Download UNIT TWO: INTRODUCTION INTO MACROECONOMICS Part One

UNIT TWO: INTRODUCTION INTO MACROECONOMICS
Part One ( the first 12 pages: testing will occur at the end of Part One)
Macroeconomics: Focus is one National and International Economics. As opposed to
Microeconomics which focuses on individual businesses and product markets.
I.
A.
Basic Macroeconomics
Macroeconomics
National/International
Aggregate Demand/Supply
Inflation
Unemployment
GDP
Economic Growth
Exchange Rates
vs.
Microeconomics
Businesses and Markets
Supply/Demand of Products
Price Changes (Ind. Prod)
Market Competition
Stock Market Performance
Profits
B. Key Concepts/Terms
1. Gross Domestic Product (GDP): the money value of all NEW FINAL goods and services
PRODUCED IN A COUNTRY in a GIVEN YEAR. ***Most often used measurement of
economic health.
a. Key distinctions
1. Final Goods: products in their final form
Vs.
Intermediate Goods: go into the making of a final good
***Example: a computer chip that is purchased by Microsoft to help build a personal
computer. The chip is an intermediate good while the personal computer is a final good.
2. Must be new (nothing used is counted in GDP)
3. What matters is WHERE something is produced and the YEAR in which it
is produced. (What does not matter is the country of ownership of the business or the year in
which the product is sold.)
4. Only calculates legal exchanges (illegal/underground economy-while
substantial-does not count.)
b. Formulas: how to calculate GDP***
Expenditure Model: Consumption ( C ) + Investment (I) + Government Spending on
Goods and services (G) + Net Exports (Nx)
Income Model (National Income): Wages (cost of Labor) + Rent (cost of Land) + Interest
(cost of Capital) + Profit
*****It is essential to be constantly aware of the equivalence of GDP and National Income.
c. Real GDP (GDP adjusted for inflation) vs.
Nominal GDP (unadjusted)
****It is essential to use Real terms for historical comparisons
d. Limitations on the use of GDP as the major indicator of economic well-being.
****This is a typical course of study for us. Learn a lot about an important statistic, but also
learn its limitations.
1. There are some negative things that can happen to a country that
because they cause an increase in government spending-can cause an
increase in GDP. (This does not make the good economically in the
long run or indicate you should want these things to happen)
a.
b.
2. Pollution issues: Pollution is not good for the long term health of a
people or their economy (witness the issues China will be dealing
with)-BUT BY ALLOWING MANUFACTURES TO POLLUTETHEY CAN PRODUCE MORE PRODUCTS AT A LOWER COST,
AND THIS WILL INCREASE GDP. (AGAIN WITNESS CHINA)This does not make polluting a good economic policy.
3. Overall GDP Numbers can be deceptive-especially when comparing
large population countries to smaller countries.
China
vs.
Belgium
****For this purpose Per Capita GDP (GDP divided by population) is a better statistic.
4. Underground and Illegal Economies
a. The Term Underground Economy usually refers to Barter and
Cash exchanges which do not get counted in GDP.
b. Illegal transactions are things like drug trades. This can be an
important part of some economies, but are not recorded in GDP
statistics.
****For many underdeveloped nations this can be a big part of their economic activity-but they
are not counted in official GDP stats.
2. Aggregate Demand: The amount of Real GDP that will be demanded at all possible price
levels. (Calculated just a Expenditure GDP is: C+I+G+NX)*****Important to remember
Graphing Aggregate Demand
Price Level
________________________________________________
Real GDP
a. Assume that the federal government cut the personal income tax:
1. Would this increase or decrease Aggregate Demand? Why?
2. Using the graph above illustrate the change in Aggregate Demand you
identified in (1) and how that shift will affect equilibrium price level and
equilibrium quantity demanded/supplied.
3. Aggregate Supply: The amount of Real GDP that will be produced at all possible price
levels.
Graphing Aggregate Supply
Price Level
____________________________________________________
Real GDP
a. Assume that the federal government increases environmental regulation of industry
in response to the threat of global climate change
1. Will this action increase or decrease aggregate supply? Why?
2. Using the graph above illustrate the change in Aggregate Demand you
identified in (1) and how that shift will affect equilibrium price level and
equilibrium quantity demanded/supplied.
****We will typically not use any specific numbers when we graph Aggregate Demand/Supply.
We could and will do it occasionally. The key thing will be to see the relative changes that
occur-is Price Level and/or GDP going up or going down.
****There is no formula that we use to calculate Aggregate Supply
****We will go into much more depth on Aggregate Demand and Aggregate Supply in Unit 3.
****key thing to focus on with aggregate supply are things that change the cost of producing
products and things that change productivity.
4. Inflation: a rise in the general level of prices (aka price level)
a. Most often used measurement of inflation is the Consumer Price Index (CPI)
b. It is important to realize that inflation is NOT WHEN GAS PRICES GO UPIT IS WHEN THE OVERALL PRICE LEVEL GOES UP.
***More on inflation in Part 2 of this Unit.
5. Deflation: a decline in the general level of prices (Price Level)
a. ***While this sounds good, it is very bad for an economy-and is avoided if
possible. (discuss current FED policy)
6. Unemployment Rate: Percentage of the Civilian Labor Force that is not working.
CLF (Non-defense, 16 or older, either working Full-time, or actively pursuing Full-time
work. (currently the unemployment rate is _______)
***More on unemployment in Part 2
7. Economic Growth: Refers to the long term ability of a country to produce Goods and
Services.
***It will be important to be able to distinguish between what helps an economy in the
short-run (like the Stimulus Package) vs. what helps and economy in the long-run (like
lowering Federal Deficits and Debt)-they can often be in conflict.
****More on unemployment in Part 2
8. The Business Cycle: refers to the historic pattern (in market economies) of recurring
expansions and recessions. It is accepted by most mainstream economists that this pattern is
natural to market economies.
Illustration (see Board)
________________________________________________________________________
1980
1985
1990
1995
2000
2005
2008
1.
2.
3.
4.
Expansion: Period of Real GDP Growth.
Peak: Point of maximum Real GDP Growth
Recession: 6 consecutive months of decline in Real GDP.
Trough: Point at which a recession bottoms out, and begins to
grow again. (“Finding a bottom”
****Notice that the expansion last much longer than the recessions-and that the trend line of
GDP Growth (through the ups and downs) is in an upward direction.
9. The Circular Flow of the Economy: illustrates that the money businesses spend to produce
products comes back to them when consumers/households purchase products.
Illustration (see board)
PRODUCT MARKET
HOUSEHOLDS
FIRMS
FACTORS MARKET
PRODUCT MARKET: WHERE CONSUMER GOODS ARE BOUGHT AND SOLD
FACTORS MARKET: WHERE THE FACTORS OF PRODUCTION ARE BOUGHT AND SOLD.
FIRMS: THE BUSINESSES THAT PRODUCE/SELL GOODS AND SERVICES (THEY BUY FACTORS OF
PRODUCTION AND SELL CONSUMER GOODS.
HOUSEHOLDS: PROVIDE THE FACTORS OF PRODUCTION AND PURCHASE CONSUMER GOODS.
LEAKAGES: when savings is greater than investment (money leaves the circular flow)
INJECTIONS: when investment is greater than savings (extra money enters the circular flow
III. HISTORICAL OVERVIEW OF MACROECONOMICS
A. Pre-Great Depression:
1. Classical Economics: belief that government should have little or no role in
regulating economic activity (aka: Laissez-faire capitalism)-Adam Smith-later Thomas Malthus
and David Ricardo. BECAUSE THE ECONOMY IS SELF-CORRECTING IN THE LONG
RUN.
Below are some of the concepts that Classical Economists believe in-and to some degree they
show how the economy is self-correcting in the long run.
a. Price as a Natural Stabilizer: when economies are in a recession,
prices will begin to drop. They will drop to the point where that increases aggregate demand,
and this will cure the recession.
When an economy is experiencing severe inflation, prices will rise to the point where aggregate
demand will be reduced, and this will correct the inflation.
****IN THE LONG RUN PRICES ARE FLEXIBLE (FLEXIBLE PRICES)
b. Say’s Law: Belief that the act of producing products creates the demand for those
products-ie “Supply Creates its own Demand” (THINK CIRCULAR FLOW)
Implication of Both Concepts: economies if left alone (by government) are self-correcting. (in
the Long Run)Dominated economic thinking until the Great Depression which seemed to show that economies
were not self-correcting
B. Demand-side Economics
1. Developed by John Maynard Keynes: The General Theory of
Employment, Interest, and Money (1936)
2. Believed that recessions were caused by a drop in consumer spending and
business investment. HE DEVELOPED THE FORMULA(C+I+G+NX)
3. Government must respond to correct this problem
a. Fiscal Policy (Taxing and Spending Policy)
1. Decreases Taxes on Individuals (increase C)
2. Increase Government Spending (both on Goods and Services WHICH
Increases G / and Transfer Payments which increase C)
3. Automatic Stabilizers: government programs that automatically
put money into the hands of consumers during recessions. (Increases C)
Examples
***Discuss debate between US and Europeans over Stimulus-VS. Automatic Stabilizers.
b. Monetary Policy ( Federal Reserve System’s aka THE FED control of interest
rates)
Lower Interest Rates to increase Investment (I): which is both business investment in new plants
and equipment (technology) and new home purchases by households
4. Other important Keynes Contributions
3 Part Aggregate Supply Curve
Classical Phase
Intermediate
(Keynesian Phase)
Price Level
___________________
(Recession Phase
________________________________________________
REAL GDP
Interpretation and Concepts.
a. Horizontal or Recession Phase: as an economy comes out of a recession more Real
GDP can increase without an increase in prices. (under-used capacity)
b. Upward Sloping-Keynesian Phase: as prices begin the rise as the economy expands
producers react to higher prices by producing more products.
1. Sticky Wages: Keynesian belief that as the economy expands (GDP
rises) wages will go up only slowly. Prices will rise faster than wages.
Significance: this explains the diagonal supply curve. Businesses
will produce more as prices rises, because they can make more
money on the additional products they produce.
This is very important-so let’s make sure we understand this. (I MAY REDRAW GRAPH
HERE)
c. Vertical or Classical Phase: at this point prices will continue to rise, but production
does not increase.
1. Flexible Wages: as an economy expands wages will rise easily as
prices rise. As prices rise, so will wages.
Significance: this is the explanation of the vertical supply curve. At
this point there is not advantage to produce more as prices rise,
because any additional revenue is offset by increased cost of labor
(wages)
*****This also points out two places of conflict between modern Classical Economists and more
Mainstream Demand-side Economists
Demand-side (Keynesian)
vs.
Classical
1. Supply Curve is mostly upward sloping
Supply Curve is mostly vertical
2. Wages are mostly sticky
Wages are mostly flexible
C. Stagflation of the late 70s:
1. In the mid-1970s the oil producing countries in the Middle East (OPEC)
imposed a boycott on the selling of oil to the US. (“Arab Oil Boycott)-this
caused a huge increase in gas/energy prices in the US.
2. Something like this is caused a “Supply Shock”: something that causes
significantly less to be produced because of a sharp and unexpected increase
in the cost of production (in this case energy costs)
3. Supply Shocks cause a shift in the Aggregate Supply Curve to the left.
Illustration
Price Level
___________________________________________
Real GDP
4. This causes high rates of inflation, and low GDP Growth (high
unemployment)-this is called Stagflation.
****Contradicts a major Demand-side (Keynesian) belief called the Phillips Curve.
HISTORICAL RELATIONSHIP BETWEEN THE RATE OF INFLATION AND
UNEMPLOYMENT-WHEN ONE RISES THE OTHER TENDS TO FALL
****Keynesian Economics does not have a good response for Stagflation. (Explain)
5. Led to the Development of Supply-side Economics:
Economic Theory that focuses on increasing Aggregate Supply, rather than Aggregate Demand,
as the preferred way to correct economic problems.
****Supply-side economics not accepted as Theory in mainstream economics.
****If it does work-major advantage is to growth the economy (lower unemployment) with- out
an increase in prices (as the Phillips Curve would predict)
Illustration of Supply-side effect on Stagflation
PRICE
LEVEL
_______________________________________________________
REAL GDP
a. Supply-side Policies and Beliefs
1. Cut marginal tax rates on individuals and businesses.
Marginal Tax Rate: additional tax paid on each additional dollar earned.
a. Effect of lower marginal rates on individuals
b. Effect of lower marginal rates on businesses
**”Laffer Curve”
-Lower Marginal Tax rates increase individual and business productivity so much that the
Tax Base (the amount of money available to tax) Expands so much that a cut in tax rates increase
the revenue coming into the federal government.
****Hard to prove whether this is correct or not. This is a big part of the political debate over the
effect tax cuts have on deficits.
2. Deregulation: reducing or eliminating government regulation on
businesses. (remember this lowers the cost of production and increases Aggregate Supply)
****Key is the trade-off between benefits of regulation and the costs of deregulation-and
visa versa.
__________________________________________________________________
Macroeconomic Theory Review (Some of this will expand as we move thru the year) BE FAMILIAR
WITH THE FOLLOWING
I.
Classical Economic
1. Define: Macroeconomic Theory that believes (in the long run) market economies are selfcorrecting. Hence the theory supports as little government role in the economy as possible.
II.
2.
Say’s Law: Belief that the act of producing products creates the ability to purchase products.
Supply creates Demand. One of the ideas that supports economies being self-correcting.
3.
Flexible Prices (Price as a Natural Stabilizer): idea that prices fall easily during recessions and
rise easily when a economy grows too quickly. The lower prices during a recession will at
some point increase Aggregate Demand (correcting the recession); higher prices will at some
point lower Aggregate Demand thus correcting inflation.
4.
Flexible Wages: idea that wages rise easily as prices rise. This idea supports the concept of a
more vertical Aggregate Supply Curve.
5.
Long-run Aggregate Supply (vertical representation of the Aggregate Supply Curve) AKA
Full-employment GDP or Potential GDP.
6.
No policy role for government (Classical economists support a very limited role for the
government in the economy.
Demand-side Economics (Keynesian Economics)
1. Define: Macroeconomic Theory that focuses on increasing Aggregate Demand as the means of
correctly recessions. Implies a significant role for the government in the economy.
2.
Phillips Curve: Illustrates the historical relationship between the Unemployment Rate and the rate
of Inflation. The relationship is that when one of those statistics go up the other one goes down
3.
Sticky Prices: Belief that prices to not drop easily during a recession. Hence the reason Keynes did
not believe that recessions will correct themselves thru lower prices.
4.
Sticky Wages: Belief that as an economy grows and prices rise; wages will not rise easily as
prices rise. This is the explanation for the upward sloping/diagonal version of the Aggregate
Supply Curve.
5.
Short-run Aggregate Supply: upward sloping/diagonal representation of the Aggregate Supply
Curve.
6.
Use of Fiscal/MONETARY Policy to correct Recessions
Fiscal Policy
Lower Taxes
Increase Government Purchases/Spending
Monetary Policy
FED works to lower interest rates
7.
III.
Automatic Stabilizers: government programs (such as Unemployment Compensation) that
automatically give money to people hurt by a recession (the unemployed)
Supply-side Economics (Reaganomics)
1. Define: Macroeconomic Theory that focuses on increasing Aggregate Supply (rather than
Aggregate Demand) as the best way to correct recessions. AKA Reagonomics
2. Laffer Curve: Belief that reductions in marginal tax rates on individuals and business will create
major incentives to make more money. By doing this, lower marginal tax rates can increase the tax
base so much, that cuts in taxes can increase government revenue.
3. Use of Marginal Tax Rate cuts (Marginal Tax Rates is the additional tax rate paid on each
additional dollar earned.
4.
Use of Deregulation (reducing or eliminating government regulation on businesses: lowers
the cost of production and increases Aggregate Supply)
PART II: FOCUS ON ECONOMIC GROWTH, INFLATION AND
UNEMPLOYMENT.
I. Economic Growth (Policy) vs. Stabilization Policy (More on this in Unit 3)
A. Stabilization Policy: Short term policy used by a National Government to
combat either recessions (unemployment) or inflation.
****Short-term
****Keynesian
1. Short-run Phillips Curve: illustrates the historic relationship between
the rates of inflation and unemployment.
a. They tend to move in opposite directions. Implies a short-term
trade-off: in order to reduced unemployment-inflation may rise,
in order to reduce inflation-the unemployment rate may rise.
Short term (run) Phillips Curve
Rate of
Inflation
__________________________________________
Unemployment Rate
2. Stabilization Policy (Keynesian)
a. To combat recessions (unemployment)-Expansionary
1. Fiscal Policy
a. Tax Policy: lower taxes especially on households-increase
Consumption (C)
b. Spending Policy
1. Government Purchases: increase government
Purchases of goods/services (increases G)
2. Transfer Payments: increase Transfer payments-leads
To an increase in consumption (C)
2. Monetary Policy: FED works to lower interest rates which will increase
Investment (I): business investment and households purchases of new homes.
Illustrate effects of Expansionary Policy on Aggregate Demand, Price Level, and Output
PRICE
LEVEL
__________________________________________________
REAL GDP
b. To combat inflation (Contractionary)
1. Fiscal Policy
a. Tax Policy: increase taxes on individuals-lowers Consumption
b. Spending Policy
1. Government Purchases: decrease the purchases of
goods/services-lowers G
2. Transfer Payments: decrease Transfer Payments to reduce
Consumption.
2. Monetary Policy: FED works to raise interest rates- lowers
Investment (I)
PRICE
LEVEL
_____________________________________________
REAL GDP
****SHORT TERM POLICY
*****SHORT RUN PHILLIPS CURVE TRADE-OF (Unemployment vs. Inflation)
B. Economic Growth (Policy): Long term-Government actions that can create an
increased potential in the Economy. Economists who focus on the long run often do not believe
that there is an inherent trade-off between inflation and unemployment.
Two Illustrations of Long Term Economic Growth (or decline)
Long Run Aggregate Supply (aka Full-employment GDP or Potential GDP)
PRICE
LEVEL
_____________________________________________
LRAS 1 = Increase Long Term Economic Growth
LRAS 2 = Reduction in Long Term Growth
REAL GDP
Long-run Phillips Curve: illustrates that in the long-run there is no relationship
between the rates of inflation and unemployment.
RATE OF INFLATION
_
______________________________________
UNEMPLOYMENT RATE
***VERTICAL LINE IS ALSO CALLED THE NATURAL RATE OF UNEMPLOYMENT
LRPC 1 = Improvement (Decline) in Natural Rate of Unemployment
LRPC 2 = Increase in Natural Rate of Unemployment
1. Factors that affect Economic Growth ****
a. Changes in the size of the Labor Force
i. Increase in the size of the labor force will increase long term
economic growth (more products can be produced)
ii. Decrease in the size of the labor force will decrease long term
economic growth (less products will be produced)
iii. Government Policies that can change the size of the labor
force.
1. Change legal minimum working age (lower the age
increases the work force, raising the age with decrease
the workforce)
2. Immigration policy: allowing more immigration
increases the workforce, while decreasing immigration
decreases the workforce.
****don’t let your political view about immigration policy and/or child labor
affect your economic answers. All other things being equal-more immigration is
better for long term growth-less immigration hurts long term economic growth.
And to some degree child labor is an economic benefit-though you can argue that
long term productivity would be increased if children were educated rather than
working. (key is all other things being equal more labor = more production =
increase in long term economic growth)
b. Changes in Capital Stock (amount of money available for businesses
to borrow for investment)-Changes in Capital Formation: Includes
Capital Stock but also evaluates the ease of borrowing. (lower
interest rates-easier borrowing rules etc….)
i. Increases in Capital Stock/Formation increase long term
economic growth
ii. Decreases in Capital Stock/Formation decrease long term
economic growth.
iii. Government Policies
1. Any policy that increases National Savings (this is a big
part of the money banks have to lend to businesses for
investment and households for purchasing new homes.
Examples of Policies
•
•
•
•
Taxing consumption rather than income (National Sales Tax aka a Value Added Tax)
Offering tax incentives to save money rather than spend it. (Health Care Savings
Accts; Education Savings Accts, various retirement accts: IRA, Roth IRA, 401 K;
403 B)
Anything that encourages savings, will increase Capital Stock/Formation, and will
increase Long Term Economic Growth.
This may hurt the economy in the short run, but will help the economy in the long
run.
2. The Federal Deficit and Debt
a. As Deficits increase, the government is borrowing more money. This
causes “The Crowding Out Effect: increased government borrowing to
finance the deficit increases the demand for Loanable Funds, and this
raises Real Interest Rates (interest rates adjusted for inflation)
•
This reduces Capital Stock (the amount of money available for the private sector to
borrow, and reduces Capital Formation by raising Real Interest Rates and making it
more costly to borrow money for Investment. (Business Investment and Household
buying new homes)
•
Or by raising Real Interest Rates businesses are less likely to investment in
Technology which reduces productivity and hurts long term economic growth.
b. As deficits are reduced the opposite happens. Lowering deficits cause
“The Crowding In Effect”. Less government borrowing reduces the
demand for Loanable Funds and lowers Real Interest Rates.
•
This increases Capital Stock (the amount of money available for the private sector to
borrow, and increases Capital Formation by lowering Real Interest Rates and making
it less costly to borrow money for Investment. (Business Investment and Household
buying new homes)
•
Or by lowering Real Interest Rates businesses are more likely to investment in
Technology which increases productivity and improves long term economic growth.
c. Changes in Productivity: measures the amount of products produced
by one worker.
1. Increases in productivity increase long term economic
growth
2. Decreases in productivity decrease long term economic
growth.
3. Factors that affect Productivity
a. Investments in Technology
b. Investment in Human Capital: Education and Training of the
Workforce (all other things being equal-increased investment in
education increases productivity and increases economic growth.)
****The major way government can affect investments in Technology and Human Capital is
through the tax code-“Targeted Tax Cuts, Targeted Tax Credits”. Also anything that
increases Capital Formation directly, usually indirectly improves Productivity.
*****THE CROWDING OUT EFFECT: WHEN THE FEDERAL GOVERNMENT
INCREASES DEFICITS (DEFICIT SPENDING) THE DEMAND FOR LOANABLE
FUNDS INCREASES-THIS CAUSES A RISE IN INTEREST RATES-WHICH IS BAD
FOR LONG TERM ECONOMIC GROWTH.
Illustrate Changes in Economic Growth (Economic Potential in the Long-run)
Shifts in Long-run Aggregate Supply
Price Level
________________________________________________
(Real GDP)
Changes in Production Possibility Frontier
Product One
_______________________________________________
Product Two
Shifts in the Long-run Phillips Curve
Rate of Inflation
____________________________________________
Unemployment Rate
IV.
Inflation: General rise in the level of prices (Price Level)
A. Measurements of Inflation:
1. Consumer Price Index (CPI) Most often cited measurement of inflation.
a. Index Number: measures price changes in a selected (sample)
group of products.
b. Market Basket: name given to the selected group of products.
c. “Index Number Problem” does not measure price changes for all
products-in the case of the CPI does not measure how inflation is affecting all groups.
(groups who do not buy the Market Basket as much as others)
****Senior Citizens
****Low incomes
***Does not make the stat bad-just shows a limitation/consideration.
****Same reason that the Dow Jones Index is not always the best measure of how the stock
market is doing in general.
3. Other Measurements of Inflation
a. GDP Deflator: measures prices changes in all products during a given
year. (Broadest and most historically accurate measure of inflation-used
to create “Real” data for historical purposes.
b. Core CPI: CPI minus prices for energy and food. (this are taken out
because they can be unstable in the short run-this is the measure of
inflation used by the Federal Reserve)
c. Producer Price Index (PPI): Measures changes in the prices businesses
pay for the factors of production. Sometimes referred to has changes at the “Wholesale”
level (businesses buying products etc… for sale later) vs. the CPI which measures inflation
at the retail level (where consumers are purchasing products) The PPI can be used as a
measurement to predict future inflation.
B. Types of Inflation (Labels)
1. Demand-side Inflation: inflation that is caused by a significant increase in
Aggregate Demand. This is the type of inflation that can be created by Keynesian
Expansionary Fiscal and Monetary policy.
2. Supply-side Inflation: Inflation that is caused by a significant decrease in
Aggregate Supply. This can be caused by Supply Shocks. Stagflation is an example of
Supply-side Inflation.
3. Spiraling Inflation: Slow gradual inflation that increases a little bit each
year. (1-2 percent annual inflation). This is a beneficial type of inflation (because remember
deflation is bad)
4. Galloping Inflation: higher rates of inflation that grow each year over a
period of time. (1976: 5 percent-1977: 6 percent- 1978: 7 percent-1979: 8 percent ….
****This is the type of inflation that must be halted by Keynesian Contractionary Policiesespecially in the early 1980s this was done by the FED significantly raising interest rates.
5. Hyperinflation: extremely high rates of inflation, over very short periods
of time (for instance 25 percent inflation daily for a 2 week period as Brazil had in the later
part of the 20th century)
*****This typically happens only in less developed countries with weak Central Banks. We
will talk more about this in Unit 6.
6. Stagflation: high rates of inflation combined with high rates of
unemployment (aka low GDP growth)
*****Significant because it violates the Phillips Curve. Very damaging-very difficult for
government to correct.
C. Those who benefit and those who are hurt from unexpected inflation
Expected (Anticipated) Inflation: what economist predict inflation will be over various
periods of time. Businesses, banks, unions etc… make decisions for the future based on
these predictions.
Actual Inflation: what the rate of inflation actually is over those periods of time.
****Significance of predicting future rates of inflation
Some groups benefit from unanticipated inflation-Some groups are more hurt by it
Winners
vs.
Losers
1. Product Market
Producers/Firms: because they receive higher
Prices for their products-but the wages they
Are paying do not rise (sticky wages)
(Greater marginal revenue)
Consumers/Households: prices they
pay for products rise, but
their wages do not rise.
(Real Income Drops)
Assumes wages are ______?
2. Labor Market
Employers: same as above
Employees: same as above
3. Credit Market (where money is borrowed/loaned)
Borrowers: because they pay loans back
With a lower Real Interest Rate (will be
Explained below)
Lenders: because they are being
repaid at a lower Real
Interest Rate.
Other Considerations
Menu Costs: associated with Restaurants-costs they incur when they raise prices.
People who have “Fixed Incomes, Fixed Return on Investments, Fixed Return on Savings-in
each case those people are hurt by unanticipated inflation.
****The reverse is true if actual inflation is lower than was anticipated-then Consumers win,
Employees win and Lenders win.
D. Inflation and Interest Rates
1. How various interest rates are calculated
Nominal Interest Rates (What the Lender charges Borrowers)
Anticipated Inflation
+
Rate of Return (the Real Interest Rate the
Lender wants to receive)
Example:
Real Interest Rate (after the fact calculation)
Nominal Interest Rate (what the bank
Chargers Borrowers)
Example
minus
Actual Rate
Rate of Inflation
****This explains why the winners and losers occur in the Credit Market
E. Deflating: process of creating “Real” statistics (adjusted for inflation)-must be done to
compare economic statistics over time.
Example:
Nominal GDP divided by CPI = Real GDP
***GDP Deflator is usually used for historical purposes. (but not in this class: we will do some
CPI calculations later)
IV. Unemployment and the Unemployment Rate
A. Unemployment Rate: Percentage of the Civilian Labor Force that is not working,
(but still looking for full-time work)
Civilian Labor Force: 16 or older (non-Military) who are working full-time, or who are trying
to work full-time.
B. Concepts: point to some limitations of the unemployment rate as a measure of all
workers well-being.
1. Discouraged Workers: Unemployed who are no longer actively looking for
full-time work. Since they are no longer counted in the CLF-they are not counted in the
Unemployment Rate.
a. Unemployment rate underestimates the number of unemployed
(especially during a long recession): discuss current statistics
b. The unemployment rate also recovers more slowly as the economy
expands. Because as discouraged workers start looking for work-the re-enter the Civilian Labor
Force. “Lagging Indicator”
2. Underemployment: refers to people who are working part-time, but want/need fulltime work. (technically called “INVOLUNTARY PART-TIME WORKERS)
***THEY ARE COUNTED AS EMPLOYED – BUT ARE NOT MAKING THE MONEY
THEY NEED. Discuss current statistics
4. Hidden Unemployment: Refers to full-time workers who have lost regular overtime
hours.
***COUNTED AS EMPLOYED, BUT HAVE LOST SOME OF THEIR PREVIOUS
EMPLOYMENT
C. Types (Labels) of Unemployment
1. Frictional Unemployment: naturally/regularly occurring unemployment. Can
refer to people who are “in-between jobs” (people who have left one job, but
are expecting to easily get another job), and also refers to workers who are
“seasonally unemployed” (for instance in beach resort industries during the
winter, or ski resorts during the summer)
There is always some frictional unemployment in the economy. Hence the unemployment
rate is never zero. In fact “Full Employment” is considered to be around 5 percent.
2. Cyclical Unemployment: refers to workers who have lost their jobs as a
result of a recession. Often referred to as “laid-off”. In the past these are the
workers who expect to get rehired as the economy recovers.
3. Structural Unemployment: workers who have lost their jobs due to major
changes in the economy or major changes in their industry. These workers
will typically not return to the job they lost.
Examples: jobs lost to Free-Trade: businesses moving overseas to cheaper labor markets.
Auto Industry moving to Mexico. Many high tech jobs moving to India etc….
D. Full Employment: WHAT THE UNEMPLOYMENT RATE IS PREDICTED TO BE
WHEN THE ECONOMY IS AT ITS PEAK. THE RATE IS APPROX 4-5 PERCENT.
***Number maybe readjusting to more 5-6 percent.