Download Chapter 5

Chapter 5
The Macroeconomic
Environment
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-1
Learning Objectives
• Describe the business cycle—the periodic
fluctuations in output, employment and
price levels that have characterised our
economy.
• Examine unemployment in detail—its
definition and measurement and the
structure of unemployment.
• Discuss the economic and social problems
associated with unemployment.
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-2
Learning Objectives (cont.)
• Understand the causes and consequences of
inflation, a problem that plagued us through
the 1970s and 1980s.
• Discuss the history and changes in structure of
Australia’s balance of payments, with emphasis
on the current account of the balance of
payments.
• Discuss the relationship between the current
account balance and the level of national
savings.
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-3
The Business Cycle
• The recurrent, somewhat cyclical,
increases and decreases in the level or
rate of growth in economic activity
that typify the pattern of progress of
our economy’s real GDP over time
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-4
The Australian Business
Cycle & Rate of Inflation
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-5
Phases of the Business
Cycle
• Peak
–
temporary maximum economic activity
• Recession
–
decline in output and employment to low or
negative levels
–
a depression is a severe and prolonged
recession
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-6
Phases of the Business
Cycle (cont.)
• Trough
–
output and employment bottom out at their
lowest levels
• Recovery
–
output and employment expand towards the
full-employment level or capacity level
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-7
Phases of the Business Cycle
(cont.)
Level of business activity
PEAK
RECESSION
RECOVERY
TROUGH
Time
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-8
Causes of Business Cycle
Variety of explanations/theories:
• Innovation
• Political events
• Random events
• Purely monetary phenomenon
• Immediate determinant: aggregate
expenditure
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-9
Business Cycle
• Cyclical impact: durables and non-
durables
–
Capital goods and consumer durables most
greatly affected by business cycles
–
Consumer non-durables least affected
• Postponability
• Monopoly power
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-10
Types of Unemployment
• Frictional
–
workers ‘between jobs’, temporarily laid off due to
seasonality, and new entrants
–
allows movement of labour from low to high productivity
–
inevitable and partly desirable
• Structural
–
mismatch in skills and geographic location
–
not employable without additional training, education and
geographical movement
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-11
Types of Unemployment
(cont.)
• Cyclical
–
unemployment caused by the business cycle, or
due to insufficient aggregate demand or total
spending
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-12
Full Employment
• The full-employment rate of unemployment
is called the natural rate of unemployment
–
equals the sum of frictional and structural unemployment
–
cyclical unemployment = zero
• Domestic output consistent with the natural
rate of unemployment is potential output or
GDP
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-13
Australia: Unemployment Rate
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-14
Measuring Unemployment
• Part-time employment
• Discouraged workers or the ‘hidden
unemployed’
–
those who become discouraged and drop out of
the labour force but would return if a suitable
job prospect arose
• Discouraged workers, participation
rate and the unemployment rate
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-15
Cost of Unemployment
• Economic costs
–
output forgone, measured in terms of the
GDP gap
–
Okun’s law shows the relationship between the
unemployment rate and the GDP gap
–
Unequal burdens
• Non-economic costs
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-16
Inflation
• Inflation is a continuous rise in the
general price level
• The inflation rate is measured as
follows:
Inflation
rate
=
Current year index – Previous
year index
× 100
Previous year index
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-17
Theories of Inflation
Two general theories of inflation:
• Demand-Pull Inflation
–
caused by excess demand for output
• Cost-Push Inflation
–
rise in prices arising from increased cost of
production due to:

wage push

profit push
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-18
Demand-Pull Inflation
Range 3
Price level
P
Range 1
Fullemployment
output
Q
Output and employment
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-19
Inflation & Redistribution
• Most severe when inflation is
unanticipated
• Fixed-nominal-income receivers
• Savers
• Debtors and creditors
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-20
Evaluation of Inflation
• Distribution of output
• Impact on real output
• Hyperinflation
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-21
Anticipated Inflation
• Real interest rate
–
The percentage increase in the purchasing
power that a lender receives from a borrower in
exchange for the borrower’s use of the lender’s
funds
• Nominal interest rate
–
The percentage increase in money that the
lender receives from the borrower
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-22
Output Effects of Inflation
• Stimulus of demand-pull inflation
• Cost-push inflation and unemployment
–
Hyperinflation
–
Wage-price inflationary spiral

A continuous cycle of money wage and price rises that
feed on each other
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-23
Australia’s Current
Account Problem
• Three factors
–
gradual deterioration in the terms of trade
–
high freight and transport costs
–
dependence on large levels of capital inflow
• Current account problems in the
1970s, 1980s and 1990s
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-24
Components of the Current
Account
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-25
The Capital and Financial Account
Balance 1959–60 to 2001–02
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-26
National Savings
• National savings represents savings from
national income
• Used to finance gross capital formation
• Continuous fall in household savings in
Australia in recent years:
–
increases in household wealth
–
replacement of direct savings with alternatives such as
superannuation
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-27
Australia: National Savings
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-28
Next Chapter:
The Aggregate
Expenditures Model
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
5-29