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Exploring Economics
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Chapter 11
Introduction to the
Macroeconomy
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11.1 Macroeconomic Goals

Three major macroeconomic goals

maintain unemployment of human
resources at a low level
meaning that jobs are relatively plentiful and
 financial suffering from lack of work is relatively
uncommon


maintain relatively stable price level,


so that consumers and producers can make
better decisions; and
achieve a high rate of economic growth,

with growth in real, per-capita total output over
time.
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11.1 Macroeconomic Goals



We use the term real gross domestic
product (RGDP) to measure output or
production.
It is the total value of all final goods and
services produced in a given time
period.
The term real is used to indicate that the
output is adjusted for the general
increases in prices over time.
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Economic Growth, Unemployment Rates and
Inflation Rates, 1990–2003
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11.1 Macroeconomic Goals

In addition to these primary goals,
concern has been expressed at various
times and places about other economic
issues:




the "quality of life,"
reducing “bads” such as pollution,
fairness in the distribution of income or
wealth, or
becoming self-sufficient in the production of
certain goods or services.
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11.1 Macroeconomic Goals

Individuals differ considerably in
evaluating the issues, or whether
certain "problems" are really problems.
Economic growth is viewed positively by
most people but negatively by some.
 Some think the income distribution is about
right; others think the poorer members of
society have insufficient incomes.
 Others think confiscation of the income of
the relatively rich reduces incentives to
income-producing activities.
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
.
11.1 Macroeconomic Goals

Many economic problems are pressing
concerns for the Canadian government,
particularly



unemployment,
price instability, and
economic stagnation.
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11.2 Employment and
Unemployment

The concern over both unemployment
and price instability led the various
levels of government to commit to
policies designed to reduce
unemployment in a manner consistent
with price stability. The government
began holding itself responsible for
short-run economic fluctuations.
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11.2 Employment and
Unemployment



Nearly everyone agrees that it is
unfortunate when a person who wants a
job cannot find one.
A loss of a job can mean financial
insecurity and a great deal of anxiety.
High rates of unemployment in a society
can lead to increased tensions and
despair.
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11.2 Employment and
Unemployment


Society loses some potential output of
goods when some of its productive
resources—human or non-human—
remain idle, and potential consumption
is also reduced.
Clearly, there is a loss in efficiency
when people are willing to work but
productive equipment remains idle.
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11.2 Employment and
Unemployment



Hence, other things equal, relatively
high rates of unemployment are almost
universally viewed as bad.
The unemployment rate is one measure
of labour market conditions.
The unemployment rate is the number
of people officially unemployed divided
by the labour force.
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11.2 Employment and
Unemployment


Official unemployment measures those
over the age of 15 who are able and
available for employment, but are
unable to obtain a job.
The labour force is the number of
people over the age of 15 who are
either employed or unemployed.
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11.2 Employment and
Unemployment

The labour force figure excludes




The infirm
homemakers,
retirees, and
full-time students because
they are not considered currently
available for employment. Any individual
who is not working and not looking for
work is NOT in the labour force.
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The Canadian Labour Force, 2002
labour Force
(Employed + Unemployed)
17.046 Million
Employed
(15.746
million)
Unemployed
(1.300 million)
Total Adult Population
25.250 Million
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Out of
labour Force
(8.204 million)
11.2 Employment and
Unemployment

By far the worst employment downturn
in history was the Great Depression,
which began in Canada in 1929 and
continued until 1939.


Unemployment fell from only 2.9 percent of
the labour force to more than 19 percent in
the early 1930s, and
double-digit unemployment persisted
through 1939.
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11.2 Employment and
Unemployment

The debilitating impact of having
millions of productive persons out of
work led Canadians (and people in
other countries too) to say "Never
again."
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11.2 Employment and
Unemployment

Some economists would argue that
modern macroeconomics, with its
emphasis on the determinants of
unemployment and its elimination, truly
began in the 1930s.
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11.2 Employment and
Unemployment



Unemployment since 1976 has ranged
from a low of 6.8 percent in 2000 to a
high of 11.9 percent in 1983.
Unemployment in the worst years is
twice or more what it is in good years.
Before 1960, variations tended to be
even more pronounced.
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Canada Unemployment rate for both
sexes, 15 years and over
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11.2 Employment and
Unemployment


In periods of prolonged recession, some
individuals feel that the chances of
landing a job are so bleak that they quit
looking.
These "discouraged workers," who have
not actively sought work, are not
counted as unemployed; instead they
fall out of the labour force.
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11.2 Employment and
Unemployment

Also, people looking for full-time work
who grudgingly settle for a part-time job
are counted as “fully” employed, yet
they are only “partly” employed.
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11.2 Employment and
Unemployment


However, at least partially balancing
these biases in government
employment statistics is the number of
people who are over employed—that is,
working overtime or extra jobs.
Also, there are a number of jobs in the
underground economy that are not
reported at all.
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11.2 Employment and
Unemployment

In addition, there may be many people
who claim they are actually seeking
work when, in fact, they may just be
going through the motions so that they
can continue to collect employment
insurance or receive other government
benefits.
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11.2 Employment and
Unemployment

Unemployment usually varies greatly
between different segments of the
population and over time.
 unemployment rate is significantly
lower for university and college
graduates than
 those
without a high-school diploma
across sex and race, or
 for those with some post secondary
education, but did not complete the
requirements.
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11.2 Employment and
Unemployment

Unemployment tends to be greater
among
 Those in certain regions of the
country
 the very young,
 women
 less-skilled workers.
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11.2 Employment and
Unemployment

Considering the great variations in
unemployment for different groups in
the population, we calculate separate
unemployment rates for groups
classified by gender, age, province,
family status, and type of occupation.
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Unemployment in Canada by Age, Sex, and
Region
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11.2 Employment and
Unemployment

There are four main categories of
unemployed workers




job losers (temporarily laid off or fired),
job leavers (quit),
re-entrants (worked before and now
reentering labour force)
new entrants (entering the labour force for
first time—primarily teenagers).
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11.2 Employment and
Unemployment

Job losers typically account for 50 to 60
percent of the unemployed, but sizeable
fractions are also due to,new entrants,
and re-entrants. Job leavers make up
the smallest source of unemployment.
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11.2 Employment and
Unemployment

While unemployment is painful,
reducing unemployment is not without
costs.


In the short run, reducing unemployment
may generate a higher inflation rate,
especially if resources are fully employed.
Matching employees with jobs quickly may
lead to mismatches between the worker’s
skill level and that required for a job.
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11.2 Employment and
Unemployment


The duration of unemployment is
equally as important as the amount of
unemployment in determining its
financial consequences.
Therefore, it is useful to look at the
average duration of unemployment.
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11.2 Employment and
Unemployment

The duration of unemployment tends to



be greater when the amount of
unemployment is high, and
be smaller when the amount of
unemployment is low.
Unemployment of any duration, of
course, means a potential loss of output
that is permanent; it is not made up
when unemployment starts falling again.
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11.2 Employment and
Unemployment

The percentage of the population that is
in the labour force is called the labour
force participation rate.


Since 1976 it has increased from 61.5
percent to 67.5 percent.
The increase can be attributed in large part
to the entry of the baby boom into the
labour force and a 15.9 percentage point
increase in women’s labour force
participation rate.
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11.2 Employment and
Unemployment
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11.3 Different Types of
Unemployment

Types of unemployment.

Frictional unemployment
people are temporarily between jobs
 is short term and results from the normal
turnover in the labour market


Structural unemployment


people lack the necessary skills for available
jobs
Cyclical unemployment

results from short-term cyclical fluctuations in
the economy
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11.3 Different Types of
Unemployment

With frictional unemployment,
geographic and occupational mobility
are considered good for the economy,
generally leading human resources from
activities of relatively low productivity or
value to areas of higher productivity,
increasing output in society as well as
the wage income of the mover.
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11.3 Different Types of
Unemployment


Hence, frictional unemployment,
while not good in itself, is a by-product
of a healthy phenomenon, and because
it is short-lived, it is therefore not
generally viewed as a serious problem.
It tends to be somewhat greater in
periods of low unemployment, when job
opportunities are plentiful.
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11.3 Different Types of
Unemployment



Structural employment makes it
wise to look at both unemployment and
job vacancy statistics in assessing
labour market conditions.
Like frictional unemployment, it reflects
the dynamic dimension of a changing
economy.
Over time, new jobs open up that
require new skills, while old jobs that
required different skills disappear.
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11.3 Different Types of
Unemployment


Many persons advocate governmentsubsidized retraining programs as a
means of reducing structural
unemployment.
The dimensions of structural
unemployment are debatable, in part
because of the difficulty in precisely
defining the term in an operational
sense. Structural unemployment varies
considerably.
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11.3 Different Types of
Unemployment

To a considerable extent, one can view
both frictional and structural
unemployment as phenomena resulting
from imperfections in the labour market.
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11.3 Different Types of
Unemployment


If individuals seeking jobs and
employers seeking workers had better
information about each other, the
amount of frictional unemployment
would be considerably lower.
But because information and job search
are costly, the coordination of
demanders and suppliers of labour
services does not occur
instantaneously.
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11.3 Different Types of
Unemployment


In years of relatively high
unemployment, cyclical
unemployment may result from the
short-term cyclical fluctuations in the
economy.
During a recession, or whenever the
unemployment rate is greater than what
is considered to be a natural rate of
unemployment, there is cyclical
unemployment.
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11.3 Different Types of
Unemployment


Given its volatility and dimensions,
governments have viewed
unemployment resulting from
inadequate demand to be especially
correctable through government
policies.
Most attempts to solve the
unemployment problem have placed an
emphasis on increasing aggregate
demand.
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11.3 Different Types of
Unemployment

The median, or typical annual
unemployment rate has been at or
slightly above 7.4 percent since 1999.


Some economists call this the natural rate
of unemployment.
When unemployment rises well above 7.4
percent, we have abnormally high
unemployment; when it falls below 7.4
percent, we have abnormally low
unemployment.
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11.3 Different Types of
Unemployment

The 7.4 percent natural rate of
unemployment roughly equals the sum
of frictional and structural
unemployment at a maximum.


Thus, unemployment rates below the
natural rate reflect a below-average level of
frictional and structural unemployment.
Unemployment above the natural rate,
however, reflects cyclical unemployment.
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11.3 Different Types of
Unemployment


Today most economists estimate the
natural rate of unemployment to lie in
the range of 6.5 to 7.5 percent.
The natural rate of unemployment may
change over time as technological,
demographic, institutional, and other
conditions vary.
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11.3 Different Types of
Unemployment


When all of the economy’s labour
resources, and other resources like
capital are fully employed, the economy
is said to be producing at its potential
level of output.
That is, at the natural rate of
unemployment, all resources are fully
employed and the economy is
producing its potential output.
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11.3 Different Types of
Unemployment


The economy can also temporarily
exceed potential output as workers take
on overtime or moonlight by taking on
extra employment.
When the economy is experiencing
cyclical unemployment:
 unemployment rate > the natural rate.
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11.4 Inflation

Overall stable price level increases
security.




Inflation is a continuing rise in the overall
price level.
Deflation is a falling overall price level.
In both cases, a country’s currency unit
changes in purchasing power.
Without price stability, consumers and
producers will experience more difficulty in
coordinating their plans and decisions.
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11.4 Inflation


In general, the only thing that can cause
a sustained increase in the rate of
inflation is a high rate of growth in
money.
Unanticipated and sharp price changes
are almost universally considered to be
a "bad" thing that needs to be remedied
by some policy.
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11.4 Inflation


The Consumer Price Index (CPI) is the
standard measure of inflation.
The CPI from 1915 to 2003 is presented
in the next slide.
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.
The Consumer Price Level in Canada,
1920–2002
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11.4 Inflation

Effects of Inflation




Erodes the purchasing power of retirees on
fixed pensions, creditors, and those whose
incomes are tied to long-term contracts.
Debtors and those who can quickly raise
the prices on their goods can gain from
inflation.
Wage earners can lose if wages rise more
slowly than the price level.
Inflation’s uncertainties discourages
investment and economic growth.
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11.4 Inflation


Inflation brings about changes in real
incomes of persons, and these changes
may be either desirable or undesirable.
The redistributional impact of inflation is
not the result of conscious public policy;
it just happens.
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11.4 Inflation

Inflation can raise one nation's price
level relative to price levels in other
countries, which can lead to


difficulties in financing the purchase of
foreign goods or
to a decline in the value of the national
currency relative to that of other countries.
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11.4 Inflation

In its extreme form, inflation can lead to
a complete erosion of faith in the value
of money.


as in Germany after both world wars,
or hyperinflation,


as in Argentina in the 1980s and
Brazil in the 1990s.
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11.4 Inflation


In periods of high and variable inflation,
households and firms have a difficult
time distinguishing changes in relative
prices from changes in the general price
level, distorting the information that
flows from price signals.
This undermines good decision-making.
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11.4 Inflation

Another cost of inflation is the cost that
firms incur as a result of being forced to
change their prices more often.



menu costs—the costs of changing posted
prices
shoe-leather costs—the costs of checking
on your assets.
These costs are modest with low
inflation rates, but can be quite large
where inflation is substantial.
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11.4 Inflation

The real interest rate equals the
nominal interest rate minus the inflation
rate.


Real interest rate—the increase in
purchasing power per year
Nominal interest rate—the amount you
have to pay in dollars and cents
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11.4 Inflation


If people correctly anticipate inflation,
they will behave in a manner that will
largely protect them against loss.
To protect themselves, creditors will
demand a rate of interest that is large
enough to compensate for the
deteriorating value of the dollar.
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11.4 Inflation


An interest rate is, in effect, the price
that one pays for the use of funds. Like
other prices, interest rates are
determined by the interaction of
demand and supply forces.
The lower (higher) the interest rate, the
greater (fewer) the quantity of loanable
funds demanded, ceteris paribus.
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Nominal Interest Rates
Nominal Interests Rate
S1
S0
r1
r0
D1
D0
0
Quantity of Loanable Funds
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.
11.4 Inflation


The higher (lower) the interest rate, the
greater (fewer) the quantity of loanable
funds supplied by individuals and
institutions like banks, ceteris paribus.
The equilibrium price, or interest rate,
will be where the quantity demanded
equals the quantity supplied.
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.
11.4 Inflation


When people start expecting future
inflation, creditors become less willing to
lend funds at any given interest rate
because they fear they will be repaid in
dollars of lesser value than those they
loaned.
This is depicted by a leftward shift in the
supply curve of loanable funds (a
decrease in supply).
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11.4 Inflation


Likewise, demanders of funds
(borrowers) are more anxious to borrow
because they think they will pay their
loans back in dollars of lesser
purchasing power than the dollars they
borrowed. Thus, the demand for funds
increases.
Whether the equilibrium quantity of
loanable funds will increase or decrease
depends on the relative sizes of the
shifts in the respective curves.
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11.4 Inflation



Both the decrease in supply and the
increase in demand push up the interest
rate to a new, higher equilibrium level.
Often, lenders are able to anticipate
inflation with reasonable accuracy.
If the inflation rate is accurately
anticipated, new creditors do not lose,
nor do debtors gain, from inflation.
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11.4 Inflation

Nominal interest rates and real interest
rates do not always move together.

In periods of high unexpected inflation, the
nominal interest rates can be very high
while the real interest rates are low or even
negative.
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11.4 Inflation

Increasingly, labourers, pensioners, etc.
try to protect themselves from inflation
by using cost-of-living (COLA) clauses
in contracts. Personal income taxes are
also now indexed for inflation.
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11.4 Inflation

Some have argued that we should go
one step further and index everything.


All contractual arrangements would be
adjusted frequently to take account of
changing prices.
Such an arrangement might reduce the
impact of inflation, but it would also entail
additional contracting costs (and not every
good—notably currency—can be indexed).
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11.4 Inflation

Approaches to try to stop inflation
include various policies relating to the
amount of government spending, tax
rates, or the amount of money created.
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11.5 Economic Fluctuations

Business cycles refer to the short-term
fluctuations in economic activity, not to
the long-term trend in output, which in
modern times has usually been upward.
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.
Real GDP per Year
Business Cycles and Economic Growth
0
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.
Time
11.5 Economic Fluctuations

A business cycle has four phases:
 expansion,
 peak,
 contraction, and
 trough.
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.
Real GDP per Year
Four Phases of a Business Cycle
Peak
Peak
Trough
Recession Recovery
0
Time
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11.5 Economic Fluctuations

Expansion phase



Usually is longer than the contraction.
In a growing economy, output (real GDP)
will rise from one business cycle peak to
the next.
When output is rising significantly,
unemployment is falling and both
consumer and business confidence is high.

Investment is rising, as well as expenditures for
expensive durable consumer goods, such as
automobiles and household appliances.
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11.5 Economic Fluctuations

Peak



when the expansion comes to an end
when output is at the highest point in the
cycle.
Contraction



a period of falling real output
rising unemployment and declining
business and consumer confidence
investment spending and consumer
durable expenditures fall sharply
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11.5 Economic Fluctuations


Contraction phase can also be called a
recession.
Usually a recession is said to occur if
there are two quarters of declining real
GDP.
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11.5 Economic Fluctuations

Trough



the point in time when output stops
declining
the moment when business activity is at its
lowest point in the cycle
Unemployment is relatively high at the
trough, although the actual maximum
amount of unemployment may not occur
exactly at the trough.
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11.5 Economic Fluctuations




Often, unemployment remains fairly
high well into the expansion phase.
There is no uniformity to a business
cycle's length.
Severe recessions are called
depressions . Such as the 1930’s
A prolonged expansion is sometimes
referred to as a boom. This happened
in the 1960’s when the RGDP grew by
about 6% a year.
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11.5 Economic Fluctuations


The contraction phase is one of
recession, a decline in business activity.
Contractions seem to be getting shorter
over time.
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Growth in Canadian Real GDP 1962-2003
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11.5 Economic Fluctuations


Businesses, government agencies, and
to a lesser extent, consumers, rely on
economic forecasts to learn of
forthcoming developments in the
business cycles.
Economists gather statistics on
economic activity in the immediate past,
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11.5 Economic Fluctuations
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These past historical relationship factors
and the overall level of economic
activity (which form the basis of the
economic theories used)are then used
to formulate econometric models
Statistics from the immediate past are
plugged into the models and forecasts
are made.
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11.5 Economic Fluctuations
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Because human behaviour changes,
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we cannot correctly make assumptions
about certain future developments,
economists’ numbers are imperfect and
econometric forecasts are not always
accurate.
But while they are not perfect, they are
helpful.
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11.5 Economic Fluctuations
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Some types of economic activity can be
useful in predicting change. These are
known as Economic Indicators
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a less sophisticated but very useful
forecasting tool is watching trends in areas
that tend to change before the economy as
a whole changes.
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11.5 Economic Fluctuations
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Statistics Canada identified about 10
such indicators:
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Furniture and Appliance sales
Durable Goods sales
Length of Average work week
New orders in manufacturing
Shipments-to-inventory ratio
Housing Starts
Business and Personal services employment
Index of stock prices
Money supply
U.S. leading indicators
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11.5 Economic Fluctuations
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Since the development of the index of
leading economic indicators, it has
never failed to give some warning of an
economic downturn.
Unfortunately, the lead time has varied
widely, which makes it less accurate
and can cause timing and expectation
problems with policy.
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.
11.5 Economic Fluctuations
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While the economic indicators do
provide a warning of a likely downturn,
they do not provide accurate information
on the depth or duration of the
downturn.
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.