Macro233 - JFGAC Economic Growth, Business Cycles, Unemployment, and Inflation Chapter 6.

Macro233 - JFGAC

Economic Growth, Economic Growth, Business Cycles, Business Cycles,

Unemployment, and Unemployment, and InflationInflation

Chapter 6

Macro233 - JAFGAC

Laugher CurveLaugher Curve

An Indian-born economist once explained his personal theory of reincarnation to his graduate economics class.

Macro233 - JAFGAC

Laugher CurveLaugher 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.”

Macro233 - JAFGAC

IntroductionIntroduction

Macroeconomics is the study of the aggregate moods of the economy.

The four central problems are growth, business cycles, unemployment, and inflation.

Macro233 - JAFGAC

Two Frameworks: The Two Frameworks: The Long Run and the Short Long Run and the Short RunRun Issues of growth are considered in a long-

run framework. Business cycles are generally considered

in a short-run framework. Inflation and unemployment fall within both

frameworks.

Macro233 - JAFGAC

GrowthGrowth

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.

Macro233 - JAFGAC

GrowthGrowth

The U.S. secular growth rate is between 2.5 to 3.5 percent per year.

Macro233 - JAFGAC

GrowthGrowth

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.

Macro233 - JAFGAC

Global Experience with Global Experience with GrowthGrowth 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.

Macro233 - JAFGAC

Global Experience with Global Experience with GrowthGrowth 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.

Macro233 - JAFGAC

The Benefits and Costs of The Benefits and Costs of GrowthGrowth Per capita economic growth allows

everyone in society, on average to have more.

Growth, or predictions of growth, allows governments to avoid hard questions.

Macro233 - JAFGAC

The Benefits and Costs of The Benefits and Costs of GrowthGrowth The costs of growth include pollution,

resource exhaustion, and destruction of natural habitat.

Macro233 - JAFGAC

Business CyclesBusiness Cycles

The business cycle is the upward and downward movement of economic activity that occurs around the growth trend.

Macro233 - JAFGAC

Business CyclesBusiness Cycles

There are a number of policies regarding business cycles.

Classical economists generally favor laissez-faire or noninterventionist policies.

Keynesians generally favor activist policies.

U. S. Business CyclesU. S. Business Cycles

20

10

0

–10

–20

‘90‘801860 ‘70 1900 ‘10 ‘20 ‘30 ‘40 ‘50 ‘60 ‘70 ‘80 ‘90 ‘102000

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Civil War

Recoveryof 1895

World War I

Panicof 1893 Panic

of 1907Great

Depression

Korean War Vietnam War

World War II

Macro233 - JAFGAC

The Phases of the The Phases of the Business CycleBusiness 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.

Macro233 - JAFGAC

The Phases of the The Phases of the Business CycleBusiness 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.

Macro233 - JAFGAC

The Phases of the The Phases of the Business CycleBusiness Cycle An expansion is an upturn that lasts at

least two consecutive quarters of a year.

Expansion ExpansionRecession

The Phases of the The Phases of the Business CycleBusiness Cycle

Boom

Secular growth trend

DownturnUptu

rn

Trough

Peak

0Jan.-Mar

Tot

al O

utpu

t

Apr.-June

July-Sept.

Oct.-Dec.

Jan.-Mar

Apr.-June

July-Sept.

Oct.-Dec.

Jan.-Mar

Apr.-June

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Macro233 - JAFGAC

Why Do Business Cycles Why Do Business Cycles OccurOccur Recessions and expansions are caused

primarily by demand-side of the economy. A debate exists about whether these

fluctuations can and should be reduced.

Macro233 - JAFGAC

Why Do Business Cycles Why Do Business Cycles OccurOccur Most economists believe that potential

depressions should be offset by economic policy.

Macro233 - JAFGAC

Why Do Business Cycles Why Do Business Cycles OccurOccur 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.

Macro233 - JAFGAC

Why Do Business Cycles Why Do Business Cycles OccurOccur Most economists believe that business

fluctuations have become less severe because of the stronger role of government in the economy.

Macro233 - JAFGAC

Leading IndicatorsLeading Indicators

Leading indicators tell us what's likely to happen in the economy 12 to 15 months from now.

Macro233 - JAFGAC

Leading IndicatorsLeading Indicators

Leading indicators include the following: Average workweek for production

workers in manufacturing. Unemployment claims. New orders for consumer goods and

materials.

Macro233 - JAFGAC

Leading IndicatorsLeading 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.

Macro233 - JAFGAC

Leading IndicatorsLeading 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.

Macro233 - JAFGAC

UnemploymentUnemployment

The unemployment rate is the number of people who are willing and able to work but are not working.

Macro233 - JAFGAC

UnemploymentUnemployment

Cyclical unemployment is that which results from fluctuations in economic activity.

Structural unemployment is that caused by economic restructuring making some skills obsolete.

Macro233 - JAFGAC

Unemployment as a Unemployment as a Social ProblemSocial 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.

Macro233 - JAFGAC

Unemployment as Unemployment as Government’s ProblemGovernment’s Problem As capitalism evolved, capitalist societies

no longer saw the fear of hunger as an acceptable answer to unemployment.

Macro233 - JAFGAC

Unemployment as Unemployment as Government’s ProblemGovernment’s Problem Full employment – an economic climate

in which just about everyone who wants a job can have one.

Macro233 - JAFGAC

Unemployment as Unemployment as Government’s ProblemGovernment’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.

Macro233 - JAFGAC

Unemployment as Unemployment as Government’s ProblemGovernment’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.

Macro233 - JAFGAC

Unemployment as Unemployment as Government’s ProblemGovernment’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.

Macro233 - JAFGAC

Why the Target Rate of Why the Target Rate of Unemployment ChangedUnemployment 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.

Macro233 - JAFGAC

Why the Target Rate of Why the Target Rate of Unemployment ChangedUnemployment Changed Social and institutional structures have

changed. Governmental institutions also changed.

Macro233 - JAFGAC

Whose Responsibility Is Whose Responsibility Is Unemployment?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.

Macro233 - JAFGAC

How Is Unemployment How Is Unemployment Measured?Measured? The unemployment rate is published by the

U.S. Department of Labor's Bureau of labor Statistics.

Unemployment Rate Unemployment Rate Since 1900Since 1900

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

30

20

10

01910 1920 1940 1950 1960 1980 1990 2000 201019701930

Target rate

Macro233 - JAFGAC

Calculating the Calculating the Unemployment RateUnemployment Rate The unemployment rate – the number of

unemployed individuals divided by the number of people in the civilian labor force then multiplied by 100.

Macro233 - JAFGAC

Calculating the Calculating the Unemployment RateUnemployment 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.

Unemployment/Unemployment/Employment Figures (in Employment Figures (in millions)millions)

Total civilian population (288.4 million)

Noninstitutional population (214.0 million)

Labor force (142.5 million)

Employed (134.3 million)

Not in labor force (71.4 million)

Unemployed (8.3 million)

Incapable of working (74.4 million)

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Macro233 - JAFGAC

How Accurate Is the How Accurate Is the Official Unemployment Official Unemployment Rate?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.

Macro233 - JAFGAC

How Accurate Is the How Accurate Is the Official Unemployment Official Unemployment Rate?Rate? The unemployment rate counts as

employed those who are underemployed. Underemployed – part-time workers who

would prefer full-time work.

Macro233 - JAFGAC

How Accurate Is the How Accurate Is the Official Unemployment Official Unemployment Rate?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.

Macro233 - JAFGAC

How Accurate Is the How Accurate Is the Official Unemployment Official Unemployment Rate?Rate? The Bureau of Labor Statistics uses the

labor force participation rate and the employment rate to gauge the state of the labor market.

Macro233 - JAFGAC

How Accurate Is the How Accurate Is the Official Unemployment Official Unemployment Rate?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.

Macro233 - JAFGAC

Unemployment and Unemployment and Potential OutputPotential 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.

Macro233 - JAFGAC

Unemployment and Unemployment and Potential OutputPotential Output Potential output – output that would be

achieved at the target rates of unemployment and of capacity utilization.

Macro233 - JAFGAC

Unemployment and Unemployment and Potential OutputPotential 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.

Macro233 - JAFGAC

Microeconomic Microeconomic Categories of Categories of UnemploymentUnemployment Microeconomic policies are sometimes

used to supplement macroeconomic policies for dealing with unemployment.

Macro233 - JAFGAC

Microeconomic Microeconomic Categories of Categories of UnemploymentUnemployment The following categories of unemployment

are analyzed by economists: How people become unemployed. Demographic unemployment. Duration of unemployment. Unemployment by industry.

Unemployment by Unemployment by Microeconomic Microeconomic Subcategories, 2002Subcategories, 2002

16-191.2 million(15.4%)

20-241.0 million

(9.2%)

Male – 4.5 million (6.0%)

Unemployment rate by age

25-54 – 4.8 million (4.7%)55 and over0.8 million

(3.8%)

Female – 3.7 million (5.6%)

Unemployment rate by sex

Total unemployment – 8.3 million (5.8%)

Total unemployment rate

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Unemployment by Unemployment by Microeconomic Microeconomic Subcategories, 2002Subcategories, 2002

Job losers – 4.5 million

Less than 5 weeks – 2.8 million

White – 6.1 million (5.1%)

Duration of unemployment

Unemployment rate by race*

Black – 2.2 million (9.1%)

5-14 weeks – 2.5 million

Reason for unemployment

Job leavers0.9 million

Re-entrants – 2.4 million

More than 15 weeks2.9 million

Newentrants

0.5 million

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Macro233 - JAFGAC

InflationInflation

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.

Inflation Since 1900Inflation Since 1900

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

3020101900 40 50 60 70 80 90 2000

–10

–5

0

5

10

15

20

25

Macro233 - JAFGAC

Measurement of InflationMeasurement 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.

Macro233 - JAFGAC

Creating a Price IndexCreating 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.

100 X yearbase in basket of Price

yearcurrent in basket of Priceindex Price

Macro233 - JAFGAC

A Simple Year-to-Year A Simple Year-to-Year Market Basket Market Basket ComparisonComparison

125 100 X $540

$6752003 in index Price

Macro233 - JAFGAC

Real-World Price IndexesReal-World Price Indexes

Real-world price indexes include the PPI, the CPI, and the GDP deflator.

Macro233 - JAFGAC

The GDP DeflatorThe 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.

Macro233 - JAFGAC

The GDP DeflatorThe GDP Deflator

Another price index is the chain-type price index for GDP which uses a GDP deflator with a constantly moving base year.

Macro233 - JAFGAC

The GDP DeflatorThe GDP Deflator

The GDP deflator is the measure of inflation most economists favor since it includes the widest number of goods.

Macro233 - JAFGAC

The Consumer Price The Consumer Price Index (CPI)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.

Macro233 - JAFGAC

The Consumer Price The Consumer Price Index (CPI)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.

Macro233 - JAFGAC

The Consumer Price The Consumer Price Index (CPI)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.

Macro233 - JAFGAC

Composition of CPIComposition of CPI

Recreation (5.9%)

Food and beverage (16.4%)

Apparel (4.2%)

Transportation (16.6%)

Medical care (6.0%)

Housing (40.5%)

Other (5.0%)

Education and Communication (5.4%)

Macro233 - JAFGAC

The Producer Price Index The Producer Price Index (PPI)(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.

Macro233 - JAFGAC

Real and Nominal Real and Nominal ConceptsConcepts 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.

Macro233 - JAFGAC

Real and Nominal Real and Nominal ConceptsConcepts The “real” amount is the nominal amount

divided by the price index. It is the nominal amount adjusted for

inflation.

Macro233 - JAFGAC

Expected and Expected and Unexpected InflationUnexpected Inflation Expected and unexpected inflation affects

behavior differently. Expected inflation is inflation people

expect to occur. Unexpected inflation is inflation that

surprises people.

Macro233 - JAFGAC

Expected and Expected and Unexpected InflationUnexpected Inflation Expectations of inflation play an important

role in the inflation process. Inflationary expectations can accelerate

large inflation.

Macro233 - JAFGAC

Costs of InflationCosts 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.

Macro233 - JAFGAC

Costs of InflationCosts of Inflation

Inflation is usually accepted by governments as long as it stays at a low level.

What worries policymakers is hyperinflation.

Macro233 - JAFGAC

Costs of InflationCosts 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).

Macro233 - JFGAC

Economic Growth, Economic Growth, Business Cycles, Business Cycles,

Unemployment, and Unemployment, and InflationInflation

End of Chapter 6