Goal #2 Limit Unemployment 1 Copyright ACDC Leadership 2015

The Business Cycle 26-2 Level of Real Output Time Peak Recession Expansion Trough Growth Trend Durable and nondurable industries affected differently

Causes of Business Cycles Shocks and price stickiness Change in output instead of price Supply and productivity shocks innovation Monetary shocks Financial bursts and bubbles Unexpected political events Common link Unexpected changes in spending 26-3

Unemployment Twin problems of the business cycle Unemployment Inflation Who is in the Labor Force? Above 16 years old Able and willing to work Not institutionalized (in jails or hospitals) Not in military, in school full time, or retired Why is a stay at home mom not unemployed? Problems with the unemployment rate Part-time employment counts Discouraged workers 26-4 Unemployment Rate Unemployed Labor Force = x 100

Unemployment 26-5 Under 16 And/or Institutionalized (71.8 Million) 2007 data Total Population (303.6 Million) Not in Labor Force (78.7 Million) Employed (146.0 Million) Labor Force (153.1 Million) Unemployed (7.1 Million) Source: Bureau of Labor Statistics

Three Types of Unemployment 6 Copyright ACDC Leadership 2015

Unemployment Types of unemployment Frictional (search and wait) I Quit! --- You’re Fired! Structural (occupational and geographical) Cyclical Full employment redefined No cyclical unemployment Natural rate of unemployment Stay tuned Full employment rate 26-7

SOME JOBS DISAPPEAR Copyright ACDC Leadership 2015

Frictional and structural unemployment are present at all times because people will always be between jobs or replaced by technology. So, the economy is doing great if there is only frictional and structural unemployment. Natural Rate of Unemployment (NRU)- Frictional plus structural unemployment. The amount of employment that exists when the economy is healthy and growing. Full Employment Output (Y)- The Real GDP created when there is no cyclical unemployment The US is at full employment when there is 4-6% unemployment The Natural Rate of Unemployment 9

Unemployment Natural rate of unemployment 2000’s 4-5% Today 5-6% Changing structure of U.S. economy Why do you think the NRU is higher nowadays? Much Human Capital misaligned with industries with Labor demand 26-10

Capital Goods Consumer Goods The PPC and the Business Cycle 11 Full Employment 5% Unemployment Copyright ACDC Leadership 2015 Max Capacity 0% Unemployment Time Real GDP Real GDP 6+% Unemployment 4-6% Unemployment Super low unemployment leads to inflation

Cost of Unemployment Foregone output Potential output GDP gap (Actual output – potential output) Negative or positive Okun’s Law Each 1% above NRU creates negative 2% output gap 26-13

Unemployment The GDP Gap 12,000 11,000 10,000 9,000 8,000 7,000 6,000 5,000 GDP (billions of 1996 dollars) The Unemployment Rate Unemployment (percent of civilian Labor force) Source: Congressional Budget Office & Bureau of Economic Analysis GDP gap (positive) GDP gap (negative) Potential GDP Actual GDP

Unemployment – Things to consider Unequal burdens Occupation Age Race and ethnicity Gender Education Duration Noneconomic costs Psychological, social, political 26-15

Long-Term Unemployment 26-16

Long-Term Unemployment 26-17

Unemployment Source: Bureau of Labor Statistics Unemployment Rates in Five Industrial Nations,

The natural rate in France and Germany is around 8–10%. Why? Some economists attribute the difference to more generous unemployment benefits in European countries –In the U.S. unemployment benefits last for 6 months –Unemployment benefits in some European countries are indefinite –The generous benefits reduce incentives to search for a job The Natural Rate of Unemployment Copyright ACDC Leadership 2015

Question….. How can we reduce unemployment? Pain = Progress?

Review: NAME THAT CONCEPT 1.Macroeconomics 2.Inflation 3.Nominal GDP 4.Structural Unemp. 5.C+I+G+Xn Copyright ACDC Leadership 2015

Review: NAME THAT CONCEPT 1.REAL GDP 2.FULL EMPLOYM. 3.CYCLICAL UNEMP. 4.NATURAL RATE 5.FRICTIONAL UNEMPLOYMENT Copyright ACDC Leadership 2015

Goal #3 LIMIT INFLATION Country and Time- Zimbabwe, 2008 Annual Inflation Rate- 79,600,000,000% Time for Prices to Double hours Copyright ACDC Leadership 2015

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Inflation Rise in general level of prices Reduction in Purchasing Power Examples: It takes $2 to buy what $1 bought in 1987 It takes $6 to buy what $1 bought in 1970 It takes $24 to buy what $1 bought in Is Inflation Good or Bad?

Good or Bad? In general, ramped inflation is bad because banks don’t lend and people don’t save. This decreases investment and GDP. What about deflation? Deflation- Decrease in general prices or a negative inflation rate. Deflation is bad because people will hoard money (financial assets) This decreases consumer spending and GDP. Disinflation- Prices increasing at slower rates Copyright ACDC Leadership 2015

But inflation doesn’t effect everyone equally. Identify which people are helped and which are hurt by unanticipated inflation 1.A man who lent out $500 to his friend in 1960 and gets paid back in A tenant who is charged $850 rent each year. 3.An elderly couple living off fixed retirement payments of $2000 a month 4.A man that borrowed $1,000 in 1995 and paid it back in A woman who saved $500 in 1950 by putting it under her mattress Copyright ACDC Leadership 2015

Effects of Unanticipated Inflation Borrowers-People who borrow money A business where the price of the product increases faster than the price of resources Lenders-People who lend money (at fixed interest rates) People with fixed incomes Savers Hurt by Inflation Helped by Inflation Nominal Wage- Wage measured by dollars rather than purchasing power Real Wage- Wage adjusted for inflation If there is inflation, you must ask your boss for a raise Copyright ACDC Leadership 2015

Historic Inflation Rates Copyright ACDC Leadership 2015

Copyright ACDC Leadership 2015

Inflation 26-31

CPI Consumer price index (CPI) Market basket 300 goods and services Typical urban consumer 2 year updates *****Base year used by Bureau of Labor Statistics is (CPI = 100) CPI Price of the Most Recent Market Basket in the Particular Year Price estimate of the Market Basket in Base Year = x 100

Rate of Inflation This year index – Last year index Last year index 26-34

Problems with the CPI 1.Substitution Bias- As prices increase for the fixed market basket, consumers buy less of these products and more substitutes that may not be part of the market basket. (Result: CPI may be higher than what consumers are really paying) 2.New Products- The CPI market basket may not include the newest consumer products. (Result: CPI measures prices but not the increase in choices) 3.Product Quality- The CPI ignores both improvements and decline in product quality. (Result: CPI may suggest that prices stay the same though the economic well being has improved significantly) Copyright ACDC Leadership 2015

Three Causes of Inflation 1.If everyone suddenly had a million dollars, what would happen? 2.What two things cause prices to increase? Use Supply and Demand Copyright ACDC Leadership 2015

1. The Government Prints TOO MUCH Money (The Quantity Theory) 3 Causes of Inflation Governments that keep printing money to pay debts end up with hyperinflation. Result: Banks refuse to lend so investment falls and people don’t save up to buy things. Examples: Bolivia, Peru, Brazil Germany after WWI Copyright ACDC Leadership 2015

2. Demand- Pull Inflation DEMAND PULLS UP PRICES!!! “Too many dollars chasing too few goods” An overheated economy with excessive spending but same amount of goods. 3 Causes of Inflation 3. Cost-Push Inflation Higher production costs increase prices A negative supply shock increases the costs of production and forces producers to increase prices. Copyright ACDC Leadership 2015

A Perpetual Process: 1.Workers demand raises 2.Owners increase prices to pay for raises 3. High prices cause workers to demand higher raises 4. Owners increase prices to pay for higher raises 5. High prices cause workers to demand higher raises 6. Owners increase prices to pay for higher raises The Wage-Price Spiral

Anticipated Inflation and Interest Rates Nominal Interest Rate Real Interest Rate Inflation Premium Nominal Interest Rate Real Interest Rate Inflation Premium 11% 5% 6% =+

= Real GDP x 100 GDP Deflator Nominal GDP CPI vs. GDP Deflator The GDP deflator measures the prices of all goods produced, whereas the CPI measures prices of only the goods and services bought by consumers. An increase in the price of goods bought by firms or the government will show up in the GDP deflator but not in the CPI. The GDP deflator includes only those goods and services produced domestically. Imported goods are not a part of GDP and therefore don’t show up in the GDP deflator. Copyright ACDC Leadership 2015

Calculations 1.In an economy, Real GDP is $80 billion and the Nominal GDP is $100 billion. Calculate the GDP deflator. 2.In an economy, Real GDP is $200 billion and the deflator is 120. Calculate Nominal GDP. 3.In an economy, Nominal GDP is $300 billion and the GDP deflator is 150. Calculate the Real GDP. Copyright ACDC Leadership $240B $200B

Achieving the Three Goals UnemploymentInflationGDP Growth Good6% or less1%-4%2.5%-5% Worry6.5%-8%5%-8%1%-2% Bad8.5 % or more9% or more.5% or less The governments role is to prevent unemployment and prevent inflation at the same time. If the government focuses too much on preventing inflation and slows down the economy we will have unemployment. If the government focuses too much on limiting unemployment and overheats the economy we will have inflation