AP_Krugman_Textbook

Both inflation and deflation can pose problems for the economy. Inflation discour-
ages people from holding on to cash, because if the price level is rising, cash loses value.
That is, if the price level rises, a dollar will buy less than it would before. As we will see
later in our more detailed discussion of inflation, in periods of rapidly rising prices,
people stop holding cash altogether and instead trade goods for goods.
Deflation can cause the opposite problem. That is, if the overall price level falls, a
dollar will buy more than it would before. In this situation it can be more attractive for
people with cash to hold on to it than to invest in new factories and other productive
assets. This can deepen a recession.
In later modules we will look at other costs of inflation and deflation. For now we
note that, in general, economists regard price stability—meaning that the overall price
level is changing either not at all or only very slowly—as a desirable goal because it helps
keep the economy stable.

Economic Growth

In 1955 Americans were delighted with the nation’s prosperity. The economy was ex-
panding, consumer goods that had been rationed during World War II were available
for everyone to buy, and most Americans believed, rightly, that they were better off
than citizens of any other nation, past or present. Yet by today’s standards Ameri-
cans were quite poor in 1955. For example, in 1955 only 33% of American homes
contained washing machines, and hardly anyone had air conditioning. If we turn the
clock back to 1905, we find that life for most Americans was startlingly primitive by
today’s standards.
Why are the vast majority of Americans today able to afford conveniences that
many lacked in 1955? The answer is economic growth,an increase in the maxi-
mum possible output of an economy. Unlike the short-term increases in aggregate
output that occur as an economy recovers from a downturn in the business cycle,
economic growth is an increase in productive capacity that permits a sustained rise
in aggregate output over time. Figure 2.2 shows annual figures for U.S. real gross
domestic product (GDP) per capita—the value of final goods and services produced
in the U.S. per person—from 1900 to 2009. As a result of this economic growth, the
U.S. economy’s aggregate output per person was almost nine times as large in 2009
as it was in 1900.

module 2 Introduction to Macroeconomics 13

Section I Basic Economic Concepts

figure 2.2

Growth, the Long View

Over the long run, growth in real GDP

per capita has dwarfed the ups and

downs of the business cycle. Except

for the recession that began the

Great Depression, recessions are al-

most invisible.

Source:Angus Maddison, “Statistics on World

Population, GDP and Per Capita GDP, 1–2006 AD,”

http://www.ggdc.net/maddison; Bureau of Eco-

nomic Analysis.

Year

Real GDP

per capita

(2005 dollars)

$50,000

40,000

30,000

20,000

10,000

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 20002009

The economy has price stabilitywhen

the aggregate price level is changing

only slowly.

Economic growth is an increase in

the maximum amount of goods and

services an economy can produce.

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