Download Intro_To_Inflation_and Unemployment

Intro to Inflation and
Unemployment
AP Economics: Macro – Unit II
Mr. Griffin
MHS
Part 1: The Goal of Economic
Growth
ECONOMIC GROWTH
An increase in real GDP over time
An increase in real GDP per capita
over time
•Growth as a Goal
•Arithmetic of Growth
•Rule of 70
•Main Sources of Growth
•Increases in Resources
•Increases in Productivity
ECONOMIC GROWTH
Growth in the United States
•Improved Products and
Services
•Added Leisure
•Other Impacts
•Relative International
Growth Rates
THE BUSINESS CYCLE
Phases of the Business Cycle
RECESSION
TROUGH
Level of business activity
PEAK
Time
RECOVERY
The Capacity to Produce:
Potential GDP
• Potential GDP = the real GDP that the
economy could produce if the labor force
and other resources were fully employed
• Production Function = Mathematical
depiction of the relationship between an
economy’s inputs and outputs.
The Capacity to Produce:
Potential GDP
• The growth rate of potential GDP depends
on:
– The growth rate of the labor force
– The growth rate of the nation’s capital stock
– The rate of technical progress
The Economy’s Production
Function
B
Y1
A
Y0
0
K
L0 Labor input
(hours)
(a)
Y1
Real GDP
Real GDP
M
K1
A
Y0
0
K0
L0 Labor input
(hours)
(b)
The Growth Rate of Potential
GDP
• Growth rate of potential GDP depends on:
– Growth rate of the labor force
– Growth rate of the nation’s capital stock
– The rate of technical progress
• Labor productivity
– Labor productivity = total output/total hours
– This measures output per hour of work
The Growth Rate of Potential
GDP
• GDP can be expressed as:
GDP = Hours of work x Labor productivity
• The equation above in growth rates is:
Growth rate of potential GDP = Growth rate of labor
input + Growth rate of labor productivity
Recent Real GDP Growth in the
U.S.
Part 2: The Goal of Low
Unemployment
The Human Costs of High
Unemployment
• Unemployment rate = the number of
unemployed people, expressed as a
percentage of the labor force
• Unemployment entails a loss in output for
the society as a whole, a loss that can
never be recovered.
The Economic Costs of High
Unemployment
UNEMPLOYMENT
Measurement of Unemployment, 2002
Total
Population
288,600,000
Under 16
and/or
institutionalized
74,700,000
Not in
labor
force
71,400,000
134,200,000
Employed
Unemployed
Labor
force
142,500,000
8,300,000
UNEMPLOYMENT
Measurement of Unemployment, 2002
Unemployment
rate
unemployed
=
labor force
x 100
Part-Time Employment
Discouraged Workers
Actual and Potential GDP in the
United States
11,000
10,500
10,000
9,500
9,000
Actual GDP
8,500
8,000
7,500
Billions of 2000 Dollars
7,000
6,500
Potential GDP
6,000
5,500
5,000
1982 –1983
Recession
4,500
1974 –1975
Recession
4,000
3,500
1960s
Boom
3,000
2,500
1957 –1958
Recession
2,000
1955
1959
1960 –1961
Recession
1963
1967
1971
1975
1979
Year
1983
1987
1991
1995
1999
2004
UNEMPLOYMENT
Economic Costs of Unemployment
GDP Gap and Okun’s Law
The amount by which actual GDP
falls short of potential GDP
For every 1% unemployment
exceeds the natural rate...
Approximately a
2% GDP Gap occurs
The Human Costs of High
Unemployment
• Unemployment is a serious personal
problem for the unemployed.
– Income forgone
– Psychological distress
The Human Costs of High
Unemployment
• In good times and bad some groups suffer
more than others from unemployment
– Below average unemployment rates:
• Married men
• Well-educated workers
– Above average unemployment rates:
• Teenagers
• Nonwhites
• Blue-collar workers
Unemployment Rates for
Selected Groups, 2004
40
35
31.7
Percent
30
25
20
17.0
Percent
15
10.4
10
5
0
8.0
2.7
3.1
College
Graduates
Married
Men
8.5
Women
Adults
Blacks
Who Who Did Not
Maintain Graduate from
Families High School
Teenagers
Black
Male
Teenagers
Counting the Unemployed: The
Official Statistics
• The BLS estimates the labor force, the
employed, and the unemployed.
– These distinctions cannot deal very well with
the problems of discouraged workers and of
“hidden” or “disguised” unemployment.
– Discouraged Worker: An unemployed person
who gives up looking for work and is therefore
no longer counted as part of the labor force.
Types of Unemployment
• Frictional unemployment is the normal
movement of workers from one job to
another.
• Structural unemployment exists when
workers’ characteristics do not fit with
employers’ requirements.
• Cyclical unemployment occurs when the
level of economic activity declines
How Much Unemployment is
“Full Employment”?
• It was once thought that 4% was a good
target.
• Events from the early 1990s through 2002
have left economists uncertain of the fullemployment unemployment rate.
– Government reports estimate full employment
unemployment is slightly above 5 percent.
Unemployment Insurance: The
Invaluable Cushion
• Unemployment insurance cushions (but
does not completely prevent) the monetary
loss to some (but not all) unemployed
people.
• Payroll taxes and unemployment benefits
– Spread the costs of unemployment over the
entire population
– Do not eliminate its basic economic cost
GLOBAL PERSPECTIVE
Unemployment Rates 5 Industrial Nations
1992 - 2002
15
France
U.K.
10
Germany
U.S.
Japan
5
0
1992
1997
2002
Source: Economic Report of the President, 2003
Part 3: The Goal of Low Inflation
Inflation: The Myth and the
Reality
• The costs of inflation are less obvious than
those of unemployment, yet people
certainly fear it.
• Inflation and Real Wages: Inflation does
not typically erode real wages, because
increases in nominal wages compensate
for the rising prices.
Rates of Change of Wages and
Prices in the U.S.
11
11
10
10
Wages
9
9
8
8
7
7
6
6
5
5
4
4
3
3
Prices
2
2
Percentage
Change in Wages
1
1
0
0
1950
1960
1955
1970
1965
1975
Year
1980
1990
1985
2000
1995
Percentage Change i
Reasons for Wages
to Increase
Amount
Higher productivity
2%
Compensation for higher prices
3%
Total
5%
Inflation: The Myth and the
Reality
• The Importance of Relative Prices:
Inflation is not usually to blame when
some goods become more expensive
relative to others.
Inflation as a Redistributor of
Income and Wealth
• Because inflation does not proceed
evenly, it redistributes income and wealth
in arbitrary, unfair ways.
• It systematically discriminates against
people on fixed incomes, and it may favor
borrowers at the expense of lenders.
Real versus Nominal Interest
Rates
• Real rate of interest = percentage increase
in purchasing power that the borrower
pays the lender in exchange for the loan.
• Nominal rate of interest = Real interest
rate + expected rate of inflation
Real versus Nominal Interest
Rates
• Inflation that is accurately anticipated need
not redistribute wealth between borrowers
and lenders.
– The nominal interest rate will include an
adequate inflation premium, above the real
interest rate.
• If the actual inflation rate turns out to be
different from the expected rate
unanticipated redistribution will occur.
Inflation Distorts Measurements
• Confusing Real and Nominal Interest
Rates
– Hides true economic cost of borrowing money.
• Many Americans viewed the 12% mortgage
interest rates that banks charged in 1980 as
scandalously high while they saw the 6% mortgage
rates of 2004 as a great bargain.
• In truth, however, the real interest rate in 2004
(about 4%) was well above the bargain-basement
real rates in 1980 (about 2%).
ANTICIPATED INFLATION
11%
=
+
5%
Nominal
Interest
Rate
Real
Interest
Rate
6%
Inflation
Premium
The Costs of Low versus High
Inflation
• Inflation creates fewer social problems if
– It is low rather than high.
– It is steady (and therefore relatively
predictable) rather than variable.
Low Does Not Necessarily Lead
to High Inflation
• Low inflation does not necessarily lead to
high inflation
– Creeping inflation sometimes accelerates, but
it sometimes decelerates.
– While creeping inflations have many causes,
galloping inflations have occurred only when
the government has printed incredible
amounts of money.
Index Numbers for Inflation
• The price index is a measure of the cost of
a basket of goods in a current year,
relative to the cost of the same basket in a
base year.
• There is no perfect price index.
The Consumer Price Index
• The Consumer Price Index (CPI), often
known as "the cost of living," is the most
widely cited index.
• Nominal values can be deflated by the CPI
in order to estimate real changes.
Prices in 2004
INFLATION
Defined and Measurement
• A rising general level of prices
• Rate of inflation calculated
using index numbers
Consumer Price Index
CPI =
Price of most recent market
basket in the particular year
Price of the same market
basket in 1982-1984
x 100
How to Use a Price Index to
“Deflate” Monetary Figures
• The GDP deflator is somewhat different
from the CPI, in that its basket includes all
the components of GDP, not just
consumer goods.
– It is usually, although not always, very close to
the CPI.
GLOBAL PERSPECTIVE
Inflation Rates in Five Industrial Nations
1992 - 2002
10
Italy
5
Germany
U.S.
France
Japan
0
1992
1997
2002
Source: Bureau of Labor Statistics
Types of
Inflation
1)DEMAND-PULL INFLATION
- Consumption
- = shift in D
2) COST-PUSH INFLATION
- Rising Per-Unit Production Costs
- = Shift in S
- Supply Shocks
REDISTRIBUTIVE EFFECTS
OF INFLATION
Nominal Income
Real Income
Anticipations
• Anticipated Inflation
• Unanticipated Inflation
REDISTRIBUTIVE EFFECTS
OF INFLATION
Who is Hurt by Inflation?
• Fixed-Income Receivers
• Savers
• Creditors
REDISTRIBUTIVE EFFECTS
OF INFLATION
Who is Unaffected or
Helped by Inflation?
• Flexible-Income Receivers
• Cost of Living
Adjustments (COLAs)
• Debtors
EFFECTS OF INFLATION
ON OUTPUT
•Cost-Push Inflation
and Real Output
•Demand-Pull Inflation
and Real Output
•Hyperinflation &
Breakdown
When Inflation Strikes!
(and Deflation too)
Mr. Griffin – AP Macro - MHS
Source: Mint.com and WallStats.com
Source: Mint.com and WallStats.com
WARM UP
• Demonstrate Cost Push Inflation
• Demonstrate Demand Pull Inflation
• Demonstrate Recessionary Deflation
The Inflation Game
•Who is most hurt by
inflation?
–Record your
response on the
score card.
Review of CPI
and
the GDP Deflator
Mr. Griffin
MHS – AP ECON
INFLATION
Defined and Measurement
• A rising general level of prices
• Rate of inflation calculated
using index numbers
Consumer Price Index
CPI =
Price of most recent market
basket in the particular year
Price of the same market
basket in 1982-1984
x 100
How to Use a Price Index to
“Deflate” Monetary Figures
• The GDP deflator is somewhat different
from the CPI, in that its basket includes all
the components of GDP, not just
consumer goods.
– It is usually, although not always, very close to
the CPI.
NOMINAL GDP vs. REAL GDP
• Adjustment Process
• GDP Price Index
Price of market basket
in specific year
Price Index
in a given
year
=
Real GDP
Price of same market
basket in base year
=
Nominal GDP
Price Index
(in hundredths)
An Alternative Method
Price Index
(in hundredths)
=
Nominal GDP
Real GDP
x 100
If 2000 were made the base year for the GDP
price deflator index, the value of the index
number for 1990 (rounded to the nearest
whole number) would be
a. zero
b. 42.
c. 142.
d. 212.
e. 256.
• b
The value of the gross domestic
product in 2000, in terms of 1990
prices, was
a.$600. d.
b.$700. e.
c.$1,000.
$1,200.
$1,300.
• a
If the price index in a country were 100 for the
year
2000 and 120 for 2003 and nominal gross
domestic product in 2003 were $480 billion,
then
real gross domestic product for 2003 in2000
dollars would be
a. about $360 billion.
d.
billion
b. about $380 billion.
e.
with the given information.
c. about $400 billion.
about $600
indeterminate
• c
If your wages increase by 12 percent at the
same time the CPI increases by 3 percent,
then the increase in your real wages is
equal to
a. 12 percent.
b. 9 percent.
c. 6 percent.
d. 3 percent.
e. 4 percent
• b
• e