2. Intro to Inflation and Unemployment AP Economics: Macro – Unit II Mr. Griffin MHS

3. Part 1: The Goal of Economic Growth

4. ECONOMIC GROWTH An increase in real GDP over time An increase in real GDP per capita over time Growth as a Goal Arithmetic of Growth Rule of 70 Main Sources of Growth Increases in Resources Increases in Productivity

5. ECONOMIC GROWTH Growth in the United States Improved Products and Services Added Leisure Other Impacts Relative International Growth Rates

6. THE BUSINESS CYCLE Phases of the Business Cycle PEAK Level of business activity Time RECESSION TROUGH RECOVERY GROWTH TREND

7. The Capacity to Produce: Potential GDP Potential GDP = the real GDP that the economy could produce if the labor force and other resources were fully employed Production Function = Mathematical depiction of the relationship between an economy’s inputs and outputs.

8. The Capacity to Produce: Potential GDP The growth rate of potential GDP depends on: –The growth rate of the labor force –The growth rate of the nation’s capital stock –The rate of technical progress

9. The Economy’s Production Function (b) L 0 Real GDP Labor input (hours) K 0 0 Y 0 Y 1 (a) L 0 Real GDP Labor input (hours) K 0 Y 0 Y 1 A M K 1 B A

10. The Growth Rate of Potential GDP Growth rate of potential GDP depends on: –Growth rate of the labor force –Growth rate of the nation’s capital stock –The rate of technical progress Labor productivity –Labor productivity = total output/total hours –This measures output per hour of work

11. The Growth Rate of Potential GDP GDP can be expressed as: GDP = Hours of work x Labor productivity The equation above in growth rates is: Growth rate of potential GDP = Growth rate of labor input + Growth rate of labor productivity

12. Recent Real GDP Growth in the U.S.

13. Part 2: The Goal of Low Unemployment

14. The Human Costs of High Unemployment Unemployment rate = the number of unemployed people, expressed as a percentage of the labor force Unemployment entails a loss in output for the society as a whole, a loss that can never be recovered.

15. The Economic Costs of High Unemployment

16. UNEMPLOYMENT Measurement of Unemployment, 2002 Employed Not in labor force Under 16 and/or institutionalized Total Population 288,600,000 Labor force 142,500,000 74,700,000 71,400,000 Unemployed 8,300,000 134,200,000

17. UNEMPLOYMENT Measurement of Unemployment, 2002 Unemployment rate unemployed labor force x 100 = Part-Time Employment Discouraged Workers

18. Actual and Potential GDP in the United States 1957–1958 Recession 1960–1961 Recession 1960s Boom 1974–1975 Recession 1982–1983 Recession Actual GDP Potential GDP 1955195919631967197119751979198319871991199519992004 10,000 2,500 3,000 3,500 4,000 4,500 5,000 5,500 6,000 6,500 7,000 8,000 9,000 Year 7,500 8,500 9,500 11,000 10,500 2,000 Billions of 2000 Dollars

19. UNEMPLOYMENT Economic Costs of Unemployment GDP Gap and Okun’s Law Approximately a 2% GDP Gap occurs For every 1% unemployment exceeds the natural rate... The amount by which actual GDP falls short of potential GDP

20. The Human Costs of High Unemployment Unemployment is a serious personal problem for the unemployed. –Income forgone –Psychological distress

21. The Human Costs of High Unemployment In good times and bad some groups suffer more than others from unemployment –Below average unemployment rates: Married men Well-educated workers –Above average unemployment rates: Teenagers Nonwhites Blue-collar workers

22. Unemployment Rates for Selected Groups, 2004 0 5 10 15 20 25 30 35 40 Percent Teenagers Black Male Teenagers Adults Who Did Not Graduate from High School Women Who Maintain Families Married Men Blacks College Graduates 2.7 3.1 8.5 17.0 10.4 8.0 31.7 Percent

23. Counting the Unemployed: The Official Statistics The BLS estimates the labor force, the employed, and the unemployed. –These distinctions cannot deal very well with the problems of discouraged workers and of “hidden” or “disguised” unemployment. –Discouraged Worker: An unemployed person who gives up looking for work and is therefore no longer counted as part of the labor force.

24. Types of Unemployment Frictional unemployment is the normal movement of workers from one job to another. Structural unemployment exists when workers’ characteristics do not fit with employers’ requirements. Cyclical unemployment occurs when the level of economic activity declines

25. How Much Unemployment is “Full Employment”? It was once thought that 4% was a good target. Events from the early 1990s through 2002 have left economists uncertain of the full- employment unemployment rate. –Government reports estimate full employment unemployment is slightly above 5 percent.

26. Unemployment Insurance: The Invaluable Cushion Unemployment insurance cushions (but does not completely prevent) the monetary loss to some (but not all) unemployed people. Payroll taxes and unemployment benefits –Spread the costs of unemployment over the entire population –Do not eliminate its basic economic cost

27. 1997 15 10 5 0 France U.K. Germany U.S. Japan 1992 2002 GLOBAL PERSPECTIVE Unemployment Rates 5 Industrial Nations 1992 - 2002 Source: Economic Report of the President, 2003

28. Part 3: The Goal of Low Inflation

29. Inflation: The Myth and the Reality The costs of inflation are less obvious than those of unemployment, yet people certainly fear it. Inflation and Real Wages: Inflation does not typically erode real wages, because increases in nominal wages compensate for the rising prices.

30. Rates of Change of Wages and Prices in the U.S. Percentage Change in Prices Prices 0 2 4 6 8 10 1 3 5 7 9 11 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Year Wages 0 2 4 6 8 10 1 3 5 7 9 11 Percentage Change in Wages

31. Amount Higher productivity Compensation for higher prices Total Reasons for Wages to Increase 2% 3% 5%

32. Inflation: The Myth and the Reality The Importance of Relative Prices: Inflation is not usually to blame when some goods become more expensive relative to others.

33. Inflation as a Redistributor of Income and Wealth Because inflation does not proceed evenly, it redistributes income and wealth in arbitrary, unfair ways. It systematically discriminates against people on fixed incomes, and it may favor borrowers at the expense of lenders.

34. Real versus Nominal Interest Rates Real rate of interest = percentage increase in purchasing power that the borrower pays the lender in exchange for the loan. Nominal rate of interest = Real interest rate + expected rate of inflation

35. Real versus Nominal Interest Rates Inflation that is accurately anticipated need not redistribute wealth between borrowers and lenders. –The nominal interest rate will include an adequate inflation premium, above the real interest rate. If the actual inflation rate turns out to be different from the expected rate unanticipated redistribution will occur.

36. Inflation Distorts Measurements Confusing Real and Nominal Interest Rates –Hides true economic cost of borrowing money. Many Americans viewed the 12% mortgage interest rates that banks charged in 1980 as scandalously high while they saw the 6% mortgage rates of 2004 as a great bargain. In truth, however, the real interest rate in 2004 (about 4%) was well above the bargain-basement real rates in 1980 (about 2%).

37. Nominal Interest Rate Real Interest Rate Inflation Premium = 11% 5% 6% + ANTICIPATED INFLATION

38. The Costs of Low versus High Inflation Inflation creates fewer social problems if –It is low rather than high. –It is steady (and therefore relatively predictable) rather than variable.

39. Low Does Not Necessarily Lead to High Inflation Low inflation does not necessarily lead to high inflation –Creeping inflation sometimes accelerates, but it sometimes decelerates. –While creeping inflations have many causes, galloping inflations have occurred only when the government has printed incredible amounts of money.

40. The price index is a measure of the cost of a basket of goods in a current year, relative to the cost of the same basket in a base year. There is no perfect price index. Index Numbers for Inflation

41. The Consumer Price Index (CPI), often known as "the cost of living," is the most widely cited index. Nominal values can be deflated by the CPI in order to estimate real changes. The Consumer Price Index

42. Prices in 2004

43. INFLATION Defined and Measurement A rising general level of prices Rate of inflation calculated using index numbers Consumer Price Index = Price of the same market basket in 1982-1984 x 100 CPI Price of most recent market basket in the particular year

44. The GDP deflator is somewhat different from the CPI, in that its basket includes all the components of GDP, not just consumer goods. –It is usually, although not always, very close to the CPI. How to Use a Price Index to “Deflate” Monetary Figures

45. 10 5 0 France Italy Germany U.S. Japan Source: Bureau of Labor Statistics GLOBAL PERSPECTIVE Inflation Rates in Five Industrial Nations 1992 - 2002 1997 1992 2002

46. 1)DEMAND-PULL INFLATION -Consumption -= shift in D Types of Inflation 2) COST-PUSH INFLATION - Rising Per-Unit Production Costs - = Shift in S - Supply Shocks

47. REDISTRIBUTIVE EFFECTS OF INFLATION Nominal Income Real Income Anticipations Anticipated Inflation Unanticipated Inflation

48. REDISTRIBUTIVE EFFECTS OF INFLATION Who is Hurt by Inflation? Fixed-Income Receivers Savers Creditors

49. REDISTRIBUTIVE EFFECTS OF INFLATION Who is Unaffected or Helped by Inflation? Flexible-Income Receivers Cost of Living Adjustments (COLAs) Debtors

50. EFFECTS OF INFLATION ON OUTPUT Cost-Push Inflation and Real Output Demand-Pull Inflation and Real Output Hyperinflation & Breakdown

51. When Inflation Strikes! (and Deflation too) Mr. Griffin – AP Macro - MHS

52. Source: Mint.com and WallStats.com

78. WARM UP Demonstrate Cost Push Inflation Demonstrate Demand Pull Inflation Demonstrate Recessionary Deflation

79. The Inflation Game Who is most hurt by inflation? –Record your response on the score card.

93. Review of CPI and the GDP Deflator Mr. Griffin MHS – AP ECON

94. INFLATION Defined and Measurement A rising general level of prices Rate of inflation calculated using index numbers Consumer Price Index = Price of the same market basket in 1982-1984 x 100 CPI Price of most recent market basket in the particular year

95. The GDP deflator is somewhat different from the CPI, in that its basket includes all the components of GDP, not just consumer goods. –It is usually, although not always, very close to the CPI. How to Use a Price Index to “Deflate” Monetary Figures

96. Adjustment Process GDP Price Index Price Index in a given year = Price of market basket in specific year Price of same market basket in base year x 100 Real GDP = Nominal GDP Price Index (in hundredths) Price Index (in hundredths) = Nominal GDP Real GDP An Alternative Method NOMINAL GDP vs. REAL GDP

97. If 2000 were made the base year for the GDP price deflator index, the value of the index number for 1990 (rounded to the nearest whole number) would be a. zero d.212. b.42. e.256. c.142.

98. b

99. The value of the gross domestic product in 2000, in terms of 1990 prices, was a.$600.d.$1,200. b.$700.e.$1,300. c.$1,000.

100. a

101. If the price index in a country were 100 for the year 2000 and 120 for 2003 and nominal gross domestic product in 2003 were $480 billion, then real gross domestic product for 2003 in2000 dollars would be a.about $360 billion.d.about $600 billion b.about $380 billion.e.indeterminate with the given information. c.about $400 billion.

102. c

103. If your wages increase by 12 percent at the same time the CPI increases by 3 percent, then the increase in your real wages is equal to a.12 percent. b.9 percent. c.6 percent. d.3 percent. e.4 percent

104. b

106. e