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Chapter 22
ECONOMIC
GROWTH,
BUSINESS
CYCLES,
UNEMPLOYMENT,
AND INFLATION
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22-2
Today’s lecture will:
• Explain the difference between the
long-run framework and the short-run
framework.
• Summarize some relevant statistics
about growth, business cycles,
unemployment, and inflation.
• Discuss four phases of the business
cycle.
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22-3
Today’s lecture will:
• Explain how unemployment is measured
•
•
•
and state some microeconomic
categories of unemployment.
Relate the target rate of unemployment
to potential income.
Define inflation and distinguish a real
concept from a nominal concept.
Discuss two important costs of inflation.
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22-4
Macroeconomics
• Macroeconomics is the study of the
•
economy as a whole.
The four central problems are:
 Growth
 Business cycles
 Unemployment
 Inflation
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Two Frameworks: The Long
Run and the Short Run
• Issues of growth are considered in a
•
•
long-run framework, which focuses
on supply.
Business cycles are generally
considered in a short-run framework,
which focuses on demand.
Inflation and unemployment fall
within both frameworks.
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22-6
Growth
• The primary measurement of growth is
•
•
changes in real gross domestic product (real
GDP) – the market value of final goods and
services produced in an economy, stated in the
prices of a given year.
The U.S. secular growth rate and the per capital
real output growth have been 2.5 to 3.5 percent
per year.
Per capita real output is real GDP divided by
the total population.
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22-7
Global Experience with Growth
• Today’s per capita growth rates are historically
•
•
•
high. Today’s trends began in the late 1700s,
about the same time markets and democracies
took hold.
Growth rates rose from 0.9% in 1820-1950 to
1.9% since 1950.
African economies have consistently lagged
behind.
Annual per capita income in Africa is about
$1,500, compared to the world average of
$6,000.
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22-8
The Benefits and Costs of Growth
• Per capita economic growth allows everyone
•
•
in society, on average, to have more.
Growth, or the prediction of growth, allows
governments to avoid hard questions.
The costs of growth include:
 Pollution
 Resource exhaustion
 Destruction of natural habitat
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22-9
Business Cycles
• The business cycle is the upward and
•
downward movement of economic activity that
occurs around the growth trend.
There are two main views on policy regarding
business cycles:
 Classical economists argue that fluctuations are to

be expected and favor laissez-faire.
Keynesians feel that fluctuations are symptoms of
underlying problems and should be addressed with
activist government policy.
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22-10
U.S. Business Cycles
20
Recovery
of 1895
Civil
10 War
World War I
World War II
Korean
War Vietnam War
0
Panic
of 1893 Panic
of 1907
–10
Great
Depression
–20
1860 ‘70
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‘80
‘90
1900
‘10
‘20
‘30 ‘40 ‘50 ‘60 ‘70 ‘80 ‘90 2000 ‘10
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22-11
Four Phases of the
Business Cycle
2 qtrs decline
Expansion
Recession
2 qtrs rise
Expansion
Total Output
Peak
0
Trough
Secular
growth
trend
Jan.- Apr.- July- Oct.- Jan.- Apr.- July- Oct.- Jan.- Apr.Mar June Sept. Dec. Mar June Sept. Dec. Mar June
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22-12
Change in the Nature of Business Cycles
Duration (in months)
Business Cycles
Pre-World War II
(1854-1945)
Number
22
Average Duration
50
Length of longest cycle
99(1870-79)
Length of shortest cycle
28(1919-21)
Average length of expansions
29
Length of shortest expansion 10(1919-20)
Length of longest expansion 80(1938-45)
Average length of recessions
21
Length of shortest recession
7(1918-19)
Length of longest recession
65(1873-79)
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Post-World War II
(1945-2004
10
67
128(1991-2001)
28(1980-82)
57
12(1980-81)
120(1991-2001)
11
6(1980)
16(1981-1982)
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22-13
Leading Indicators
• Average work week
• New orders for
• Unemployment claims capital goods
• Building permits
• New orders for
consumer goods
• Stock prices
• Vendor performance • Interest rate
spread
• Index of consumer
expectations
• Money supply, M2
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22-14
Unemployment
• The unemployment rate is the
•
•
percentage of people who are willing and
able to work but are not working.
Cyclical unemployment is that which
results from fluctuations in economic
activity.
Structural unemployment is that caused
by economic restructuring making some
skills obsolete.
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22-15
Unemployment as
Government’s Problem
• In the Employment Act of 1946, the
•
•
U.S. government took responsibility
for unemployment.
Full employment – an economic
climate where nearly everyone who
wants a job has one.
Some unemployment is unavoidable.
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22-16
Target Rate of Unemployment
• The target rate of unemployment is the lowest
•
•
sustainable rate of unemployment achievable
under existing conditions.
Today thought to be 5%. Earlier thought to be
5-7%.
Changed due to changing
 Demographics
 Social and institutional structures
 Unemployment insurance and welfare
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22-17
Why the Target Rate Changed
• In the 1970s and early 1980s, a low inflation
•
•
•
rate seemed to be incompatible with a low
unemployment rate.
Demographics have changed – different age
groups have different unemployment rates.
Social and institutional structures have
changed.
Government institutions changed with
programs such as unemployment insurance
and public welfare.
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22-18
Whose Responsibility
is Unemployment
• Classical economists believe that
individuals are responsible for their own
jobs.
 If people really want a job, they will find one.
• Keynesian economists tend to say that
society owes people jobs commensurate
with their training or past job experience.
 Jobs should be close enough to home so that
people don’t have to move.
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22-19
Unemployment Rate since 1900
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Calculating the Unemployment
Rate
number unemployed
unemployment rate 
 100
labor force
• The labor force – those people in an
•
economy who are willing and able to
work.
The labor force excludes those incapable
of working and those not looking for
work.
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Unemployment/Employment
Figures (in millions)
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Accuracy of the
Unemployment Rate
• Does not include discouraged workers.
• Does not take into account the
•
•
underemployed.
Includes people who say they’re
unemployed, but aren’t.
The labor force participation and
unemployment rates provide additional
information.
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22-23
Unemployment and
Potential Output
• Potential output – output that would be
achieved at the target rates of
unemployment and of capacity utilization.
• Okun’s rule of thumb:
1%Δ unemployment →
2% Δ output in opposite direction
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22-24
Microeconomic Categories
of Unemployment
• Microeconomic policies are sometimes used to
•
supplement macroeconomic policies for
unemployment.
The following are microeconomic categories of
unemployment are analyzed:
 How people become unemployed
 Demographic unemployment
 Duration of unemployment
 Unemployment by industry
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22-25
Unemployment by
Microeconomic Subcategories
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Inflation
• Inflation is a continual rise in the price
•
•
•
level.
Deflation is a continual fall in the price
level.
Inflation or deflation is measured with
changes in price indexes.
Price index – a number that summarizes
what happens to a weighted composite of
prices of a selection of goods over time.
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22-27
Creating a Price Index
• A price index is calculated by dividing
the current price of a basket of goods
by the price of the basket in a base year
then multiplying by 100.
Price of basket in current year
Price index 
 100
Price of basket in base year
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22-28
Creating a Price Index
Basket of Goods
Prices
2005
2006
Expenditures
2005
2006
10 pairs of jeans
$20.00/pr. $25.00/pr.
$200
$250
12 flannel shirts
15.00/ea. 20.00/ea.
180
240
100 lbs. Apples
0.80/lb.
1.05/lb.
80
105
80 lbs. Oranges
1.00/lb.
1.00/lb.
80
80
$540
$675
Total Expenditures
$675
Price index in 2006 
X 100
$540
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 125
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22-29
Real World Price Indexes
• The GDP deflator
 Measures prices for aggregate output.
 Favored because it is broad.
• Consumer Price index
 Measures prices facing consumers.
 Based on a fixed basket of goods.
 May overstate true inflation.
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Composition of CPI
Food and beverage (15.4%)
Housing (42.1%)
Apparel (4.0%)
Transportation
(16.9%)
Other (3.7%)
Medical care (6.1%)
Education and
Communication
(5.9%)
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Recreation (5.9%)
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22-31
Real World Price Indexes
• Personal consumption expenditure
(PCE) deflator
 measures prices facing consumers
 updates the fixed basket of goods yearly
 favored by the Federal Reserve
• Producer Price Index (PPI)
 measures prices facing producers
 early predictor of consumer inflation
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Real and Nominal Concepts
• Nominal output is the total amount of goods
•
and services measured at current prices.
Real output is the total amount of goods and
services produced, adjusted for price level
changes.
nominal output
real output 
 100
price index
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22-33
Expected and Unexpected Inflation
• Expected and unexpected inflations
•
•
•
affects behavior differently.
Expected inflation is inflation people
expect to occur.
Unexpected inflation is inflation that
surprises people.
Inflationary expectations can
accelerate large inflation.
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Costs of Inflation
• Inflation may not make a nation poorer.
• It can redistribute income from those who do
•
•
not raise their prices to those who do.
It can reduce the amount of information that
prices convey.
Inflation is a very serious problem it increases
to hyperinflation – exceptionally high levels of
inflation, 100 percent or more a year.
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Summary
• Economists use two frameworks to
analyze macroeconomic problems:
 The long-run growth framework focuses on
supply.
 The short-run business cycle framework
focuses on demand.
• Growth is measured by the change in:
 Real gross domestic product (GDP)
 Per capita real GDP
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Summary
• The secular trend growth rate of the
•
•
economy is 2.5% to 3.5%.
Business cycles are fluctuations of real
output around the secular growth trend.
Phases of the business cycle are:
 Peak
 Downturn
 Trough
 Upturn
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Summary
• Unemployment is calculated as the number of
•
•
•
unemployed people divided by the labor force.
Unemployment rises during a recession and
falls during an expansion.
The target rate of unemployment is the lowest
sustainable rate of unemployment possible
under existing institutions.
The lower the target rate of unemployment, the
higher an economy’s potential output.
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Summary
• A real concept is a nominal concept
•
•
•
adjusted for inflation.
Real output equals nominal output
divided by the price index.
Inflation is the continual rise in the price
level.
The CPI, the PPI, and the GDP deflator
are all price indexes used to measure
inflation.
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Summary
• Expectations of inflation can provide
•
•
pressure for inflation to continue
even when other causes don’t exist.
Inflation redistributes income from
people who do not raise their prices
to people who do raise their prices.
Inflation reduces the information that
prices convey.
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22-40
Review Question 22-1 Suppose that the nominal price of gasoline is
$2 per gallon. The CPI (1982 base year) is 190%. Find the real price
of a gallon of gasoline.
nominal price $2.00
real price 

 100  $1.05
price index
190
Review Question 22-2 Suppose that the number of people, at least
16 years old, able to work is 200. The labor force is 150 and the
number of employed people is 140. Find the labor force participation
rate and the unemployment rate.
labor force participat ion rate 
150
 100  75%
200
150 - 140
unemployment rate 
 100  6.67%
150
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