South-Western College Publishing - Economics  
The Dow at 10,000
Subject Economic Fluctuations and Growth
Topic Productivity and Growth
Key Words Productivity, Inflation, Unemployment, Economic Growth
News Story

The headlines read, "Dow Industrials Top 10,000." The extraordinary growth of the Dow-it has increased over 50% since December 1996 when Federal Reserve Chairman Alan Greenspan warned of irrational exuberance-has fueled economic growth and created a great deal of personal wealth. The same headlines that touted the Dow's performance raised the question of whether the Dow's climb can continue.

In the past, economic expansions were throttled by increases in interest rates as the Federal Reserve applied the brakes to prevent inflation. Low unemployment would produce inflationary wage increases followed by price hikes and interest rates. The rise in interest rates would decrease aggregate demand and reduce profits. The reduction in profits, in turn, would depress stock market prices. A typical prescription for the stock market's continued assent is for the economy to avoid inflation and recession.

Unlike previous expansions, current economic growth has not resulted in inflation. One reason why inflation has not occurred is an increase in productivity. Over the past few years, economic data indicate a doubling of productivity. An increase in the productivity rate by a half of a percentage point increases Gross Domestic Product by $45 billion without any extra manpower.

Another reason for the market's strength has been an increase in the demand for stocks on the part of the investor. As long as people continue to want to hold stocks, and to pay more for them, the stock market will continue to rise. On the other hand, if stock ownership is a fad, then individual tastes can change causing the stock market bubble to burst.

(Updated May 1, 1999)

Questions
1. How is productivity defined?
2. How is productivity measured?
3. How does an increase in productivity allow a firm to pay higher wages and not face higher costs?
4. How does an increase in productivity affect a firm's profits?
Source David Wessel, "The Economy: If This Is a Bubbles, It Sure is Hard to Pop", The Wall Street Journal, March 30, 1999.

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