Download Economic Growth, Business Cycles, Unemployment, and Inflation

Economic Growth, Business
Cycles, Unemployment, and
Inflation
Chapter 6
Macro233 - JFGAC
Laugher Curve
An Indian-born economist once explained
his personal theory of reincarnation to his
graduate economics class.
Macro233 - JAFGAC
Laugher Curve
“If you are a good economist, a virtuous
economist,” he said, “you are reborn as a
physicist.”
“But if you are an evil, wicked economist,
you are reborn as a sociologist.”
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Introduction
Macroeconomics is the study of the
aggregate moods of the economy.
 The four central problems are growth,
business cycles, unemployment, and
inflation.

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Two Frameworks: The Long
Run and the Short Run
Issues of growth are considered in a longrun framework.
 Business cycles are generally considered
in a short-run framework.
 Inflation and unemployment fall within both
frameworks.

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Growth
The primary measurement of growth is
changes in real gross domestic product.
 Real gross domestic product (real GDP)
– the market value of goods and services
stated in the prices of a given year.

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Growth

The U.S. secular growth rate is between
2.5 to 3.5 percent per year.
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Growth
Per capita real output growth has been 2.5
to 3.5 percent per year.
 Per capita real output is real GDP divided
by the total population.

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Global Experience with
Growth
Today's growth rates are high by historical
standards.
 The range of growth rates among nations
is wide.
 African countries have consistently grown
below the world average.

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Global Experience with
Growth
The growth trend we now take for granted
started at the end of the of the18th century.
 At about the same time, markets and
democracies became the primary
organizing structures of society.

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The Benefits and Costs of
Growth
Per capita economic growth allows
everyone in society, on average to have
more.
 Growth, or predictions of growth, allows
governments to avoid hard questions.

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The Benefits and Costs of
Growth

The costs of growth include pollution,
resource exhaustion, and destruction of
natural habitat.
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Business Cycles

The business cycle is the upward and
downward movement of economic activity
that occurs around the growth trend.
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Business Cycles
There are a number of policies regarding
business cycles.
 Classical economists generally favor
laissez-faire or noninterventionist policies.
 Keynesians generally favor activist
policies.

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U. S. Business Cycles
20
Recovery
of 1895
Civil
10 War
World War I
World War II
Korean
War Vietnam War
0
Panic
of 1893
–10
Panic
of 1907
Great
Depression
–20
1860 ‘70
McGraw-Hill/Irwin
‘80
‘90
1900
‘10
‘20
‘30 ‘40 ‘50 ‘60
‘70 ‘80 ‘90 2000 ‘10
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
The Phases of the Business
Cycle
The peak is the top of the business cycle.
 A boom is a very high peak, representing a
big jump in output.
 The downturn is the phenomenon of
economic activity starting to fall from a
peak.

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The Phases of the Business
Cycle
A recession is a decline in output that
persists for more than two consecutive
quarters in a year.
 A depression is a large recession.
 A trough is the bottom of the recession or
depression.

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The Phases of the Business
Cycle

An expansion is an upturn that lasts at
least two consecutive quarters of a year.
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The Phases of the Business
Cycle
Expansion
Recession
Expansion
Total Output
Peak
0
McGraw-Hill/Irwin
Trough
Secular
growth
trend
Jan.- Apr.- July- Oct.- Jan.- Apr.- July- Oct.- Jan.- Apr.Mar June Sept. Dec. Mar June Sept. Dec. Mar June
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Why Do Business Cycles Occur
Recessions and expansions are caused
primarily by demand-side of the economy.
 A debate exists about whether these
fluctuations can and should be reduced.

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Why Do Business Cycles Occur

Most economists believe that potential
depressions should be offset by economic
policy.
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Why Do Business Cycles Occur

Since the late 1940s, compared to prior
years:
Downturns and panics have generally been
less severe.
 The duration of business cycles has increased.
 The average length of expansions has
increased while the average length of
contractions has decreased.

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Why Do Business Cycles Occur

Most economists believe that business
fluctuations have become less severe
because of the stronger role of government
in the economy.
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Leading Indicators

Leading indicators tell us what's likely to
happen in the economy 12 to 15 months
from now.
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Leading Indicators

Leading indicators include the following:
Average workweek for production workers in
manufacturing.
 Unemployment claims.
 New orders for consumer goods and
materials.

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Leading Indicators

Leading indicators include the following:
Vendor performance, measured as a
percentage of companies reporting slower
deliveries from suppliers.
 Index of consumer expectations.
 New orders for plant and equipment.

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Leading Indicators

Leading indicators include the following:
Number of new building permits issued for
private housing units.
 Change in stock prices.
 Interest rate spread.
 Changes in the money supply.

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Unemployment

The unemployment rate is the number of
people who are willing and able to work but
are not working.
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Unemployment
Cyclical unemployment is that which
results from fluctuations in economic
activity.
 Structural unemployment is that caused
by economic restructuring making some
skills obsolete.

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Unemployment as a Social
Problem
The Industrial Revolution created the
possibility of cyclical unemployment.
 It brought a change in how families dealt
with unemployment.
 What had previously been a family
problem, became a social problem.

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Unemployment as
Government’s Problem

As capitalism evolved, capitalist societies
no longer saw the fear of hunger as an
acceptable answer to unemployment.
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Unemployment as
Government’s Problem

Full employment – an economic climate
in which just about everyone who wants a
job can have one.
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Unemployment as
Government’s Problem

Frictional unemployment is the
unemployment caused by:
New entrants into the job market, and
 People quitting a job just long enough to look
for and find another one.

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Unemployment as
Government’s Problem
The target rate of unemployment is the
lowest sustainable rate of unemployment
that policymakers believe is achievable
under existing conditions.
 It is sometimes called the natural rate of
unemployment.

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Unemployment as
Government’s Problem
In the 1980s and 1990s, the target rate of
unemployment was been between 5 and 7
percent.
 Today, the target rate of unemployment is
about 5 percent.

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Why the Target Rate of
Unemployment Changed
In the 1970s and early 1980s, a low
inflation rate seemed to be incompatible
with a low unemployment rate.
 Demographics have changed – different
age groups have different rates of
unemployment.

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Why the Target Rate of
Unemployment Changed
Social and institutional structures have
changed.
 Governmental institutions also changed.

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Whose Responsibility Is
Unemployment?
Classical economists believe that
individuals are responsible for their own
jobs.
 Keynesian economists tend to say that
society owes people jobs commensurate
with their training or past job experience.

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How Is Unemployment
Measured?

The unemployment rate is published by the
U.S. Department of Labor's Bureau of
labor Statistics.
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Unemployment Rate Since 1900
30
20
Target rate
10
0
1910 1920 1930
McGraw-Hill/Irwin
1940 1950 1960 1970
1980 1990 2000
2010
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Calculating the Unemployment
Rate

The unemployment rate – the number of
unemployed individuals divided by the
number of people in the civilian labor force
then multiplied by 100.
number unemployed
unemployment rate =
100
labor force
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Calculating the Unemployment
Rate
The labor force – those people in an
economy who are willing and able to work.
 The labor force excludes those incapable
of working and those not looking for work.

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Unemployment/Employment
Figures (in millions)
Total civilian population (288.4 million)
Noninstitutional population (214.0 million)
Labor force (142.5 million)
Employed (134.3 million)
McGraw-Hill/Irwin
Incapable of working (74.4 million)
Not in labor force (71.4 million)
Unemployed (8.3 million)
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
How Accurate Is the Official
Unemployment Rate?
The unemployment rate does not include
discouraged workers.
 Discouraged workers – people who do
not look for a job because they feel they do
not have a chance of getting one.

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How Accurate Is the Official
Unemployment Rate?
The unemployment rate counts as
employed those who are underemployed.
 Underemployed – part-time workers who
would prefer full-time work.

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How Accurate Is the Official
Unemployment Rate?
The unemployment rate includes as
unemployed, people who say they are
looking for a job who are really not.
 Many are “working off the books, others
are vacationing.

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How Accurate Is the Official
Unemployment Rate?

The Bureau of Labor Statistics uses the
labor force participation rate and the
employment rate to gauge the state of the
labor market.
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How Accurate Is the Official
Unemployment Rate?
The labor force participation rate
measures the labor force as a percentage
of the total population at least 16 years old.
 The employment rate measures the
number of people who are working as a
percentage of the labor force.

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Unemployment and Potential
Output

The capacity utilization rate indicates how
much capital is available for economic
growth.

Capacity utilization rate – the rate at which
factories and machines are operating
compared to the maximum sustainable rate at
which they could be used.
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Unemployment and Potential
Output

Potential output – output that would be
achieved at the target rates of
unemployment and of capacity utilization.
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Unemployment and Potential
Output

Okum's rule of thumb is used to
determine the effect changes in the
unemployment rate will have on income.

A one percent change in unemployment will
cause output to change in the opposite
direction by two percent.
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Microeconomic Categories of
Unemployment

Microeconomic policies are sometimes
used to supplement macroeconomic
policies for dealing with unemployment.
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Microeconomic Categories of
Unemployment

The following categories of unemployment
are analyzed by economists:
How people become unemployed.
 Demographic unemployment.
 Duration of unemployment.
 Unemployment by industry.

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Unemployment by
Microeconomic Subcategories,
2002
Total unemployment rate
Total unemployment – 8.3 million (5.8%)
Unemployment rate by sex
Male – 4.5 million (6.0%)
16-19
1.2 million
(15.4%)
McGraw-Hill/Irwin
20-24
1.0 million
(9.2%)
Female – 3.7 million (5.6%)
Unemployment rate by age
25-54 – 4.8 million (4.7%)
55 and over
0.8 million
(3.8%)
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Unemployment by
Microeconomic Subcategories,
2002
Unemployment rate by race*
White – 6.1 million (5.1%)
Black – 2.2 million (9.1%)
Duration of unemployment
Less than 5 weeks – 2.8 million
5-14 weeks – 2.5 million
More than 15 weeks
2.9 million
Reason for unemployment
Job losers – 4.5 million
McGraw-Hill/Irwin
New
Job leavers Re-entrants – 2.4 million entrants
0.5 million
0.9 million
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Inflation

Inflation is a continual rise in the price
level.
From 1800 until World War II, the U.S.
inflation rate and price level fluctuated.
 Since World War II, the rate fluctuated, but the
movement of the price level has been
consistently upward.

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Inflation Since 1900
25
20
15
10
5
0
–5
–10
1900
McGraw-Hill/Irwin
10
20
30
40
50
60
70
80
90
2000
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Measurement of Inflation
Inflation is measured with changes in price
indexes.
 Price index – a number that summarizes
what happens to a weighted composite of
prices of a selection of goods over time.

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Creating a Price Index

A price index is calculated by dividing the
current price of a basket of goods by the
price of the basket in a base year then
multiplying by 100.
Price of basket in current year
Price index 
X 100
Price of basket in base year
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A Simple Year-to-Year Market
Basket Comparison
Basket of Goods
Prices
2003
2004
Expenditures
2003
2004
10 pairs of jeans
$20.00/pr. $25.00/pr.
$200
$200
12 flannel shirts
15.00/ea. 20.00/ea.
180
240
100 lbs. Apples
0.80/lb.
1.05/lb.
80
105
80 lbs. Oranges
1.00/lb.
1.00/lb.
80
80
$540
$675
Total Expenditures
Price index in 2003 
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$675
X 100  125
$540
Real-World Price Indexes

Real-world price indexes include the PPI,
the CPI, and the GDP deflator.
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The GDP Deflator

The GDP deflator (gross domestic
product deflator) is an index of the price
level of aggregate output or the average
price of the components in GDP relative to
a base year.
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The GDP Deflator

Another price index is the chain-type
price index for GDP which uses a GDP
deflator with a constantly moving base
year.
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The GDP Deflator

The GDP deflator is the measure of
inflation most economists favor since it
includes the widest number of goods.
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The Consumer Price Index
(CPI)
The consumer price index (CPI)
measures the prices of a fixed "basket" of
consumer goods.
 It is weighed according to each
component's share of an average
consumer's expenditures.

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The Consumer Price Index
(CPI)
Many economists believe that the CPI as
currently constituted, overstates inflation by
one percentage point.
 To avoid some of the problems of the CPI,
some policymakers have been focusing on
the personal consumption expenditure
(PCE) deflator.

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The Consumer Price Index
(CPI)

Personal consumption expenditure
(PCE) deflator – a measure of prices of
goods that consumers buy that allows
yearly changes in the basket of goods that
reflect actual consumer purchasing habits.
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Composition of CPI
Food and beverage (16.4%)
Housing (40.5%)
Apparel (4.2%)
Transportation
(16.6%)
Other (5.0%)
Medical care (6.0%)
Education and
Communication (5.4%)
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Recreation (5.9%)
The Producer Price Index (PPI)
The producer price index (PPI) is an
index of prices that measures average
change in selling prices received by
domestic producers of goods and services
over time.
 It gives an early indication as to where
inflation is headed.

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Real and Nominal Concepts
Nominal output is the total amount of
goods and services measured at current
prices.
 Real output is the total amount of goods
and services produced, adjusted for price
level changes.

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Real and Nominal Concepts
The “real” amount is the nominal amount
divided by the price index.
 It is the nominal amount adjusted for
inflation.

nominal output
real output =
X 100
price index
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Expected and Unexpected
Inflation
Expected and unexpected inflation affects
behavior differently.
 Expected inflation is inflation people
expect to occur.
 Unexpected inflation is inflation that
surprises people.

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Expected and Unexpected
Inflation
Expectations of inflation play an important
role in the inflation process.
 Inflationary expectations can accelerate
large inflation.

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Costs of Inflation
Inflation may not make a nation poorer.
 It can redistribute income from those who
do not raise their prices to those who do.
 It can reduce the amount of information
that prices are supposed to convey.

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Costs of Inflation
Inflation is usually accepted by
governments as long as it stays at a low
level.
 What worries policymakers is
hyperinflation.

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Costs of Inflation
Hyperinflation – exceptionally high levels
of inflation of, say, 100 percent or more a
year.
 The U.S. has not experienced hyperinflation
since the Civil War (1861-65).

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Economic Growth, Business
Cycles, Unemployment, and
Inflation
End of Chapter 6
Macro233 - JFGAC