Inflation “Too much money” Real GDP Unemployment BusinessCycles Unemployment 1960-Present Inflation Economic Growth and Instability Economic Growth and Instability

ECONOMIC GROWTH Real GDP An increase in Real GDP over time Real GDP per capita An increase in Real GDP per capita over time RealGDPpopulationReal GDP per capita [Real GDP/population = Real GDP per capita] Growth is a Goal because it lessens the burden of scarcity (everyone has more of everything). Main Sources of Growth Increases in Resources Increases in Productivity (Health, training, and education).

Added Leisure [Workweek decreased from 50 to 35 hours] From LPs to CDs Icebox – cooled by “natural” ice 1927 GE Monitor Top electric refrigerator- $300 Growth in the United States Improved Products - iceboxes to refrigerators

“Real Income” “Real Income” measures the amount of goods/services nominal income will buy. [% change in real income% change in nominal income% change in PL [% change in real income = % change in nominal income - % change in PL] 5%10%5% 5% 10% 5% Nominal income rose by 10%,PL increased by 4% real income rose by Nominal income rose by 10%, PL increased by 4% - then real income rose by ___%. Nominal income rose by 20%,PL increased by 5% real income rose by Nominal income rose by 20%, PL increased by 5% - then real income rose by ___%. _________________________ “Rule of 70” “Rule of 70” = % annual rate of increase (3%) = 23 years Investments [Investments to double] GDP 10 = ______ 12 = _____ 9 = _____ [GDP (standard of living) to double]] “Rule of 70” (The arithmetic of economic growth) “Rule of 70” (The arithmetic of economic growth) 7 years 6 years 8 years

Peak Trough One cycle Expansion Real GDP per year Peak: Peak: real GDP reaches its maximum. Contraction: Contraction: real GDP declines 6 months. Expansion: Expansion: an upturn - real GDP rises. Trough: Trough: real GDP reaches its minimum. Contraction Time Peak Four Phases of the Business Cycle

THE BUSINESS CYCLE Phases of the Business Cycle PEAK Level of business activity Time RECESSION TROUGH RECOVERY GROWTHTREND

B u s i n e s s C y c l e s An Actual Business Cycle ($ billion, 1992 dollars) An Actual Business Cycle ($ billion, 1992 dollars) Real GDP Peak Peak Trough One Cycle ‘80‘85 ‘

Characteristics of Expansions and Recessions Characteristics of Expansions and Recessions Expansions 1. Less unemployment 2. Increase in real GDP 3. Rapid job growth 4. Increasing interest rate 5. Increasing prices 6. Fewer social problems (alcoholism, domestic violence, divorce, and suicides) Four Phases of Business Cycle Recessions 1. More unemployment 2. Decrease in Real GDP 3. Reduced job growth 4. Lower interest rates 5. Decreasing prices 6. More social problems (alcoholism, domestic violence, divorce and suicide)

Average Business Cycle last 5-7 years. The period from peak to trough (if longer than 6 months) is referred to as an economic recession. The period from trough to peak is referred to as economic recovery.

Business Cycles since 1930

There has been 10 recessions since They have ranged from 6 months to 10 years in length (averaging 7 years.) Periods of expansion have averaged 2-10 years. There has been a recession each decade in the our 200 year history. Usually 1 out of every 20 workers loses their job. But the other 19 are better off Because interest rates go down.

Unemployment: To measure the unemployment rate, we must fist determine who is eligible & available to work.

Labor Force = Total Population age 16 and over actively working or looking Not in Labor Force Not in Labor Force Armed forces Household workers Students Retirees Disabled persons Institutionalized Discouraged workers Civilian labor force Employed Employed Employees Self-employed Unemployed Unemployed New entrants Re-entrants Lost job & looking Quit job & looking Laid off & looking

UNEMPLOYMENT Measurement of Unemployment, 2004 Employed Not in labor force Under 16 and/or institutionalizedTotalPopulation293,400,000 Laborforce142,500,000 74,700,000 (kids, Crazies, and military) 71,400,000 (Retired or not looking for work) Unemployed 8,300,000 (no job but looking) 134,200,000

The formula for determining the unemployment rate is; Unemployment rate = unemployed labor forceX 100 labor forceX 100 Full employment does not equal 100% employment. Why? Because there are different types of Unemployment. Wish I had not dropped out of Economics.

Three Types of Unemployment Frictional Frictional – a temporary, transitional, or short-term, type of unemployment (someone between jobs) Examples: 1.People who get “fired” or “quits” to look for a better job. 2. Graduates from high school or college who are looking for a job. 3. Seasonal jobs such as agriculture, construction, tourism, or holiday work. Since there will always be frictional unemployment and it does not affect economic growth, it is not included in unemployment rates. (Workers plan for there job lose)

Structural Structural – a technological, or long-term type of unemployment, caused by changes in the job market that make certain skills obsolete. Causes of structural unemployment; Automation Automation Consumer taste Consumer taste Creative destruction; Creative destruction; as jobs are created jobs are lost. (The creation of the auto reduced the need for carriage makers.) Even though these jobs do not come back, structural unemployment is not counted in unemployment rates. Most workers will be retained (out of the labor force) until they can find a new job. Also structural changes are good for economic growth.

Cyclical Cyclical – an economic downturn in the business cycle, caused by decreased aggregate demand for goods and services. These cyclical fluctuations can lead to lay-offs, and cyclical unemployment. Even though these jobs will come back cyclical unemployment is real unemployment, because it affects economic growth.

When the number of job seekers equals the number of job vacancies the economy is said to be at its natural rate of unemployment. At the NRU, the economy is said to be producing its potential output. The NRU is set at about 4% unemployment. This is the unemployment that the economy works best at.

When the economy fails to create enough jobs for all who are able and willing to work (unemployment is on the rise), then the economy loses it full potential to produce goods and services. This called the GDP gap. GDP gap = the amount by which actual GDP falls short of potential GDP.

7,750 7,500 7,250 7,000 6,750 6,500 6,250 6, Billions of 1992 dollars Actual Real GDP Potential Real GDP (Full-Employment GDP) Potential and Actual GDP, P otential GDP greater than Actual GDP During 1991 recession $300 billion of production is lost Potential GDP less Actual GDP The GDP gap measures the monetary loss of cyclical unemployment The higher the unemployment rate, the larger the GDP gap.

Okun’s Law – for every percentage point of unemployment above the natural rate (4%), there will occur a 2% lose of economic potential. (A 2% GDP gap will be created for every percent above NRU.)

Okun’s Law GDP Gap = Unemployment Rate over 4% x2 6.5% unemployment, so 1.5 x 2% = 3%. If nominal GDP =$100 Billion, then economy will lose $3 Billion in potential productivity. (100 x.03 = 3) 1. Unemployment is 7 % ; Nominal GDP is $200 billion. Real unemp. is __%. The % gap is __%. Y being forgone is $__ B. 2. Unemployment is 8%; Nominal GDP is $500 billion. Real unemp. is __%. The % gap is __%. Y being forgone is $__ B. 3. Unemployment is 10%; Nominal GDP is $100 billion. Real unemp. is __%. The % gap is __%. Y being forgone is $__ B

Inflation: Inflation; is a rise in the general level of prices. Moderate inflation (about 3%) is necessary for economic stability. It is the byproduct of a strong spending/full employment economy. It also makes it easier for businesses to adjust real wages downward if demand falls.

But too much inflation (hyperinflation) can be a disruptive economic force. Causing economic collapse and making money worth less. In the 1920s, Germany staggered under the effects of hyperinflation. This worthless pile of money was supposed to be burned.

Regardless of the amount all inflation hurts the following people; Those on fixed-incomes; inflation causes their real income to fall. Savers; inflation deteriorates the value of savings. Creditors; inflation deteriorates the value of loans to be paid back. If inflation is anticipated creditors can avoid the affects of it, by charging enough interest to cover inflation rates.

Nominal Interest Rate RealInterestRate AnticipatedInflation - 10% 4% 6%6%6%6% Real Interest Rate Nominal I.R. – inflation rate = Real I.R. =

Consumer Price Index (CPI) (CPI = rate of inflation) The CPI is a market basket of 364 items that the typical householder buys. It does not include exports because we do not buy exports but does include imports. About 55% of the CPI is services.

The “Market Basket” When inflation is studied in a certain period (inflation in the last 10 yrs) you choose the year that has the cheapest market basket price total. This will be your base year and will have a CPI = 100 (1 basket = 1 basket x 100). All other years can measured from the base year to see the affects of inflation.

Current yr index – last yr index =6 Current yr index – last yr index =6 C.P.I. = Last yr index x 100; 166 x100 = 3.6% (6.7) (-4) (33) (6.7) (-4) (33) x 100 = ____ 120 x 100 = ____ 300 x 100 = ____ x 100 = ____ 120 x 100 = ____ 300 x 100 = ____ Figuring Inflation 5.4% -3.3% 11% The CPI was in 1999 and in Therefore, the rate of inflation for 2000 was (2.7/3.4/4.2)% If the CPI falls from 160 to 149 in a particular year, the economy has experienced (inflation/deflation) of (5/-4.9/-6.9)%. If CPI rises from to in a particular year, the rate of inflation for that year is (1.6/2.0/4.0)%. [5.6/166.6 x 100 = 3.4%] [-11/160 x 100 = -6.9%]

Demand-Pull Inflation Demand-Pull Inflation – an increase in total spending beyond the full employment output rate in the economy. “Too many dollars chasing too few goods” The demand for goods is pulling the price level up. Types of Inflation

AD 1 AD 2 Demand-Pull Inflation AS PL 1 PL 2 Q1Q1Q1Q1 Q2Q2Q2Q2 “Good News” - more jobs “Bad News” -higher prices E1E1E1E1 E2E2E2E2

Cost-Push Inflation Cost-Push Inflation – an increase in per-unit production cost, which cause higher price levels. Caused by; 1.Wage-push 1.Wage-push – an increase labor wages increase production cost. 2. Supply-side shocks 2. Supply-side shocks – increase in the cost of raw materials (oil prices).

Cost-push inflation ADAS 1 PL 1 Q1Q1Q1Q1 Q2Q2Q2Q2 AS 2 $2.25 This economy isstagnating As PL areinflating. Stagflation PL 2 Stagnating Inflating

Beneficial cost push AD AS 1 PL 1 Q1Q1Q1Q1 PL 2 Q2Q2Q2Q2 99 cents AS 2

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