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Economic Instability 13.1 Business Cycles Economic growth is something that is beneficial to almost everyone We cannot take it for granted Business Cycles – regular ups and downs of real GDP – interrupt economic growth Business Fluctuations – the rise and fall of real GDP over time in an irregular manner – interrupt growth at other times. GDP GDP - is the market value of all final goods and services produced within a country in a given period of time. GDP by Comparison http://www.google.com/publicdata?ds=wb- wdi&met=ny_gdp_mktp_cd&idim=country:USA&dl=en&h l=en&q=gdp#met=ny_gdp_mktp_cd&idim=country:USA: CHN:JPN:DEU:FRA:GBR:CAN:MEX Slower Economic Growth • Slower economic growth always a matter of concern • Businesses lose sales • Voters become unhappy • Investors get nervous • Stock market shows its disapproval • Because of this economists have developed elaborate forecasting models and statistical tools The Phases of a Business Cycle • 2 Phases of a business cycle • First Phase = Recession – a period during which real GDP – declines for at least two quarters in a row, or six consecutive months • The recession begins when the economy reaches a peak • The point where real GDP stops going up • It ends when the economy reaches a trough – the turnaround point where real GDP stops going down. Phases of a Business Cycle Second Phase As soon as the declining real GDP bottoms out Expansion – a period of recovery from a recession Expansion continues until the economy reaches a new peak. When it does the current business cycle ends and a new one begins Trend Line Trend Line – The economy departs from, and then returns to, its trend line as it passes from through phases or recession and expansion Or Growth path the economy would follow if it were not interrupted by alternating periods of recession and recovery Depression If a recession is very severe – it may turn into a depression – a state of economy with large numbers of people out of work, acute shortages, and excess capacity in manufacturing plans Causes of Business Cycles Changes in Investment Spending Innovation and Imitation Monetary Policy Decisions External Shocks The Great Depression of the 1930s • 1929 – 1933 GDP declined 50 % • $103 Billion - $55 Billion • Unemployment rose 800% • 1.6 million to 12.8 million • 25 % of the workforce • Wages fell from $.55 to $.05 per hour • Banks across the country failed • FDIC did not exist • Bank Holidays • Depression Script Causes 1. Enormous gap between Rich and Poor 2.Easy Credit – buying on margin 3. Global Economic Conditions 4. High Tariffs Causes of the Great Depression Disparity in the distribution of income – the Great Gatsby effect. America did not really have a middle class. It was split up into the very poor and the very rich. The poor could not stimulate the economy with consumer spending, because they had very little or no money to spend. The rich had the money, but didn’t use it in ways to spark economic growth. They either saved it in banks or used it to speculate on the stock market. Causes of the Great Depression Easy and Plentiful credit Many people borrowed heavily in the 1920s – more than they could afford to pay back. High interests rates and business fluctuations also impacted this. Causes of the Great Depression Global Economic Conditions: Europe was still recovering from a massive war (WWI). A good deal of farmable land had been decimated by trench warfare. During the 1920s, banks, businesses and public institutions made tons of loans to foreign companies, interests and nations to help support business and international trade. When the Depression began, these companies called in their debts. This left these foreign interests broke. As a result, they didn’t have any money to buy American goods. This led to American job losses. High American tariffs made foreign good too expensive for Americans to buy. Recovery and Legislation Social Security Act of 1935 Minimum Wage Unemployment Benefits/Programs SEC – Securities and Exchange Commission (Companies required to give full disclosure of financial statements) FDIC Great Recession of the 2000s Why? How were we able to avoid another Great Depression? Huge Government Bail Outs - CPI and the Cost of Living The Consumer Price Index Consumer price index (CPI) Measure of the overall cost of goods & services bought by a typical consumer How the consumer price index is calculated 1. 2. 3. Fix the basket Find the prices Compute the basket’s cost 21 The Consumer Price Index How the consumer price index is calculated 4. Chose a base year and compute the CPI Price of basket of goods & services in current year Divided by price of basket in base year Times 100 5. Compute the inflation rate Percentage change in the price index from the preceding period CPI in year 2 - CPI in year 1 Inflation rate in year 2 100 CPI in year 1 22 1 The typical basket of goods and services This figure shows how the typical consumer divides spending among various categories of goods and services. The Bureau of Labor Statistics calls each percentage the “relative importance” of the category. 23 The Consumer Price Index Producer price index (PPI) Measure of the cost of a basket of goods and services bought by firms Problems in measuring the cost of living Substitution bias Introduction of new goods Unmeasured quality change 24 The Consumer Price Index The GDP deflator vs. consumer price index GDP deflator Ratio of nominal GDP to real GDP Reflects prices of all goods & services produced domestically CPI Reflects prices of goods & services bought by consumers 25 The Consumer Price Index The GDP deflator vs. consumer price index GDP deflator Compares the price of currently produced goods and services to the price of the same goods and services in the base year CPI Compares price of a fixed basket of goods and services to the price of the basket in the base year 26 “The Warning” http://www.pbs.org/wgbh/pages/frontline/warni ng/view/?utm_campaign=viewpage&utm_medium =grid&utm_source=grid Inlfation Chapter 13 Section 2 Hyperinflation was so severe in the 1920s that it completely wiped out the savings of many middle-class Germans. By the end of 1923, $1 was worth four trillion German marks. Inflation The inflation rate is determined by comparing the price level at the beginning and end of a period. Sometimes Deflation can occur when there is a decrease in the general price level. Creeping inflation is inflation in a range of 1 to 3 percent annually. Galloping inflation is when inflation can go as high as 100 to 300 percent annually. Inflation of more than 500% a year is known as hyperinflation. What Happens when there is inflation? Money loses its value. People have difficult comparing prices. Bartering takes place. Causes of Inflation Demand-pull inflation occurs when all sectors of the economy try to buy more goods and services than the economy can produce. Shortages occur and prices go up. Prices are “pulled up” by excessive demand. sometimes caused by the federal government’s deficit spending. Causes of Inflation Cost-push inflation occurs when input costs – especially labor – drive production costs up. This is usually only possible when the unemployment rate is exceptionally low. The wage-price spiral occurs when higher prices force workers to demand higher wages. This forces producers to raise their prices even more. Why do you think this is called a “spiral?” Causes of Inflation Excessive monetary growth can cause inflation. Most popular explanation. In other words, there is more money than there should be. Supply outpaces GDP growth. Consequences of Inflation When inflation occurs, the dollar buys less. (see chart on page 366) This hurts people on fixed incomes (why?) Inflation causes people to change their spending habits, which disrupts the economy. See example on Page 293 about the housing market, second column, second paragraph. Inflation tempts people to speculate heavily to take advantage of the higher price level. It alters the distribution of income Unemployment 13.3 What is the unemployment rate of the United States? Michigan? US & Michigan Facts USA: 7.6% Michigan: 8.5% Detroit-Livonia-Warren: 18% Troy-Farmington Hills: 7.4% Natural Rate of Unemployment: 5-6% How do we compare to the rest of the world? World Facts Greece: 26.8% Brazil: 5.7% European Union: 10.7% U.K: 7.8% Saudi Arabia: 10.7% (25% for men) Senegal: 10.2% Crow Reservation: 46.5% Liberia: 5.1% True Unemployment How do we figure it out? Census Bureau surveys about 50,000 Americans per month, in 200 counties, across all 50 states to gain a sample number they hope reflects the entire nation. They are looking for the people who are officially unemployed per the definition of the US government. What is that? Unemployment “People available for work who made a specific effort to find a job during the past month” Plus! In addition, they have to have worked for less than one hour for par or profit a week. You have to have worked at a family business without pay for less than 15 hours a week. o Also, you have to be over the age of 15 and not a dependent. All this data is turned over to the BLS and published once per month Unemployment Rate To figure this out, we take the total number of people unemployed and divide it by the total workforce. Look at figure 13.6 on page 371. You’ll see that there is a usually a direct relationship between unemployment and an economic recession. What is it? Group Work! Get into groups of three and write down what you think are the limitations of this system. What does this rate miss? Understatement 3 major reasons that this reported number is too low. 1. Frustrated or discouraged workers 2. Underemployment 3. People who do not want/care about traditional employment Overstatement? What might not be taken into account, that would lower the unemployment rate? Types of Unemployment Much like Econ teachers, not all types of unemployment are created equal. What causes lead to unemployment make a difference to the BLS on why you are unemployed. Bob Bob is a salesmen who has left his job at GM and has three weeks before he starts his job at Kroger. What type of unemployment is this? Frictional Short-term unemployed Little amount of hardship from their unemployment. Young workers There will always be frictional unemployment Bob 2 Bob worked really hard on the line at Ford, but now is out of a job due to the rise in sales from BMW. What type of unemployment is this? Structural Unemployment This occurs when a fundamental change in the economy reduces the demand for workers and their skills. Michigan: Cars Congress decision to close some military bases New skills forced on old workers Bob 3 Bob got laid off from work because his company’s sales were down What type of unemployment is this? Cyclical Unemployment Business cycles. Recessions Expansions Bob 4 Bob picks apples, but now it is December and there are no apples to pick What type of unemployment is this? Seasonal Unemployment Results from the changes in the weather or changes in demand for certain products. Cutting grass Picking fruit Comerica Park Peanut Vendor Bob 5 Bob studied hard at ITT Tech to become a VCR repair. He now has no job, since most of you do not even know how to use a VCR… What type of unemployment is this? Technological Unemployment Technological improvement makes jobs obsolete. Full Employment What is it? How does it relate to unemployment?
