Download Real GDP

Are Your Smart Choices
Smart for All?
Macroeconomics & Microeconomics
LEARNING OBJECTIVES
1.1
Explain the differences between microeconomics
and macroeconomics
1.2
Describe the hands-off and hands-on views
on government policy and connect each to
the fundamental macroeconomic question
1.3
Define three key measures of macroeconomic
performance, and identify good outcomes for each
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
1.4
Identify five groups of macroeconomic players
and their choices
1.5
Explain three MAPS for focusing your thinking
like a macroeconomist
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
RECONCILING MACRO AND MICRO:
IS THE WHOLE GREATER THAN
THE SUM OF THE PARTS?
Smart microeconomic choices by individuals
may or may not add up to smart macroeconomic outcomes
for the economy as a whole.
“If left alone, do markets quickly self-adjust?”
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
RECONCILING MACRO AND MICRO
• Great Recession (2008 – 2009)
• Great Depression (1929 – 1933)
involved financial bubbles that
burst, high unemployment,
falling living standards,
bankruptcies, and government
policy mistakes
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Business cycles
ups and downs of overall economic activity
• Macroeconomics
analyzes the performance of the whole Canadian
economy and global economy — the combined
outcomes of all individual microeconomic choices
• Microeconomics
analyzes choices that individuals in households,
individual businesses, and governments make,
and how those choices interact in markets
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Fallacy of composition
what is true for one is not true for all;
whole is greater than the sum of the parts
• Paradox of thrift
attempts to increase savings cause aggregate
savings to decrease due to falling incomes
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Fundamental Macroeconomic Question
If left alone by government,
do the price mechanisms of market economies
adjust quickly to maintain steady growth in
living standards, full employment, stable prices?
or
If left alone, do markets quickly self-adjust?
• “Yes” Say’s Law “supply creates its own demand”
• “No” Keynes rejected Say’s Law
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
GOVERNMENT HANDS-OFF OR HANDS-ON?
ECONOMICS AND POLITICS
The “Yes” and “No” camps disagree on
fallacy of composition, causes of business cycles,
risk of government failure versus market failure,
role for government, and are on different political sides.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
COMPARING CAMPS
• YES — Left Alone, Markets Quickly Self-Adjust
–
no fallacy of composition so micro = macro
–
business cycles from external
causes or government policy mistakes
–
government failure worse than
market failure
–
hands-off role for government
–
political right
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• NO — Left Alone, Markets Fail to Self-Adjust
–
fallacy of composition is real, so micro ≠ macro
–
business cycles from internal causes —
coordination failures between input & output
markets; money, banks, expectations
–
market failure worse than
government failure
–
hands-on role for government
–
political left
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
DOES THE ECONOMY MEASURE UP?
GDP, UNEMPLOYMENT, INFLATION
The most important outcomes
of the Canadian economy are
GDP per person, unemployment, inflation.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
MEASURING GDP, UNEMPLOYMENT, INFLATION
• Gross Domestic Product (GDP)
value of all final products and services produced
annually in a country
• Unemployment
not employed and actively seeking work
• Inflation
rising average prices and falling value of money
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
CAN’T TELL PLAYERS WITHOUT A SCORECARD:
MACROECONOMIC PLAYERS
Five macroeconomic players are
consumers, businesses, government, Bank of Canada
and the banking system, and rest of the world.
Each group has different choices.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
CHOICES FOR MACROECONOMIC PLAYERS
• Consumer choices
– spend income or save
– buy Canadian products/services or imports
• Business choices
– investment spending
business purchases of new factories and
equipment — domestically or importing
– hiring workers or not
– buying inputs domestically or importing
– selling outputs domestically or exporting
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Government choices
– purchases of products/services
– taxes and transfer payments
– fiscal policy
changes in government purchases, taxes/transfers
to achieve macroeconomic outcomes
• Bank of Canada and Banking System choices
– monetary policy
Bank of Canada changes interest rates
and supply of money to achieve
macroeconomic outcomes
– making loans or not
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Rest of World (R.O.W.) choices
– buying Canadian exports,
selling imports to Canada
– investing money in Canada or
accepting Canadian investments
– demanding Canadian dollars
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
FOCUSING ON YOUR FUTURE:
LIVING STANDARDS, VOTING & MACROECONOMICS
Macroeconomics affects your future —
GDP per person, unemployment, and inflation.
Macroeconomics also informs your vote for politicians
and policies influencing economic performance.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
SUCCESS, VOTING, AND MAPS
• Your personal economic success depends on
– GDP
higher GDP per person = higher living standards
– Unemployment
affects odds of finding jobs
– Inflation
reduces living standards if income not rising
as fast as prices of what you buy
• Understanding macroeconomics informs your vote for
politicians whose economic policy choices influence
economic performance and your economic success
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Thinking like a macroeconomist means focusing
on targeted targeted connections in the economy
•
3 MAPS (MAcroeconomic Positioning Systems)
for finding targets
– MAPS1
focus on the connection between
input markets and output markets,
for both demand and supply sides
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
– MAPS2
focus on the connections between
Canada and the rest of the world
– MAPS3
focus on the connections between
money/banks/expectations and the
input and output markets of the
circular flow
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
Up Around the Circular Flow
GDP, Economic Growth,
and Business Cycles
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
LEARNING OBJECTIVES
2.1
Differentiate nominal GDP, real GDP, and
real GDP per person, and how each relates
to living standards
2.2
Explain how economic growth occurs and
how it is measured
2.3
Describe the language of business cycles,
including output gaps as a target for
hands-on policymakers
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
2.4
Explain how value added and the equality of
aggregate spending and aggregate income
allow us to measure GDP
2.5
Identify five limitations of real GDP per person
as a measure of well-being
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
HIGHER PRICES, MORE STUFF, OR BOTH?
NOMINAL GDP AND REAL GDP
GDP measures value final products/services produced annually;
nominal GDP combines changes in prices & quantities;
real GDP measures only changes in quantities;
real GDP per person best measure of material standard of living.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
NOMINAL GDP AND REAL GDP
• Nominal GDP
value at current prices of all final products/services
produced annually in a country
• Differences in nominal GDP between years due to
either price changes or quantity changes
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• GDP includes products/services produced within
a country’s borders, no matter what nationality
of business producing
• GDP is a flow
amount per unit of time
• Stock
fixed amount at a moment in time
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Real GDP
value at constant prices of all final products/services
produced annually in a country
– real GDP uses constant prices for a single year
to value quantities produced in different years
– differences in real GDP between years show
only changes in quantities
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
WHEN MACROECONOMIC DREAMS COME TRUE:
POTENTIAL GDP AND ECONOMIC GROWTH
By increasing quantity and quality of inputs, economic growth
increases productivity and potential GDP per person,
raising maximum possible living standards.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
POTENTIAL GDP AND ECONOMIC GROWTH
• Potential GDP
– real GDP when all inputs fully employed
(labour, capital, land/resources,
entrepreneurship)
– short-run goal for ideal economic performance
– outcome if Invisible Hand works perfectly
• Potential GDP per person
– potential GDP divided by population
– short-run maximum living standards
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Increases in labour
– quantity — population growth, immigration,
and labour force participation rate
– quality — human capital —
work experience, on-the-job training,
and education
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Increases in capital
– quantity — more factories and equipment
– quality — technological change —
innovation, research and development
• Increases in land/resources
– quantity — bringing land/resources
into circular flow of markets
– quality — usually due to increases
in capital used with land
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Increases in entrepreneurship
– quantity and quality interrelated
– better management, organization,
and worker/management relations
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• When economic growth progresses smoothly,
stock of inputs serves as a basis for choices;
choices then transform the stock of inputs,
continuing in an ever-expanding circle
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Economic growth rate
annual percentage change in real GDP per person
Real GDP
Real GDP per
Real GDP per
—
per person
person this year
person last year
growth rate =
X 100
Real GDP per person last year
(%)
• Canada’s average annual economic growth rate,
1926–2008, was 2.1 %
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Productivity
quantity of real GDP produced by an hour of labour
– increases in productivity increase living standards
– more products/services
produced
– reducing work time needed
to buy products/services
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
BOOM AND BUST: BUSINESS CYCLES
Business cycles track real GDP expansion and contraction.
Output gaps measure the difference between
real GDP and potential GDP.
“Closing the gap” is an important policy target.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
BUSINESS CYCLES
• Language of business cycles
fluctuations of real GDP around potential GDP
– expansion
period when real GDP increases
– peak
highest point of an expansion
– contraction
period when real GDP decreases
– trough
lowest point of a contraction
– recession
2+ successive quarters of real GDP contraction
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
Fig. 2.9
Most Recent Complete Canadian Business Cycle
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
• Output gaps
real GDP minus potential GDP
– recessionary gap
real GDP below potential GDP
– inflationary gap
real GDP above potential GDP
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
VALUE ADDED & THE ENLARGED CIRCULAR FLOW
• Value added
value of output minus value of intermediate
products/services bought from other businesses
• Value added solves problems of double counting,
distinguishing final and intermediate
products/services
– value of final products/services = value added
– value of final products/services = inputs’ income
– GDP = inputs’ income
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Flows of spending on the enlarged circular flow
– C
consumption spending by consumers
– I
business investment spending on factories
and machines made by businesses
– G
government spending on products/services
– X
spending by R.O.W. on Canadian exports
– IM
Canadian spending on imports produced
by R.O.W.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Aggregate Spending = Aggregate Income
C + I + G + X − IM
= Y
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
MY GDP IS BIGGER THAN YOURS: WHAT’S WRONG
WITH GDP AS A MEASURE OF WELL-BEING?
Real GDP per person is a limited measure of well-being;
excludes nonmarket production, underground economy,
environmental damage, leisure, political freedoms
and social justice.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
WHAT’S WRONG WITH GDP AS A MEASURE OF
WELL-BEING?
• Real GDP per person is limited measure of
well-being because it does not include
– non-market production
household production
that improves quality of life
– underground economy
activities that are illegal,
or legal but avoid taxes
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
– environmental damage
costs of environmental damage,
resource depletion
– leisure
leisure lowers real GDP,
but is desirable
– political freedoms and
social justice
limited freedoms,
uneven income distributions
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Growth rates of real GDP per person still useful
for judging economic progress if no significant
changes over time in the limitations
• United Nations Human Development Index (HDI)
measures quality of life across countries by
combining life expectancy, educational
achievement, and income
– Canada ranked 4th, U.S. 15th in 2006
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
Costs of (Not) Working
and Living
Unemployment and Inflation
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
LEARNING OBJECTIVES
3.1
Explain what the unemployment rate
measures and misses, and identify
four types of unemployment
3.2
Define the natural rate of unemployment
and explain its connection to recessionary
and inflationary output gaps
3.3
Explain how the inflation rate is calculated
and what it misses, and describe three
problems inflation creates
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
3.4
Use the quantity theory of money to explain
where inflation comes from
3.5
Describe the Phillips Curve and its connections
to demand-pull and cost-push inflations
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
WHO IS UNEMPLOYED?
HEALTHY & UNHEALTHY TYPES OF UNEMPLOYMENT
Unemployment rate measures percentage of labour force
out of work and actively searching for jobs, but misses
involuntary part-time and discouraged workers. Four types
of unemployment — frictional, structural, seasonal, cyclical.
Only cyclical is both unhealthy and a problem.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
Fig. 3.1
Labour Force Categories for Working-Age
Population, May 2009
Labour Force
18 380 600
(employed +
unemployed)
Unemployed
1 548 400
Not in Labour Force
8 869 400
Employed
16 832 200
Working-Age Population 27 250 000
Fig. 3.3
Unemployment & Underutilization of Labour,
May 2009
Percentage of
Labour Force
Official unemployment rate
8.7
Involuntary part-time workers
2.6
Discouraged workers
0.2
Total Underutilization Rate
11.5
LABOUR FORCE CATEGORIES
POPULATION
(31 MILLION)
WORKING AGE POPULATION
(25 MILLION)
AGE 15 AND OVER
LABOUR FORCE
(18 MILLION)
EMPLOYED
(16 MILLION)
NOT IN LABOUR FORCE
(7 MILLION)
UNEMPLOYED
(2 MILLION)
OTHERS
(6 MILLION)
Fig. 3.4
Provincial Unemployment Rates, May 2009
Province
Unemployment Rate
Newfoundland/Labrador
15.1
Prince Edward Island
13.1
Nova Scotia
8.9
New Brunswick
8.8
Quebec
8.7
Ontario
9.4
Manitoba
4.9
Saskatchewan
4.9
Alberta
6.6
British Columbia
7.6
Fig. 3.5
Type of
Varieties of Unemployment
Healthy/
Problem that
Cause
Unemployment Unhealthy Needs
Addressing?
Frictional
Healthy
No
Normal, healthy market
adjustments of demand
and supply
Structural
Healthy
Yes (worker
retraining)
Technological change,
international
competition, resource
depletion
Seasonal
Neutral
No
Weather and seasons
Cyclical
Unhealthy
Yes (fiscal or
Business cycles
monetary policy)
HOW FULL IS “FULL EMPLOYMENT?”
THE NATURAL RATE OF UNEMPLOYMENT
Natural rate of unemployment at full employment,
where only healthy frictional, structural, seasonal
unemployment. Relative to natural rate, unemployment
rate is higher in recessionary gap and lower in inflationary gap.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
UNEMPLOYMENT
• Statistics Canada sorts working-age population
(age 15 and over) into three categories
– employed
working full-time or part-time at paid job
– unemployed
not doing paid work and actively searching for
job; on temporary layoff; about to start new job
– not in the labour force
not employed or unemployed
(full-time student, homemaker, retiree)
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Labour force = employed + unemployed
• Unemployment rate
percentage of people in labour force who are
unemployed
Unemployed
× 100
– Unemployment Rate =
Labour Force
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Labour force participation rate
– percentage of working-age population in
labour force (employed or unemployed)
– Labour Force Participation Rate
Labour Force
=
Working Age Population
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
× 100
continued…
• Unemployment rate misses
– involuntary part-time workers
employed part-time but would rather
have full-time job, and can’t find one
– discouraged workers
want to work but have given up
actively searching for jobs
• Labour underutilization rate
unemployment rate including unemployed,
involuntary part-time, discouraged workers
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Healthy and unhealthy types of unemployment
– frictional unemployment
due to normal labour turnover and job search;
healthy part of changing economy; not a problem
– structural unemployment
due to technology or international competition
making workers obsolete; healthy part of
changing economy; problem requiring retraining
– seasonal unemployment
due to seasonal changes in weather;
neither healthy nor unhealthy; not a problem
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
– cyclical unemployment
due to fluctuations in economic activity;
unhealthy part of changing economy;
problem needs addressing
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
NATURAL RATE OF UNEMPLOYMENT
• Natural rate of unemployment
unemployment rate at full employment; includes
frictional, structural, seasonal unemployment
– full employment
is not zero percent unemployment
but zero percent cyclical unemployment
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Natural rate of unemployment and potential GDP
– when unemployment = natural rate
real GDP = potential GDP
full employment
– when unemployment > natural rate
real GDP < potential GDP
recessionary gap
cyclical unemployment
– when unemployment < natural rate
real GDP > potential GDP
inflationary gap
• Economists disagree about the natural rate
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
PROBLEMS WITH UR FIGURES
• MAY OVER OR UNDERESTIMATE
ACTUAL SITUATION BECAUSE
1. DOES NOT INCLUDE DISCOURAGED WORKERS
(HIDDEN UNEMPLOYMENT) = PERSON WHO DOES
NOT HAVE A JOB, IS AVAILABLE AND WILLING TO
WORK BUT HAS NOT MADE ANY EFFORTS TO FIND
A JOB WITHIN THE PREVIOUS 4 WEEKS
Chapter 3 - ‹#› Copyright © 2011 Pearson Canada Inc.
DURING RECESSIONS, WHEN
PEOPLE STOP LOOKING FOR WORK,
e.g.
HIDDEN UNEMPLOYMENT RISES.
BECAUSE THE UR FIGURED IGNORES
THIS, IT MAY UNDERESTIMATE
UNEMPLOYMENT.
Chapter 3 - ‹#› Copyright © 2011 Pearson Canada Inc.
2. INCLUDES VOLUNTARY
UNEMPLOYMENT: = PEOPLE WHO
SAY THEY ARE UNEMPLOYED BUT
ARE NOT WILLING OR INTERESTED
IN WORKING e.g. welfare
recipients
Chapter 3 - ‹#› Copyright © 2011 Pearson Canada Inc.
e.g.
DURING A BOOM, VOLUNTARY
UNEMPLOYMENT WILL
OVERESTIMATE THE UR AND KEEP
IT HIGH EVEN THOUGH THERE ARE
A LOT OF VACANCIES.
Chapter 3 - ‹#› Copyright © 2011 Pearson Canada Inc.
LIGHTENING UP YOUR WALLET:
WHAT IS INFLATION?
Inflation hurts those on fixed incomes,
creates risk for business investment and can increase
in a vicious cycle of expectations. Inflation rate overstates
cost of living increases, missing switches to cheaper
and improved products/services.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
INFLATION
• Inflation is persistent rise in average prices
and fall in value of money
– spend more to get same products/services
– your money is worth less
• Consumer Price Index (CPI)
measure of average prices of a fixed shopping
basket of products and services
– CPI = 100 for the base year, currently 2002
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
Fig. 3.7
Consumer Price Index Basket
Recreation,
education,
reading
12.2%
Health,
personal care
4.7%
Alcoholic beverages,
tobacco products
3.1%
Food 17%
Transportation
19.9%
Clothing,
footwear
5.4%
Shelter 26.6%
Household operations,
furnishing and equipment
11.1%
Chapter 3 - ‹#› Copyright © 2011 Pearson Canada Inc.
• Inflation rate
annual percentage change in consumer price index
– Inflation =
CPI for current year − CPI for previous year
CPI for previous year
× 100
– Core inflation rate
inflation rate excluding volatile categories
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Inflation is a worry because of falling value of money
– inflation reduces purchasing power
of people with fixed (unchanged dollar)
income or savings
– nominal interest rate
observed interest rate; dollars per year
in interest as percentage of dollars saved
– realized real interest rate
is nominal interest rate adjusted for inflation
= nominal interest rate − inflation rate
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Inflation is a worry because
– unpredictable prices create risk
and discourage business investment
– expectations of inflation can
cause inflation
• Predictable inflation rate
between 1 and 3 percent
is the Bank of Canada’s aim
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
VICIOUS CYCLE
Chapter 3 - ‹#› Copyright © 2011 Pearson Canada Inc.
• Deflation
persistent fall in average prices and rise in
value of money
– consumers may postpone purchases,
causing contraction and increasing unemployment
– deflation benefits
savers but hurts
borrowers
– deflation is worse
than low inflation
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
• CPI fixes quantities in shopping basket to isolate only
the impact of changing prices on cost of living
– when prices rise, CPI misses switches to cheaper
substitutes and new/improved products
– inflation rate based on CPI overstates
increases in cost of living
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
WHEN TIM HORTONS PAYS $18 PER HOUR:
UNEMPLOYMENT AND INFLATION TRADEOFFS
Phillips Curve shows tradeoff between unemployment
and inflation consistent with demand-pull inflation.
Cost-push inflation, changes in expectations and natural rate
of unemployment complicate the original Phillips Curve.
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
UNEMPLOYMENT – INFLATION TRADEOFFS
• Phillips Curve
graph showing inverse relation between
unemployment and inflation
• Demand-pull inflation
rising average prices caused by increases
in demand explain Phillips Curve’s tradeoff
between unemployment and inflation
– during expansions, demand is key force
causing shortages and pulling up prices
for inputs (wages) and outputs
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
Fig. 3.11 Phillips Curve in Canada, 1946 - 1969
Chapter 3 - ‹#› Copyright © 2011 Pearson Canada Inc.
• Cost-push inflation
rising average prices caused by decreases in supply
— does not fit Phillips Curve
– caused by supply shocks
events directly affecting business’s costs,
prices, and supply. Decrease in supply key force
pushing up output prices, while pushing economy
into contraction, increasing unemployment.
– can cause stagflation
simultaneous recession (unemployment)
and inflation
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.
continued…
• Both demand-pull and cost-push inflation require
accompanying increase in quantity of money
• Trade-offs between unemployment and inflation of
Phillips Curve are complicated due to changes in
– expectations
– natural rate of unemployment
Chapter 1 - ‹#› Copyright © 2011 Pearson Canada Inc.