought

Core Economic Concepts: Gross Domestic Product (GDP)

Definition: The total market value of all final goods and services produced in a country over a given time period.

Approaches to Measuring GDP:

·       Production Approach: GDP = Gross Value of Output – Intermediate Consumption.

·       Income Approach: GDP = Wages + Profits + Mixed Income + Operating Surplus.

·       Expenditure Approach: GDP = Consumption (C) + Investment (I) + Government Spending (G) + Net Exports (X – M).

Note: GDP is often used interchangeably with National Income, though the latter makes adjustments for depreciation, taxes, and income from abroad.

National Income

Definition: Total income earned by residents of a country in the production of goods and services.

Derived from GDP via adjustments (GNP, NNP, depreciation, etc.).

Productivity

Definition: Output per unit of input, typically labor (e.g., output per hour worked).

·      Key driver of long-term economic growth.

Closely tied to technological innovation and capital investment.

Business Cycle

Definition: The pattern of short-term fluctuations in economic activity around a long-term growth trend.

Phases:

·       Expansion (Boom): Rising output, employment, income.

Contraction (Recession/Depression): Falling output, rising unemployment.

Aggregate Demand (AD)

Definition: Total demand for goods and services in an economy.

Formula: Y = C + I + G + (X – M)

·       C = Consumption

·       I = Investment

·       G = Government spending

·       X – M = Net exports

Aggregate Supply (AS)

·  Definition: Total supply of goods and services available in the economy.

·  Driven by the efficiency of production and cost structures.

The Circular Flow of the Economy

·      Basic Model: Interaction between households and firms in goods and factor markets.

·      Extended Model: Includes financial sector, government, and the rest of the world.

Highlights the interdependence of income and expenditure.

Schools of Economic Thought and Theories of Growth

Neoclassical Economics

·       View: Long-term growth is driven by supply-side factors like innovation, capital accumulation, and productivity.

·       Policies Supported:

o   Tax cuts

o   Deregulation

o   Infrastructure and R&D support

·       Say’s Law: “Supply creates its own demand”—markets are self-correcting.

Keynesian Economics

·       View: Emphasizes the role of aggregate demand in driving investment and growth.

·       Policies Supported:

o   Government intervention

o   Fiscal and monetary policy

o   Welfare state and public employment

·       Believes in “demand management” to counteract business cycles.

Marxist Economics

·       View: Capitalism is inherently unstable and prone to crisis due to underconsumption and overproduction.

·       Advocates for the collectivization of production and sees inequality as a structural problem.

Emphasizes the contradiction between maximizing profits and maintaining consumer purchasing power.

Technological Change and Economic Development

Creative Destruction (Schumpeter)

·       Innovation leads to the rise of new industries and the fall of old ones, propelling growth.

Industrial Revolutions:

·       First: Steam engine, textiles (late 18th–early 19th c.)

·       Second: Electricity, steel, combustion engines (late 19th–early 20th c.)

·       Third: Digital revolution—computers, IT (late 20th c.)

·       Fourth: AI and robotics (21st c.)

Skill-Biased Technological Change

·       New tech favors skilled over unskilled labor, leading to labor market polarization.

Capital-Biased Technological Change

·       Increasingly, returns accrue to capital owners, not labor—risking growing inequality.

💹 Financial Assets: Stocks & Bonds

Stocks: Ownership in a company; receive dividends.

Bonds: Loans to companies/governments; receive interest.

🧮 Income vs. Wealth

Income: Flow of money over time (e.g., wages per month).

Wealth: Stock of assets at a point in time (e.g., total savings and property owned).