Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-1 Chapter 5 The macroeconomic environment

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-2 Learning objectives Describe the business cycle — the periodic fluctuations in output, employment and price levels that have characterised our economy Examine unemployment in detail — its definition and measurement, and the structure of unemployment Discuss the economic and social problems associated with unemployment

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-3 Learning objectives (cont.) Understand the causes and consequences of inflation, a problem that plagued us through the 1970s and 1980s Discuss the history and changes in structure of Australia’s balance of payments, with emphasis on the current account of the balance of payments Discuss the relationship between the current account balance and the level of national savings

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-4 The business cycle The recurrent, somewhat cyclical, increases and decreases in the level or rate of growth in economic activity that typify the pattern of progress of our economy’s real GDP over time

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-5 The Australian business cycle & rate of inflation

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-6 Phases of the business cycle Peak –Temporary maximum economic activity Recession –Decline in output and employment to low or negative levels –A depression is a severe and prolonged recession

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-7 Phases of the business cycle (cont.) Trough –Output and employment bottom out at their lowest levels Recovery –Output and employment expand towards the full- employment level or capacity level Secular/growth trend –The average (or trend) rate of expansion or contraction of an economy over the long term (25, 50 or 100 years)

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-8 GROWTH TREND The business cycle Level of business activity Time Recession Recovery Peak Trough

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-9 Causes of business cycle Variety of explanations/theories: Innovation Political events Random events Purely monetary phenomenon Immediate determinant — aggregate expenditure

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-10 Business cycle Non-cyclical fluctuations Seasonal variations in business activity are regular fluctuations in the tempo of business activity that are independent of the business cycle and occur particularly in the retail industry

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-11 Business cycle Cyclical impact: durables and non-durables –Capital goods and consumer durables most greatly affected by business cycles –Consumer non-durables least affected Postponability Monopoly power

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-12 Growth in motor vehicles registrations, new dwellings approved and retails sales in Australia

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-13 Types of unemployment Frictional –Workers ‘between jobs’, temporarily laid off due to seasonality and new entrants –Allows movement of labour from low to high productivity –Inevitable and partly desirable Structural –Mismatch in skills and geographic location –Not employable without additional training, education and geographical movement –Arises due to changes in labour demand caused by changes in consumer demand and technology Cyclical –Unemployment caused by the business cycle, or due to insufficient aggregate demand or total spending

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-14 Full employment The full-employment rate of unemployment is called the ‘natural rate of unemployment’ –Equals the sum of frictional and structural unemployment –Cyclical unemployment = zero Domestic output consistent with the natural rate of unemployment is potential output or GDP

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-15 Australia: unemployment rate

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-16 Measuring unemployment Part-time employment –Underemployed workers, prefer more hours of work Discouraged workers or the ‘hidden unemployed’ –Those who become discouraged and drop out of the labour force but would return if a suitable job prospect arose Discouraged workers, participation rate and the unemployment rate

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-17 Cost of unemployment Economic costs Output forgone, measured in terms of the GDP gap –The amount by which the actual level of GDP falls short of the potential GDP Okun’s law shows the relationship between the unemployment rate and the GDP gap Unequal burdens –Unemployment is borne more heavily by some groups than others Non-economic costs

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-18 Inflation Inflation is a continuous rise in the general price level The inflation rate is measured as follows: Inflationrate Current year index – Previous year index Previous year index × 100 = Inflationrate Current year index – Previous year index Previous year index × 100 =

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-19 Theories of inflation Two general theories of inflation: Demand-pull inflation –Caused by excess demand for output Cost-push inflation –Rise in prices arising from increased cost of production due to:  Wage push  Profit push

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-20 The price level and the level of unemployment Price level Output and employment Q Range 1 Range 2 Range 3 Full- employment output P

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-21 Inflation & redistribution Most severe when inflation is unanticipated Fixed-nominal-income receivers –Inflation penalises people living on fixed nominal income Savers –The value of savings will decline if inflation is higher than the interest rate Debtors and creditors –Inflation tend to benefit borrowers at the expense of the lenders

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-22 Anticipated inflation Real interest rate –The percentage increase in the purchasing power that a lender receives from a borrower in exchange for the borrower’s use of the lender’s funds Nominal interest rate –The percentage increase in money that the lender receives from the borrower

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-23 Output effects of inflation Stimulus of demand-pull inflation –High level of spending required for higher output and lower unemployment also causes some inflation Cost-push inflation and unemployment –Hyperinflation –Wage-price inflationary spiral  A continuous cycle of money wage and price rises that feed on each other

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-24 Australia’s current account problem Three factors –Gradual deterioration in the terms of trade –High freight and transport costs –Dependence on large levels of capital inflow Current account problems in the 1970s, 1980s, 1990s and into the 2000s

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-25 Components of the current account

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-26 The capital and financial account balance 1959–60 to 2001–02

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-27 National savings National savings represents savings from national income Used to finance gross capital formation Continuous fall in household savings in Australia in recent years: –Increases in household wealth –Replacement of direct savings with alternatives such as superannuation

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 5-28 Australia: net national savings, 1959–60 to 2004–05