Download Chapter 11 - Pearson Higher Education

CHAPTER 11
MACROECONOMIC ISSUES: ECONOMIC GROWTH
AND THE BUSINESS CYCLE
After reading Chapter 11, MACROECONOMIC ISSUES: ECONOMIC GROWTH AND THE BUSINESS CYCLE, you
should be able to:













Describe the two sources of economic growth and tell how nations can affect their economic growth
rate.
Understand production functions as they apply to aggregate output.
Be able to express the production function in terms of annual growth rates.
Understand the law of diminishing returns.
Discuss the phases of the business cycle.
Define GROSS DOMESTIC PRODUCT (GDP) and its four expenditure categories.
Relate Gross National Product, GNP, and the various measures of income to GDP.
Tell the difference between real and nominal GDP.
Define INFLATION, be able to calculate the inflation rate, and discuss the historical trends of
inflation.
Explain why inflation can harm the economy.
Give the official definition of UNEMPLOYMENT.
Calculate the unemployment rate and discuss its historical trends.
Define the concepts of FRICTIONAL UNEMPLOYMENT, CYCLICAL UNEMPLOYMENT,
STRUCTURAL UNEMPLOYMENT, and the NATURAL RATE OF UNEMPLOYMENT.
CHAPTER OUTLINE
I. ECONOMIC GROWTH
A.
ECONOMIC GROWTH consists of rightward shifts in the production possibilities frontier, since
this means that more of all goods and services can be produced.
B. There are two sources of economic growth: Increases in the nation's productive resources, which
often takes the form of CAPITAL ACCUMULATION (investment in new capital stock) and
technological progress.
1. EXTENSIVE GROWTH refers to growth created by increases in factor inputs.
2. INTENSIVE GROWTH occurs when more output can be produced from the same amount of
inputs. Advances in technology is a source of intensive growth.
C. Advanced nations grow primarily through intensive growth. Hence, government policies that are
designed to increase productivity can raise a nation's growth rate.
D. Economic growth is explained by aggregate PRODUCTION FUNCTIONS, which relate the
amount of output to labor and capital inputs and to the state of TECHNOLOGY. The production
function can be expressed in terms of annual growth rates, where the growth rate of output depends
on the growth rates of labor and capital (each weighted by its share of income) and by technological
improvements. The shape of the production function is determined by the LAW OF
DIMINISHING RETURNS. The Output-per-Worker Production Function shows that output per
worker depends on the amount of capital per worker and upon technological progress.
77
II. BUSINESS CYCLES
A.
B.
C.
The BUSINESS CYCLE is the fluctuation of increases and decreases in economic activity.
The business cycle is divided into four phases:
1. RECESSION: the period after the peak, when the production of output declines and the
unemployment rate rises.
2. TROUGH: at the end of the recession, when output reaches its low point.
3. RECOVERY: the period after the trough, when the production of output increases.
4. PEAK: at the end of the recovery, when output reaches its maximum before sliding into
another recession.
Business cycles average about 5 years in length and have important effects on politics as well as the
economy.
III. GROSS DOMESTIC PRODUCT AND NATIONAL INCOME
A.
B.
C.
D.
E.
F.
IV.
A.
B.
GROSS DOMESTIC PRODUCT (GDP) is the market value of all of the final goods and services
produced in a country in a year.
GDP can be divided into four final use categories:
1. PERSONAL CONSUMPTION EXPENDITURES are the goods and services purchased by
households for their consumption.
2. GOVERNMENT EXPENDITURES FOR GOODS AND SERVICES are the goods and
services purchased by the government at all levels (federal, state and local). Government
transfer payments are not included because they do not (directly) purchase a good or service.
3. INVESTMENTS are the goods purchased, mainly by business firms, to add to the nation's
capital stock.
4. NET EXPORTS are the domestically produced goods purchased by foreigners minus
domestic purchases of foreign produced goods.
NOMINAL GDP is the value of the output of final goods and services expressed using prevailing
prices; REAL GDP measures the amount of goods and services produced. It removes the effect of
changing prices from nominal GDP.
The circular flow demonstrates that the value of GDP produced equals the amount of income
created by this production.
GROSS NATIONAL PRODUCT (GNP) equals GDP plus income generated by U.S.-owned
factors located in other nations minus income paid in the United States to foreign-owned factors of
production.
NATIONAL INCOME equals GNP minus depreciation and indirect business taxes (such as sales
taxes). National income also equals the sum of payments made to the factors of production.
1. PERSONAL INCOME is all the income people actually receive.
2. PERSONAL DISPOSABLE INCOME equals personal income minus personal income tax
payments. Thus, personal disposable income is all the income people actually have to spend.
INFLATION
INFLATION is a general rise in prices. The ANNUAL INFLATION RATE is the rate of
increase in the level of prices over a year.
A PRICE INDEX shows the current cost of buying a bundle of goods as a percentage of its cost in
an earlier year.
1. The inflation rate can be calculated using the consumer price index (CPI) or the GDP deflator.
78
C.
D.
V.
Prior to 1930, deflations were as common as inflations; after 1940, most years have been marked
with inflation.
Inflation can be a problem for three reasons:
1. Inflation can redistribute income. This occurs primarily when inflation surprises people.
2. Inflation can have an adverse effect on the economy's efficiency as people divert resources
from productive areas to uses designed to insulate them from inflation's effects.
3. Unanticipated inflation can deceive people and firms into altering their decisions about the
amount they produce.
UNEMPLOYMENT AND EMPLOYMENT
A.
B.
C.
D.
E.
The Bureau of Labor Statistics classifies a person as unemployed if:
1. the person did not work during the previous week,
2. AND the person looked for work during the preceding four weeks,
3. AND the person is available for work,
4. OR, regardless of the above three criteria, if the person is temporarily laid off from work and
waiting to be recalled to his or her job.
The UNEMPLOYMENT RATE equals the number of unemployed divided by labor force, which
is the sum of employed plus unemployed workers.
Since 1950, the unemployment rate in the United States has tended to increase. Over this time,
employment has also risen strongly. During recessions, the unemployment rate increases and
employment generally falls.
FRICTIONAL UNEMPLOYMENT is the unemployment caused by the normal amount of
people changing jobs and entering the labor force; CYCLICAL UNEMPLOYMENT is created
by general downturns in business conditions; STRUCTURAL UNEMPLOYMENT results from
long-term declines of certain industries.
The NATURAL RATE OF UNEMPLOYMENT occurs when the number of jobs created
approximately equals the number of qualified workers searching for the jobs.
1. The level of GDP produced when the economy is at the natural rate of unemployment is called
the NATURAL LEVEL OF REAL GDP.
2. At the natural rate of unemployment, there is no tendency for inflation to increase or decrease.
REVIEW QUESTIONS
True or False
If the statement is correct, write true in the space provided; if it is wrong, write false. Below the question
give a short statement that supports your answer.
____ 1.
Extensive economic growth can occur if more people decide to work rather than retire early or
continue in school.
____ 2.
A government policy that encourages investment in human capital, such as providing below-cost
college educations, can help increase a nation's growth rate.
____ 3.
Intensive growth refers to economic growth that is the result of increases in the amount of a
nation's productive inputs.
79
____ 4.
Real GDP can fall even if nominal GDP rises.
____ 5.
The business cycle refers to the upward and downward movements in the general level of
economic activity.
____ 6.
The average business cycle has a length of about fifteen years.
____ 7.
Inflation is a general increase in prices.
____ 8.
A price index shows the current cost of buying a particular bundle of goods as related to the
bundle's cost in an earlier year.
____ 9.
The consumer price index (CPI) measures the rate at which consumers are buying consumption
goods.
____ 10. The GDP deflator includes only the prices of goods and services purchased by consumers.
____ 11. Persistent inflation has been a feature of the American economy throughout its history.
____ 12. Generally, inflation redistributes income only when people do not anticipate it.
____ 13. An unemployed individual is counted as part of the labor force.
____ 14. The unemployment rate equals the total number of unemployed workers divided by the total
number of employed workers.
____ 15. At the natural rate of unemployment, the inflation rate is high and rising.
____ 16. Frictional unemployment is, in part, the result of people shifting from one job to another in
response to changes in the economy.
____ 17. When an economy is fully employed, everyone who is seeking work has a job.
Multiple Choice
Circle the letter corresponding to the correct answer.
1.
Which of the following is not a test a person must pass to be counted as unemployed by the Bureau of
Labor Statistics?
a. The person did not work during the previous week..
b. The person did not turn down a job offer during the previous four weeks.
c. The person actively looked for work during the previous four weeks.
d. The person is currently available for work.
e. They are all necessary requirements for a person to be counted as unemployed.
80
2.
The stage of the business cycle during which output is at its lowest point is
a. the recession.
b. when the stock market is falling.
c. the peak.
d. the recovery.
e. the trough.
3.
Which of these statements about employment and unemployment is correct?
a. The total number of employed people has declined since the 1950s.
b. The unemployment rate has generally declined over the last forty years.
c. The unemployment rate rises in a recovery and falls in a recession.
d. Even though the unemployment rate generally has risen over the past forty years, the number of
employed workers also generally increased over the same period.
e. Whenever employment rises, the unemployment rate invariably falls.
4.
Which of the following is not a final use of GDP?
a. Consumption expenditures
b. Government expenditures for goods and services
c. Government expenditures for transfer payments to individuals
d. Investment
e. Net exports of goods and services
5.
Which of the following is an example of intensive growth?
a. Growth caused by an increase in technology that allows more output to be produced without any
change in the inputs utilized
b. Growth caused by an expansion of the nation's capital stock that takes place as a result of changes
in the nation's tax laws
c. Growth caused by an increase in the nation's labor force
d. All of the above
e. None of the above
6.
The amount of goods and services produced by an economy is measured by
a. national income.
b. depreciation.
c. consumption.
d. the business cycle.
e. real GDP.
7
Which of the following people would the Bureau of Labor Statistics classify as unemployed?
a. Someone who has a part-time job but wants full-time work
b. A person who has given up searching for a job because he or she is convinced that a job cannot be
found
c. A high school graduate who, though looking for a job, has yet to find one
d. A retired person under the age of 65
e. None of the above
81
8.
In a period with inflation, nominal GDP rises
a. more rapidly than real GDP.
b. at a rate equal to real GDP.
c. less rapidly than real GDP.
d. at a rate that bears no relationship to real GDP.
e. more rapidly than real GDP only if the inflation rate is at least 5 percent.
9.
At the natural rate of unemployment, real GDP ____ the natural level of real GDP and the inflation rate
is ____.
a. is greater than; rising
b. is greater than; rising
c. is equal to; rising, constant, or falling, depending on other factors
d. is equal to; not changing
e. is less than; falling
10. The production function says that
a. real GDP depends on the economy’s capital stock..
b. real GDP should increase when labor inputs increase.
c. real GDP rises when there are technological improvements.
d. a, b, and c.
e. None of the above
11. The Law of Diminishing Returns states that growth will
a. decline no matter what.
b. increase as the labor force expands.
c. increase as the capital stock expands and labor contracts.
d. eventually fall if there are no technological improvements.
e. None of the above
Essay Questions
Write a short essay or otherwise answer each question.
1. Suppose there are 10,000 unemployed workers and 90,000 employed workers in a nation. What is the
size of the labor force? What is the unemployment rate?
2. Suppose a nation has initially 10,000 unemployed people and 90,000 employed workers. If 5,000 of the
unemployed people decide they cannot find a job and stop searching for work, what will be the size of
the officially measured labor force? The officially measured unemployment rate?
3. What is the difference between real and nominal GDP?
82
4. Complete the following table.
Year Price Level Inflation Rate
1995
100.00
XX
1996
112.00
1997
123.20
1998
147.84
5. Suppose the price level in 1995 is 210.00. If the inflation rate between 1995 and 1996 is 5 percent, what
will be the price level in 1996?
6. What are the four final use categories of GDP?
7. What are the four phases of the business cycle?
8. Use the production function analysis, where the production function is expressed in terms of rates of
growth, to calculate the rate of growth of technological change when real GDP is growing at 5% per
year, and capital and labor are both growing at 2% per year.
9. Write an essay on the reasons why we are possibly overstating the rate of inflation.
ANSWERS TO REVIEW QUESTIONS
True or False
True
1.
Extensive growth occurs when productive inputs increase. By retiring later or leaving school
earlier, people increase the nation's labor force and so labor, a productive resource, increases.
True
2.
This sort of productivity-enhancing policy can raise intensive growth.
False
3.
The definition of intensive growth is growth caused by more output per input, not growth
caused by possessing more inputs.
True
4.
Even if the number of goods and services produced in an economy declines (so that real GDP
falls), it is possible for the inflation rate to be high enough so that nominal GDP, which
includes both the effects of higher prices and lower output, rises.
True
5.
This is the definition of the business cycle.
False
6.
The average business cycle has a duration of about five years.
True
7.
Inflation occurs when most or all prices are increasing.
True
8.
Price indices can be used to measure the rate of inflation.
False
9.
The CPI measures the cost of a bundle of goods purchased by a typical consumer.
83
False
10. The CPI includes only goods purchased by consumers; the GDP deflator includes prices of
goods purchased by all sectors of the economy.
False
11. Persistent inflation has been a feature of the U.S. economy since 1950, but in earlier years
deflation was as common as inflation.
True
12. If people anticipate the inflation, they can take actions to protect themselves.
True
13. The labor force includes both unemployed and employed workers.
False
14. The unemployment rate equals the number of unemployed workers divided by the total labor
force, which is the sum of employed plus unemployed workers.
False
15. At the natural rate of unemployment, the inflation rate neither increases nor decreases.
True
16. Because it is helpful to society for people to leave dead-end jobs for other more productive
work, this type of unemployment can benefit society.
False
17. The economy is fully employed well before everyone who is looking for work finds it; that is,
the unemployment rate remains above zero even when the economy is fully employed.
Multiple Choice
1.
b. Even if a person has recently declined a job offer, as long as the other three criteria are met the
person officially is counted as unemployed.
2.
e. The trough is the moment when the economy is at the bottom of the business cycle, passing from
the recession phase into the recovery phase.
3.
d. As the economy has grown, total employment has increased. The number of unemployed workers
has increased a little more rapidly so that the unemployment rate has been generally higher in
recent years than during earlier periods.
4.
c. The final use breakdown of GDP depends on who or what purchases the goods and services.
Transfer payments are given to people, but nothing—that is, no good or service—is received in
exchange. Thus, transfer payments are not part of the government expenditure on goods and
services. (Transfer payments can be spent by the recipients to help finance some of the
consumption part of GDP.)
5.
a. This is virtually the definition of intensive growth: Growth that occurs when more output can be
produced from the same amount of inputs.
6.
e. Real GDP measures the number of goods and services produced by an economy.
7.
c. The other situations do not pass all three criteria; the person in part a. has a job while the people in
parts b. and d. are not actively engaged in searching for work.
84
8.
a. Nominal GDP includes the effects of both changes in the level of actual production (measured by
real GDP) and changes in the prices of goods (measured by the inflation rate).
9.
d. When the economy is at the natural rate of unemployment, employment is not changing and so
there is no wage pressure either upwards or downwards. Because employment does not change, the
economy is producing at the natural level of real GDP. And, because there is no wage pressure, the
inflation rate is constant.
10. d. The production function says output depends on labor, capital, and technology.
11. d. The law states that output growth will decline unless technology improves.
Essay Questions
1. The labor force equals 100,000, the sum of the employed workers plus the unemployed workers. The
unemployment rate equals 10 percent, the number of unemployed divided by the labor force.
2. The labor force now equals 95,000. The unemployment rate is 5.3 percent or (5,000 unemployed) /
(95,000 labor force). In comparison with Question 1, if unemployed workers become discouraged about
finding jobs and leave the labor force, the unemployment rate declines.
3. Real GDP measures the number of goods and services produced by an economy. Nominal GDP is the
market value of these goods and services. Nominal GDP depends on the quantities produced as well as
on their prices. Real GDP depends on only the quantities.
4.
Year Price Level Inflation Rate
1995
100.00
XXX
1996
112.00
12.0%
1997
123.20
10.0%
1998
147.84
20.0%
For an example of how these answers are calculated, take the inflation rate for 1998. To calculate the
inflation rate for 1998, use
(147.84 - 123.20) / (123.20) = 20%.
The other inflation rates are calculated similarly.
5. The price level will be 220.5. If the inflation rate is 5 percent, the price level in 1996 will be 5 percent
higher than in 1995. Five percent of 210.0 is 10.5. Thus, the price level in 1996 equals 210.0 + 10.5 =
220.5.
6. The four final use categories of GDP depend on the sector that purchases the good.
a. Consumption: Goods purchased by the household sector.
b. Government purchases of goods and services: Goods purchased by the government sector.
c. Investment: Goods purchased by firms to add to their capital stock.
d. Net exports of goods and services: Goods purchased by foreign residents less the purchase of
foreign goods by domestic residents.
85
7. The four phases of the business cycle are the recovery (when the economy is growing most rapidly), the
peak (when the economy is poised at its highest level of output), the recession (when the economy is
declining) and the trough (when the economy is at its lowest point).
8. The production function, expressed in annual rates of growth, says that the growth of output will equal
the growth rate of inputs plus the growth rate of technology. With inputs both rising at 2% per year, this
means that technology is growing at the rate of 3% per year.
9. The boxed example in the text discusses the findings of the Boskin Commission, which concludes that
we are overstating inflation because we do not properly account for the changing shape of consumer
budgets and cannot properly adjust for quality improvements.
86