Chapter 4 – Goals of the Macroeconomy ECONOMICS THEORY AND PRACTICE Seventh Edition Copyright © 2004 John Wiley & Sons, Inc. All rights reserved. Patrick J. Welch St. Louis University Gerry F. Welch St. Louis Community College at Meramec & PowerPoint Presentation by: Dr. Ray Everett Pima Community College

Goals & Problems of the Macroeconomy Contents Macroeconomy Overview Unemployment & Full Employment Employment & Unemployment Stats. Inflation & Stable Prices Deflation & Disinflation Production Overview Possible Policy Problem

Goals & Problems of the Macroeconomy Chapter Objectives To introduce the three fundamental areas on which macroeconomics focuses: employment, prices, and production. To define unemployment, explain its consequences, and identify different types of unemployment. To introduce common measures and statistics on employment and unemployment and discuss the interpretation of these data. To discuss full employment. To define inflation, explain its consequences, and identify its causes. To introduce measures and statistics on inflation. To distinguish between deflation and disinflation. To define full production and economic growth. To identify factors contributing to economic growth and to introduce some costs associated with growth. To introduce GDP, the primary measure or production. To define productivity and discuss changes in U.S. productivity over the years.

Macroeconomy  Study of the operation of the economy as a whole.  Focuses on: The roles of household, business, and government sectors.  Includes: Aggregate employment & production Unemployment Inflation Economic growth Money Government stabilization policies Macroeconomy Overview 4-1

Employment Act of 1946  Legislation giving the federal government the right and responsibility to provide an environment for the achievement of full employment, full production, and stable prices. Unemployment  Resources available for production are not being used. Consequences of Unemployment  Economic loss for society Unemployment intensifies the scarcity problem, and the loss to society is the goods and services that might have been enjoyed.  Individual hardships Unemployment intensifies an individual’s struggle with scarcity because spending habits and lifestyles are altered due to the lack of employment. Unemployment & Full Employment 4-2a

Types of Unemployment  Frictional Unemployment Occurs when people are voluntarily out of work for a short period of time while searching for a job.  Cyclical Unemployment Involuntary unemployment that results from a downswing in a business cycle, or recession. –Continues until the economy breaks out of the recession.  Structural Unemployment Involuntary unemployment that results when a worker’s job is no longer part of the production structure of the economy. –Continues indefinitely; no prospect for rehire. Full Employment  Occurs when only those voluntarily out of work are unemployed, or the unemployment rate includes only frictional unemployment. Unemployment & Full Employment 4-2b

Measures & Statistics Overview  Labor Force All persons 16 years of age and older who are working or actively seeking work.  Participation Rate Percentage of some specified group that is in the labor force.  Unemployment Rate Percentage of the labor force that is unemployed and actively seeking work. Employment & Unemployment Statistics 4-3a

Measures & Statistics Overview (cont.) Employment & Unemployment Statistics 4-3b

Measures & Statistics Overview (cont.) Employment & Unemployment Statistics 4-3c

Measures & Statistics Overview (cont.) Employment & Unemployment Statistics 4-3d

Calculating Unemployment Statistics  Calculated: By the U.S. Department of Labor, Bureau of Labor Statistics (BLS). Monthly and annually. Using results from the Current Population Survey. –Survey issued to a scientifically developed sample of households across the U.S. each month.  Considered employed if: Did any work during the survey week as a paid employee. –Includes self-employed individuals. Worked without pay for 15 or more hours in a family- operated business. Was temporarily away from a job or business due to illness, weather, vacation, labor-management disputes, or personal reasons. Employment & Unemployment Statistics 4-3e

Interpreting Unemployment Statistics  Factors to consider: Discouraged Workers –Persons who drop out of the labor force because they have been unsuccessful for a long period of time in finding a job. Regional differences in unemployment Types of jobs held by the unemployed Underemployment –Resources are not used to their fullest productive capability. Employment & Unemployment Statistics 4-3f

Goal of Full Employment  Does not mean 100% of the labor force is working.  Rate associated with full employment has changed over the years due to factors such as: Changes in the composition of the work force –Women used to have higher unemployment rates than men, but those rates are not comparable to male workers. Duration and quantity of government assistance programs –May influence people’s decisions to remain out of work. Growth in temporary and part-time work –Jobs are plentiful and people are counted as employed. Natural Rate of Unemployment  Unemployment rate that includes the frictionally and structurally unemployed. Employment & Unemployment Statistics 4-3g

Inflation  An increase in the general level of prices. Hyperinflation  Extremely rapid increases in the general level of prices. Consequences of Inflation  Intensifies scarcity when income does not rise as quickly as prices.  Penalizes some groups, such as savers receiving low interest rates.  Changes the value of assets.  Politically and socially destabilizing. Inflation & Stable Prices 4-4a

Nominal Income (Money)  Income measures in terms of current currencies. Real Income  Income measured in terms of the goods and services that can be purchased with a particular amount of money income. Cost of Living Adjustments (COLAs)  Arrangement whereby an individual’s wages automatically increase with inflation. Inflation & Stable Prices 4-4b

Cost of Living Adjustments (cont.) Inflation & Stable Prices 4-4c FIGURE 4-1 The Purchasing Power of Income

Inflation and the Interest Rate  Interest Rate The price of money. –Determines the return to savers and lenders of money, and the cost to borrowers.  The Real Rate of Interest Nominal, or stated, rate of interest minus the inflation rate. –Nominal interest rate adjusted for inflation. Wealth and the Interest Rate  Wealth Measure of the value of tangible assets. –Includes such items as real estate and corporate securities. Inflation & Stable Prices 4-4d

Social and Political Consequences of Inflation Inflation & Stable Prices 4-4e

Causes of Inflationary Pressure  Demand-Pull Inflation Pressure on prices from the buyers’ side of the market. Tends to occur when spending is greater than the productive capability of the economy, and when an economy is close to or at full employment.  Cost-Push Inflation Pressure on prices from the sellers’ side of the market, particularly from increases in the costs of production. Occurs due to increased costs of labor, raw materials, fuels, machinery, borrowing, and even attempts to increase profit.  Role of Expectations Our expectations about inflation can cause inflation to occur. Inflation & Stable Prices 4-4f

Measures of Inflation  Price Index Measures changes in the price of an item or a group of items using a percentage scale. –Consumer price index –Producer price index –GDP price index Constructing a Price Index  Base Year Year against which prices in other years are compared in a price index. Inflation & Stable Prices 4-4g

Constructing a Price Index (cont.) Inflation & Stable Prices 4-4h

Consumer Price Index  Measures changes in the prices of goods and services that consumers typically purchase. Inflation & Stable Prices 4-4i FIGURE 4-6 Consumer Price Index: All Items and Various Categories for Selected Years (1982–1984 = 100.0)

Consumer Price Index (cont.) Inflation & Stable Prices 4-4j FIGURE 4-2 Annual Percentage Changes in the Overall CPI

Other Price Indexes  Producer Price Index (PPI) Measures changes in the prices of goods that businesses buy, either for further processing or for sale to a consumer.  GDP Price Index Price index used when calculating price changes for the entire economy. Inflation & Stable Prices 4-4k

Deflation and Disinflation  Deflation Sustained decrease in the general level of prices.  Disinflation Slowing of the inflation rate. Deflation & Disinflation 4-5

Production  Creation of goods and services. Full Production and Economic Growth  Full Production Occurs when an economy is producing at its maximum capacity, or when it is experiencing full employment.  Economic Growth Increase in an economy’s full production output level over time. Production Overview 4-6a

Full Production and Economic Growth (cont.) Production Overview 4-6b FIGURE 4-3 Economic Growth

Achieving Economic Growth  Technology Increase in knowledge about production and its processes.  Human Capital Investments Investments, such as formal education, that increases the productivity of people. Production Overview 4-6c FIGURE 4-4 U.S. Economic Growth: Real Output per Capita

Costs of Economic Growth  Increased amounts of waste  Depletion of resources  Reasons to purchase new or better items Dissatisfaction of possessions must be instilled in a person to encourage them to continually want replacement items. Measures of Production  Gross Domestic Product (GDP) Dollar figure that measures the value of all finished goods and services produced in an economy in one year.  Nominal GDP (Money GDP) Measures the value of production in terms of prices at the time of production.  Real GDP (Constant GDP) Money GDP adjusted to eliminate inflation. Production Overview 4-6d

Measures of Production (cont.) Production Overview 4-6e

Assessing U.S. Production Production Overview 4-6f TABLE 4-8 Money GDP, Real GDP, and the GDP Price Index for Selected Years

Underground Economy  Productive activities that are not reported for tax purposes and are not included in GDP. Nonmarket productive activities –Volunteer work, maintaining your car, etc. Unreported work –Mowing lawns, full-time housecleaning, tips, etc. Swapped services –Dental work in exchange for legal advice. Production Overview 4-6g

Productivity  Concept of assessing the amount of output produced by an economy’s resources. Often measures specifically by output per worker. Production Overview 4-6g TABLE 4-9 Growth in Labor Productivity: Business Sector, 1970–2001

Dilemma Facing Policymakers  Full production and full employment with inflation, or  Stable prices and less than full production with unemployment? Possible Policy Problem 4-7

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