Economic Growth, Business Cycles, Unemployment, and Inflation Chapter 13

Chapter Objectives Summarize some relevant statistics about growth, business cycles, unemployment, and inflation.

Chapter Objectives Summarize some relevant statistics about growth, business cycles, unemployment, and inflation. Name five sources of growth.

Chapter Objectives List four phases of the business cycle.

Chapter Objectives List four phases of the business cycle. Explain how unemployment is measured and state some microeconomic categories of unemployment.

Chapter Objectives Relate the target rate of unemployment to potential income.

Chapter Objectives Relate the target rate of unemployment to potential income. Define inflation and distinguish a real concept from a nominal concept.

Chapter Objectives Differentiate between cost-push and demand-pull inflation and expected and unexpected inflation.

Chapter Objectives Differentiate between cost-push and demand-pull inflation and expected and unexpected inflation. State two important costs of inflation.

Central Problems of Macroeconomics Growth is one of the four central problems of macroeconomics.

Central Problems of Macroeconomics Growth is one of the four central problems of macroeconomics. The others are business cycles, unemployment, and inflation.

Growth The Benefits and Costs of Growth

Growth The Benefits and Costs of Growth Generally the U.S. economy is growing or expanding.

Growth The Benefits and Costs of Growth Real gross domestic product (GDP) is the market value of goods and services stated in the prices of a given year.

Growth The Benefits and Costs of Growth Real gross domestic product (GDP) is the market value of goods and services stated in the prices of a given year. The primary measurement of growth is changes in real GDP.

Growth The Benefits and Costs of Growth Since 1890, the U.S. economic output has grown at an annual rate of 2.5 to 3.5 per annum.

Growth The Benefits and Costs of Growth Since 1890, the U.S. economic output has grown at an annual rate of 2.5 to 3.5 per annum. This is called the secular growth trend.

Growth The Benefits and Costs of Growth Per capita economic growth allows everyone in society, on average to have more.

Growth The Benefits and Costs of Growth Politically, growth, or predictions of growth, allows governments to avoid hard questions.

Growth The Benefits and Costs of Growth Politically, growth, or predictions of growth, allows governments to avoid hard questions. A growing economy creates jobs, to the joy of politicians.

Growth The Benefits and Costs of Growth The costs to material growth include pollution, resource exhaustion, and destruction to natural habitat.

Growth The Benefits and Costs of Growth Since many believe the environmental costs of growth are important, the result is often an environmental-economic growth stalemate.

Growth The Sources of Growth

Growth The Sources of Growth Institutions with incentives compatible with growth Technological development Available resources Investment and accumulated capital Entrepreneurship

Growth Institutions With Incentives Compatible With Growth

Growth Institutions With Incentives Compatible With Growth Growth-compatible institutions—those that foster growth—must have incentives built into them that lead people to work hard and discourage people from activities that inhibit growth.

Growth Institutions With Incentives Compatible With Growth Private ownership of property plays an important role in growth.

Growth Institutions With Incentives Compatible With Growth A corporation is another example of a growth-promoting economic institution because of limited liability.

Growth Institutions With Incentives Compatible With Growth Many developing nations have merchantist policies dictating governmental permission before economic activity can take place.

Growth Institutions With Incentives Compatible With Growth Many developing nations have merchantist policies dictating governmental permission before economic activity can take place. This does not foster growth.

Growth Technological Development

Growth Technological Development A much larger aspect of growth involves changes in technology—changes in the goods we buy and changes in the way we make goods.

Growth Technological Development Society gets people to work on these new developments by doing the following:

Growth Technological Development Society gets people to work on these new developments by doing the following: Providing incentives. Working with institutions that foster creativity and bold thinking. Working through institutions that foster hard work.

Growth Technological Development U.S. educational institutions do a good job of fostering creativity but a poor job of fostering hard work.

Growth Available Resources

Growth Available Resources What is a resource depends on the technology used.

Growth Available Resources What is a resource depends on the technology used. A resource in one time period may not be a resource in another.

Growth Investment and Accumulated Capital

Growth Investment and Accumulated Capital Capital accumulation and investment were once seen as the key elements to growth.

Growth Investment and Accumulated Capital This is not longer thought to be true because:

Growth Investment and Accumulated Capital This is not longer thought to be true because: The empirical evidence does not support it. Products and processes change. Capital is far more than machines.

Growth Investment and Accumulated Capital This is not longer thought to be true because: Capital also includes human capital—peoples' knowledge and social capital—the habitual way of doing things that guides people in how they approach production.

Growth Entrepreneurship

Growth Entrepreneurship Entrepreneurship involves creativity, vision, and the ability to translate that vision into reality.

Growth Turning the Sources of Growth Into Growth

Growth Turning the Sources of Growth Into Growth Even if the five ingredients to growth exist, they may not exist in the right proportion.

Growth Turning the Sources of Growth Into Growth Even if the five ingredients to growth exist, they may not exist in the right proportion. It is the combination of investing in machines and technological change that plays a central role in the growth of any economy.

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

Business Cycles The business cycle is the upward and downward movement of economic activity that occurs around the growth trend. The secular growth trend is an average 2.5 to 3.5 percent increase in GDP.

Business Cycles Percentage Fluctuations in Real GDP Civil W ar Reco v of 1895 or ld ar I P anic of 1893 1907 Great Depression 20 10 – Y ears ar II K orean V ietnam 1860 65 70 75 80 85 90 95 1900 05 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 2000

Business Cycles There are a number of theories regarding business cycles.

Business Cycles There are a number of theories regarding business cycles. The Classicals generally favor laissez-faire or noninterventionist policies.

Business Cycles There are a number of theories regarding business cycles. The Keynesians generally favor activist policies.

Business Cycles There are a number of theories regarding business cycles. The rational expectationists argue that expectations about the future based on the best current information is often undermined by the public who anticipate government's actions and do the opposite of what is expected of them.

Business Cycles Each business cycle is different.

Business Cycles Each business cycle is different. After World War II, however, down turns have been less severe.

Business Cycles Each business cycle is different. If prolonged contractions are a type of cold the economy catches, the Great Depression of the 1930s was double pneumonia.

Business Cycles Each business cycle is different. If the severity of business fluctuations has been reduced, one reason is that changes in institutional structure were made as a result of the Great Depression.

Business Cycles Each business cycle is different. Since 1945, the average expansion has lasted about 51 months.

The Phases of the Business Cycle The peak is the top of the business cycle.

The Phases of the Business Cycle The peak is the top of the business cycle. A boom is a very high peak, representing a big jump in output.

The Phases of the Business Cycle The downturn -- the phenomenon of economic activity starting to fall from a peak.

The Phases of the Business Cycle The downturn -- the phenomenon of economic activity starting to fall from a peak. A recession is a decline in output that persists for more than two consecutive quarters in a year.

The Phases of the Business Cycle A depression is a large recession.

The Phases of the Business Cycle A depression is a large recession. The bottom of the recession or depression is called the trough.

The Phases of the Business Cycle As total output starts to expand, the economy comes out of the trough into an upturn, which may turn into an expansion—an upturn that lasts at least two consecutive quarters of a year.

The Phases of the Business Cycle

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

Leading Indicators Leading indicators include the following:

Leading Indicators Leading indicators include the following: Average workweek for production workers in manufacturing Unemployment claims New orders for consumer goods and materials

Leading Indicators Leading indicators include the following: Vendor performance, measured as a percentage of companies reporting slower deliveries from suppliers Contracts and orders for plant and equipment

Leading Indicators Leading indicators include the following: Number of new building permits issued for private housing units Change in stock prices

Leading Indicators Leading indicators include the following: Change in consumer expectations Changes in the money supply

Leading Indicators The drudge work of sifting through statistical series is the backbone of business economists' work

Unemployment Business cycles and growth are directly related to unemployment in the U.S. economy.

Unemployment Unemployment occurs when people are looking for a job and cannot find one.

Unemployment The unemployment rate is the number of people who cannot find a job as a percent of those people in the economy who are willing and able to work.

Types of Unemployment 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.

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

Types of Unemployment Structural unemployment is that caused by economic restructuring making some skills obsolete. It existed in pre-industrial society.

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

Types of Unemployment Cyclical unemployment is that which results from fluctuations in economic activity. It did not exist in pre-industrial society.

Types of Unemployment Cyclical unemployment is that which results from fluctuations in economic activity. The Industrial Revolution changed the nature of work and introduced unemployment as a problem for society.

Types of Unemployment Cyclical unemployment is that which results from fluctuations in economic activity. The Industrial Revolution was accompanied by a change in how families dealt with unemployment.

Types of Unemployment Cyclical unemployment is that which results from fluctuations in economic activity. What had previously been a family problem, now became a social problem.

Types of Unemployment Cyclical unemployment is that which results from fluctuations in economic activity. Hunger was the early solution for unemployment.

Types of Unemployment Cyclical unemployment is that which results from fluctuations in economic activity. Hunger was the early solution for unemployment. It was not an effective answer to unemployment.

Types of Unemployment Cyclical unemployment is that which results from fluctuations in economic activity. In the Employment Act of 1946, government took responsibility for full employment—an economic climate in which just about everyone who wants a job can have one.

The Target Rate of Unemployment The target rate of unemployment is the lowest sustainable rate of unemployment that policymakers believe is achievable under existing conditions.

The Target Rate of Unemployment Initially government regarded 2 percent unemployment as a condition of full employment.

The Target Rate of Unemployment Initially government regarded 2 percent unemployment as a condition of full employment. The 2 percent was made up of frictional unemployment.

The Target Rate of Unemployment In the 1980s and 1990s, the target rate of unemployment was been between 5 and 7 percent.

The Target Rate of Unemployment The target rate of unemployment has changed over time for the following reasons:

The Target Rate of Unemployment The target rate of unemployment has changed over time for the following reasons: In the 1970s and early 1980s, a low inflation rate seemed to be incompatible with a low unemployment rate.

The Target Rate of Unemployment The target rate of unemployment has changed over time for the following reasons: Demographics have changed.

The Target Rate of Unemployment The target rate of unemployment has changed over time for the following reasons: Demographics have changed. Different age groups have different rates of unemployment.

The Target Rate of Unemployment The target rate of unemployment has changed over time for the following reasons: Social and institutional structures have changed.

The Target Rate of Unemployment The target rate of unemployment has changed over time for the following reasons: The economy has undergone major structural readjustments -- modifications in the types of goods produced and the methods of production.

The Target Rate of Unemployment The target rate of unemployment has changed over time for the following reasons: Governmental institutions also changed.

Whose responsibility is unemployment? The Classicals believe that individuals are responsible for their own employment.

Whose responsibility is unemployment? Keynesian economists tend to say that society owes a person a job commensurate with the individual's training or past job experience.

How is unemployment measured? The unemployment rate is published by the U.S. Department of Labor's Bureau of labor Statistics.

How is unemployment measured? The unemployment rate is published by the U.S. Department of Labor's Bureau of labor Statistics. Visit the Bureau of Labor Statistics on the Internet at : http://stats.Bls.Gov.

Unemployment Rate Since 1900 Percentage of labor force unemployed 30 20 10 T arget r ate Y ears 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 Average unemployment

Calculating the Unemployment Rate The unemployment rate is calculated by dividing the number of unemployed individuals by the number of people in the civilian labor force and multiplying by 100.

Calculating the Unemployment Rate The unemployment rate is calculated by dividing the number of unemployed individuals by the number of people in the civilian labor force and multiplying by 100.

Calculating the Unemployment Rate The unemployment rate is calculated by dividing the number of unemployed individuals by the number of people in the civilian labor force and multiplying by 100. The labor force is those people in an economy who are willing and able to work.

How accurate is the official unemployment rate? The unemployment rate does not include discouraged workers—people who do not look for a job because they feel they do not have a chance of getting one.

How accurate is the official unemployment rate? The unemployment rate counts as employed those who are underemployed—part-time workers who would prefer full-time work.

How accurate is the official unemployment rate? Both the Classicals and the Keynesians, for completely different reasons, agree that the unemployment figures are imperfect.

How accurate is the official unemployment rate? Total civilian population (258 million) Noninstitutional population (201 million) Labor force (133.9 million) Employed (126.7 million) Not in labor force—(66.6 million) Unemployed (7.2 million) Incapable of working—(63 million)

Unemployment and Potential Income The capacity utilization rate is the rate at which factories and machines are operating compared to the maximum sustainable rate at which they could be used.

Unemployment and Potential Income The capacity utilization rate indicates how much capital is available for economic growth.

Unemployment and Potential Income Potential output is the output that would materialize at the target rate of unemployment and the target rate of capacity utilization.

Unemployment and Potential Income Potential income is defined as the output that will be achieved at the target rate of unemployment and at the target level of capacity utilization.

Unemployment and Potential Income There is debate about where the actual level of potential income is.

Unemployment and Potential Income To determine the effect changes in the unemployment rate will have on income, we use Okum's rule of thumb.

Unemployment and Potential Income To determine the effect changes in the unemployment rate will have on income, we use Okum's rule of thumb. The rule states that a 1 percentage point change in unemployment will cause income to change in the opposite direction by 2.5 percent.

Microeconomic Categories of Unemployment Macroeconomic measures of unemployment may be too crude.

Microeconomic Categories of Unemployment Macroeconomic measures of unemployment may be too crude. Different types of unemployment are susceptible to different types of products.

Microeconomic Categories of Unemployment Some microeconomic categories of unemployment are reason for how people become unemployed, demographic unemployment, duration of unemployment, and unemployment by industry.

Inflation Inflation is a continual rise in the price level.

Inflation Since World War II, the U.S. inflation rate has remained positive and relatively stable.

Inflation

Measurement of Inflation In order to estimate inflation one must first create a price index.

Measurement of Inflation A price index is a composite of prices.

Measurement of Inflation A price index is a composite of prices. It is a series of numbers that summarizes what happens to prices of a selection of goods (often called a market basket of goods) over time.

Measurement of Inflation The Producer Price Index (PPI)

Measurement of Inflation The Producer Price Index (PPI) An index or ratio of a composite of prices of a number of important raw materials, such as steel, relative to a composite of the prices of those raw materials in a base year.

Measurement of Inflation The Producer Price Index (PPI) It does not accurately measure what most consumers are interested in—final goods.

Measurement of Inflation The Producer Price Index (PPI) It does not accurately measure what most consumers are interested in—final goods. It gives an early indication as to where inflation is headed.

Measurement of Inflation The GDP Deflator (Gross Domestic Product Deflator)

Measurement of Inflation The GDP Deflator (Gross Domestic Product Deflator) An index of the price level of aggregate output or the average price of the components in GDP relative to a base year.

Measurement of Inflation The GDP Deflator (Gross Domestic Product Deflator) This is the measure of inflation most economists favor since it includes the widest number of goods.

Measurement of Inflation The GDP Deflator (Gross Domestic Product Deflator) Since it is difficult to compute, it is published only quarterly and with a fairly substantial lag.

Measurement of Inflation The Consumer Price Index (CPI)

Measurement of Inflation The Consumer Price Index (CPI) Measures the prices of a fixed "basket" of consumer goods, weighed according to each component's share of an average consumer's expenditures.

Measurement of Inflation The Consumer Price Index (CPI) It is the measure of inflation most often presented in news broadcasts.

Measurement of Inflation The Consumer Price Index (CPI) Many economists believe that the CPI as currently constituted, overstates inflation by one to two percentage points.

Composition of CPI

Real and Nominal Concepts Nominal output is the total amount of goods and services as measured by current prices.

Real and Nominal Concepts Real output is the total amount of goods and services produced, adjusted for price level changes.

Real and Nominal Concepts Real output is the total amount of goods and services produced, adjusted for price level changes.

Real and Nominal Concepts The “real” amount is the nominal amount adjusted for inflation.

Why does inflation occur? The economy has nominal wage- and price-setting institutions in which people set their relative prices by setting a nominal price.

Why does inflation occur? Demand-pull inflation is the inflation that occurs when the economy is at or above full employment.

Why does inflation occur? Demand-pull inflation is the inflation that occurs when the economy is at or above full employment. When the majority of industries are close to capacity and they experience increases in demand, we say there's demand-pull inflation.

Why does inflation occur? Cost-push inflation involves a rise in the price level resulting from restrictions on supply due to some sort of legal or social pressure.

Demand-Pull Inflation Price P1 P0 Q0 Q1 Quantity D0 S0

Demand-Pull Inflation Price P1 P0 Q0 Q1 Quantity D1 D0 S0

Cost-Push Inflation Price P 1 (0-A) Quantity Q a (A-B) D S A B

Cost-Push Inflation Price P 1 (0-A) Quantity Q a (A-B) D S A B

Expected and Unexpected Inflation Expectations of inflation play an important role in exacerbating inflation further.

Expected and Unexpected Inflation Expected inflation is that which people anticipate.

Expected and Unexpected Inflation Expected inflation is that which people anticipate. Unexpected inflation is that which surprises people.

Costs of Inflation Inflation does not make a nation poorer.

Costs of Inflation Inflation causes income to be redistributed from those who do not raise their prices to those who do.

Costs of Inflation Inflation causes income to be redistributed from those who do not raise their prices to those who do. For example, from lenders to borrowers.

Costs of Inflation Inflation can reduce the amount of information that prices are supposed to convey.

Costs of Inflation Despite redisributive costs and a blurring of price information, inflation is usually accepted by governments as long as it stays at a low level.

Costs of Inflation The danger is when inflation becomes hyperinflation—exceptionally high levels of inflation of, say, 100 percent or more a year.

Costs of Inflation The U.S. has never experienced a hyperinflation.

Economic Growth, Business Cycles, Unemployment, and Inflation End of Chapter 7