Chapter 14 Economic Instability

Section 1: Business Cycles and Fluctuations Gross Domestic Product (GDP) – Total $$ value of all final goods, services and structures produced within a countries borders during a one year period.

Section 1: Business Cycles and Fluctuations PHASES OF THE BUSINESS CYCLE 1. Recession: A period in which GDP decreases for 2 consecutive quarters or 6 consecutive months. Recession begins when the economy reaches it’s peak and ends when the economy reaches a trough 2. Expansion: Period of Recovery from a recession. Expansion continues until the economy reaches its next peak

Depression (Economically Speaking) State of the economy caused by prolonged period of recession with large numbers of people out of work (high unemployment), acute shortages, and excess capacity in manufacturing plants. Most experts agree that the “Great Depression” of the 1930’s was the only depression the U.S. has suffered in the 20th Century.

What caused the “Great Depression?” Disparity in the distribution of income. Huge gap between rich and poor. – Poor did not have the $$ to simulate the economy and the rich spent most of their $$ in the market Easy and plentiful credit – Many folks borrowed heavily in the “Roaring 20’s” and did not have the means to make their pmts. When things started to go south in the 30’s Global Economic Conditions: World trade declined and American exports dropped drastically. – Eliminating previous markets and opportunities for US businesses to increase sales abroad.

Business Cycles since WWII Between 1940 and 1980, recession and expansion happened regularly. Recessions on average seemed relatively short (11 months) as opposed to expansion phases which averaged 43 months. After 1980, recession occurred less frequently. The current recession experienced starting in 2007 has been the longest economic downturn since the Great Depression!

Causes of Business Cycles Changes in Capital Expenditures – When the economy is expanding, business expects future sales to be high so they invest heavily in capital goods and vice versa Inventory Adjustments – Some businesses cut back on inventories with the first sign of an economic slowdown and vice versa Innovation and Imitation – May be a new product or new way of performing a task giving them a competitive advantage External Shocks – Increase in oil prices, wars, foreign conflict. Some will drive the economy up and others drive it down

Predicting Business Cycles Macroeconomic Modeling and Statistical Indicators – GDP = C + I + G + (X - M) Where: C = household consumption expenditures / personal consumption expenditures I = gross private domestic investment G = government consumption and gross investment expenditures X = gross exports of goods and services M = gross imports of goods and services Note: (X - M) is often written as X N, which stands for "net exports"

Index of Leading Indicators Defined… A monthly statistical series that usually turns down before real GDP turns down (recession) and turns up before real GDP turns up (expansion). 11 Leading Economic Indicators Index of new private housing units; Changes in unfulfilled orders by manufacturers of durable goods; Changes in sensitive materials prices; Index of S&P 500 (common stock prices); Money supply; Index of consumer expectations; The length of the average work week of production workers in manufacturing settings; The average weekly state unemployment insurance claims; New orders for consumer goods and materials based on 1982 dollars; Vendor performance or percentage of companies receiving slower deliveries from suppliers; Contracts and orders for equipment.

Section 2: Unemployment Measuring Unemployment~ The measure of joblessness is the unemployment rate. One of the most closely watched statistics in the economy!

Section 2: Unemployment Measuring Unemployment Cont… Unemployed: – People available for work, actively seeking work, but remain without a job. Unemployment rate: – Number of people unemployed divided by the total number of people in the civilian labor force.

Section 2: Unemployment Limitations of the Unemployment Rate Does not count those individuals who have become frustrated and have given up on looking for a job (could be millions during a recession) People are considered “employed” even if they hold part-time jobs. Individuals may have been laid off of high paying full-time positions only to settle for part-time work! Being Employed is not the same as being “Fully Employed”!

Section 2: Unemployment Kinds of Unemployment 1. Frictional Unemployment  Unemployment caused by workers who are between jobs for one reason or another.  Short-term unemployed are likely to find another job.  Unemployment of this nature is minor, but will never be avoided.

Section 2: Unemployment Kinds of Unemployment Cont… 2. Structural Unemployment  Occurs when a fundamental change in the operation of the economy reduces the demand for workers and their skills.  Caused mainly by changes in technology and changes in consumer tastes. Reduced demand for particular skills.  This is a more serious type of unemployment

Section 2: Unemployment Kinds of Unemployment Cont… 3. Cyclical Unemployment  Directly related to swings in the “business cycle”.  During a recession, many people put off buying durable goods (big ticket stuff) causing some industries to lay off workers until the economy recovers.

Section 2: Unemployment Kinds of Unemployment Cont… 4. Seasonal Unemployment  Results from changes in the weather or changes in the demand for certain products.  Examples…carpenters or road construction workers can be fully employed Spring. Summer, and Fall, but cannot work during the Winter. Resort workers will be laid off during their “off-season”…  Differs from “Cyclical” in the length of time unemployed.

Section 2: Unemployment Kinds of Unemployment Cont… 5. Technological Unemployment  Results when workers with less skills, talent, or education are replaced by machines and other equipment that do their jobs  Threat of automation or production by mechanical means that reduces the need for workers.  Robots, mechanized assembly lines, ATM’s.

Section 2: Unemployment Concept of “Full Employment” o Full employment does not mean zero unemployment. o Instead, it is the lowest possible unemployment rate, with the economy growing and all factors of production being used as efficiently as possible. o Target often used is below 4.5% unemployment.

Section 3: Inflation Inflation: Rise in general level of prices! Price Level: Relative magnitude (snap-shot) of prices at one point in time!

Section 3: Inflation Measuring Inflation: o Consumer Price Index (CPI) o Producer Price Index (PPI) o Implicit GDP Price Deflator Made up of selected basket of goods to track o Inflation is reported in terms of annual rates of change of the price level

Section 3: Inflation If the CPI at the start of one year is 111 and if it reaches 115 by the beginning of the next, inflation would be computed as follows: Inflation rate = Change in price level/beginning price level x 100 Inflation rate = / 111 x 100 Inflation rate = 4 / 111 x % = 4 / 111 x 100

Section 3: Inflation Deflation: Decrease in general level of prices! Only 2 significant cases during the 1900’s! Post WWI Recession (1920) Great Depression

Section 3: Inflation Degrees of Inflation: – Creeping inflation: In the range of 1-3% per year – Galloping inflation” More intense form that can reach %!! – Hyper inflation: Inflation is entirely out of control! 500% per year and above!

Section 3: Inflation Causes of Inflation: o Demand-pull theory As consumers and gov. converge on stores, shortages result and drive prices up! Prices are “pulled up” by excessive demand. o Federal Governments deficit spending o Rising costs of “inputs” (like labor) drive prices up. o Rising cost of non-labor “inputs” (like gas/oil) drive prices up. o Self perpetuating spiral of wages and prices. o Increase in the money supply.

Section 3: Inflation Consequences of Inflation: o The “dollar” buys less causing decreased purchasing power.  Especially hard on those with fixed incomes (elderly) o Cause people to change their spending habits o Temps people to speculate heavily in an attempt to take advantage of a higher price level. Conservative people might gamble on risky markets? o Alters the distribution of Income

Section 4: Poverty & Income Distribution Distribution of Income – The incomes of all the households are ranked from highest to lowest – These rankings are then divided into quintiles or fifths for examination – Only money income is counted (not food stamps, Medicaid, subsidized housing etc.)

Section 4: Poverty & Income Distribution Lorenz Curve – A curve that shows how much the actual distribution of income varies from an equal distribution of income

Section 4: Poverty & Income Distribution Reasons for Income Inequality 1.Education/Training 2.Wealth 3.Discrimination 4.Ability 5.Monopoly Power

Section 4: Poverty & Income Distribution Reasons for Income Inequality 1.Education/Training Some people have higher incomes than others because they have more education/training There is generally a strong relationship between median income and level of education/training Education/training typically puts people in a better position to get higher paying jobs that require higher levels of skills

Section 4: Poverty & Income Distribution Reasons for Income Inequality 2.Wealth The distribution of wealth is even more unequal than the distribution of income. The top 1% _________ The wealthy can send their children to expensive colleges The wealthy can set their children up in businesses The wealthy can earn money from investments if they choose not to work.

Section 4: Poverty & Income Distribution Reasons for Income Inequality 3.Discrimination Although discrimination in the workplace is illegal, it still takes place. Wage inequality between men and women still exists. Women may not be promoted to executive or management level positions because of old school stereotypes.

Section 4: Poverty & Income Distribution Reasons for Income Inequality 4.Ability Some earn more income because they have natural talents in a certain area (professional athletes, musicians, entertainers…)

Section 4: Poverty & Income Distribution Reasons for Income Inequality 5.Monopoly Power Organized labor (Unions), Professional Associations (American Medical Association~AMA) Corporations worth billions who lobby for laws and regulations that benefit their profitability

Section 4: Poverty & Income Distribution Poverty  A relative measure that depends on prices, standard of living, and the income that others earn.  Poverty is a major problem in the U.S. & difficult to resolve.  Individuals and families are defined as living in poverty if their incomes fall below certain levels.

Section 4: Poverty & Income Distribution Poverty Guidelines  Annual dollar amounts used to evaluate the “money” income that families and unrelated individuals receive.  Poverty Guidelines for 2011  People currently living in poverty 49.1 million About 15% of our population!

Section 4: Poverty & Income Distribution Growing Income Gap  One reason for the continued high poverty numbers is the ever growing gap in the distribution of income.  Rich are getting richer & the poor are getting poorer! Causes: 1.Structural changes in the economy from the production of “goods” to “services”. 2.Growing gap between well educated and poorly educated workers 3.Attacks on unions…which support low-skilled workers 4.Changing structure of the American family.

Section 4: Poverty & Income Distribution Antipoverty Programs 1.Income Assistance 2.General Assistance 3.Social Service Programs 4.Tax Credits 5.Enterprise Zones 6.Workfare Programs 7.Negative Income Tax

Section 4: Poverty & Income Distribution Antipoverty Programs 1.Income Assistance Programs that provide direct cash assistance to those in need (TANF) Families might receive cash payments because of the death, continuous absence, or permanent disability of a parent

Section 4: Poverty & Income Distribution Antipoverty Programs 2.General Assistance Programs that assist those in need but do not provide direct cash payments. Food Stamps and Medicaid would be examples.

Section 4: Poverty & Income Distribution Antipoverty Programs 3. Social Service Programs These include areas such as child abuse prevention, foster care, family planning, job training, child welfare and day care.

Section 4: Poverty & Income Distribution Antipoverty Programs 4.Tax Credits. Tax Credit = a sum deducted from the total amount a taxpayer owes. Most popular is the Earned Income Tax Credit (EITC) which provides federal tax credits and sometimes cash to low-income workers. If the credit is larger than the tax owed, the person can take the remainder in cash.

Section 4: Poverty & Income Distribution Antipoverty Programs 5. Enterprise Zones Areas where companies can locate free of local, state, or federal tax laws and other operating expenses. Usually created in economically depressed areas giving local residents easy access to employment A healthy and growing economy helps in the fight against poverty

Section 4: Poverty & Income Distribution Antipoverty Programs 6. Workfare Programs Program that requires welfare recipients to exchange some of their labor for benefits received. Can include things like assisting law enforcement, highway departments, parks, and various community service projects.

Section 4: Poverty & Income Distribution Antipoverty Programs 7. Negative Income Tax Proposed type of tax that would make cash payments to certain groups below the poverty line. This would take the place of existing welfare programs. Taxes = (25% of income) – 8,000 (Example) A market based program designed to encourage people to work. Not currently used.