Macroeconomics - ECO 2013 Fall 2005 – 1 Term August 24 – December 16, 2005

Chapter 8: Intro to Economic Growth & Stability Economic Growth Business Cycle Unemployment Inflation

Economic Growth Defined by two ways: An increase in real GDP occurring over some time period An increase in real GDP per capita occurring over some time period  Best for comparing living standards between countries Calculated as a percentage rate of growth per year

Growth as a Goal Expansion of total output v. population growth results in rising real wages and incomes  higher SOL Better able to meet society’s wants & resolve socioeconomic problems Rising real wages & income provide more opportunities to individuals & families w/o sacrificing others Undertake new programs to alleviate poverty or protect environment

Growth as a Goal Growth lessens the burden of SCARCITY Society can consume more today while increasing capacity to produce more in the future Relaxes society’s constraints on production

Mathematical Growth Approximation: Rule of 70 Number of years required to Double GDP: 70 ÷ Annual % Growth

Main Sources of Growth Increasing Inputs of Resources (1/3) FFOP: Land, Labor, Capital, & Entrepreneurial Abilities Increasing Production of Inputs (2/3) Improvements in health, training, education & motivation of workers Capital enhancements (machinery) Better natural resources Organization & Management Labor reallocated by efficiency

Results of Economics Growth in the U.S. Improved Products & Services Added Leisure (50 to 40 hrs/week) Environmental Impacts (Damaging) Quality of Life (Stress)

The Business Cycle: Four Phases Peak: Business activity reaches temporary maximum Recession: Period of decline in Total Output, Income, Employment, Trade Lasts more than 6 months Depression: a severe & prolonged recession, falling prices are likely Trough: Output & employment “bottoms out” at lowest levels Can be long or short Recovery: Expansion phase where output & employment rise toward full employment Prices may rise

Causes of Fluctuations Major innovations can trigger new investment and/or consumer spending Changes in Productivity Monetary Phenomenon Governments create more/less money Changes in Total Spending In the U.S., long-run growth trend is expansionary

Who is affected by Recessions in the Business Cycle? Everyone & Everywhere Firms & Industries producing Capital & Consumer Durable Goods are most affected Service industries and Nondurable Consumer Goods are somewhat “insulated”

Measuring Unemployment Who is eligible & available to work? Ineligible: Those less than 17 years and/or institutionalized Not in Labor Force: Those not employed and NOT SEEKING WORK Employed Unemployed: Those not employed and SEEKING WORK Labor Force = Employed + Unemployed Approximately 50% of U.S. Population Those “willing and able” to work

Unemployment Rate Calculated as a Percentage of Labor Force: Unemployment Rate = (Unemployed / Labor Force) * 100 BLS conducts survey of 60,000 households monthly

Unemployment Rate Part-time Employment underestimates the true unemployment rate Many would prefer full-time work but can’t find it Discouraged workers understate the true unemployment rate Not in labor force but they wish they were

Frictional Unemployment Those “between jobs” Voluntary Fired Seasonal shifts in demand “Unemployment Pool” Labor market is Imperfect & Noninstantaneous in matching workers to jobs Inevitable & Desirable Short-term

Structural Unemployment Changes over time in consumer demand & technology Demand for certain skills may decline or vanish Demand for other skills intensifies Change in the COMPOSITION of the Labor Force Geography Long-term, more serious

Cyclical Unemployment Caused by decline in total spending during recessions aka “Deficit Demand Unemployment” Serious

Full Employment Occurs when economy is experiencing only frictional & structural unemployment (i.e., no cyclical unemployment) Full Employment Rate of Unemployment or Natural Rate of Unemployment (NRU) Economy is producing its Potential Output NRU occurs when Job Seekers = Job Vacancies

Reasons for the Decline in NRU Less younger workers in the labor force Growth of temp agencies Improved information technology Welfare reform Doubling of U.S. prison population

Economic Costs of Unemployment: GDP Gap When the economy fails to create enough jobs for all who are able and willing to work, potential production of goods & services is lost GDP Gap: Potential GDP – Actual GDP Potential GDP is at the NRU

Economic Costs of Unemployment: Okun’s Law For every 1% by which actual unemployment rate exceeds the natural rate of unemployment, GDP gap of 2% occurs

Economic Costs of Unemployment: Unequal Burdens Costs are unequally distributed among different groups Occupation Low-skilled laborers > High-skilled professionals More frequent & longer unemployment spells Bear brunt of recessions Age Teenagers > Adults Lower skills Less geographical mobility New in labor market

Economic Costs of Unemployment: Unequal Burdens Race & Ethnicity: African-Americans & Hispanics > Caucasian Lower rates of educational attainment Greater concentration of low-skilled jobs Discrimination in the labor market Education: Less educated > More educated Duration

Inflation Rise in the general level of prices Does NOT mean ALL prices are rising Prices rise unevenly Measuring Inflation Consumer Price Index [CPI(2) – CPI(1)]/CPI(1) * 100

Redistribution Effects of Inflation Who is hurt by Inflation (assuming it is unanticipated) Fixed Income Receivers (e.g., elderly) Savers  Value of savings will decline if rate of inflation is greater than the rate of interest Creditors

Who is Unaffected or Benefits from Inflation? Flexible-Income Receivers Cost of Living Adjustments (COLAs) Social Security Recipients Borrowers

Anticipated Inflation If inflation is anticipated, the effects of inflation may be less severe Wage & pension contracts may have clauses (COLAs) Interest rates will be high enough to cover cost of inflation to savers & lenders (“Inflation Premium”) Real Interest Rate = Nominal Rate + Inflation Premium

Hyperinflation Extremely rapid inflation Impact on real output & employment is devastating Actions based on inflationary expectations intensifies the pressure on prices Inflation feeds on itself May cause economic collapse

Chapter 8 Study Questions 4: Business Cycle 5 & 6: Unemployment

Next Class Review Chapters 7 & 8 Review Results of Take-Home Assignment (Chapters 4 & 5) Submit Second Article Summaries