1. © 2003 McGraw-Hill Ryerson Limited. Economic Growth, Business Cycles, Unemployment, and Inflation Chapter 6

2. 6 - 2 © 2003 McGraw-Hill Ryerson Limited. Central Problems of Macroeconomics u Macroeconomics is the study of the aggregate moods of the economy. u The four central issues of macroeconomics are growth, business cycles, unemployment, and inflation.

3. 6 - 3 © 2003 McGraw-Hill Ryerson Limited. Two Timeframes: The Long Run and the Short Run u Issues of growth are considered in a long-run framework. l Long-run growth focuses on supply (also called supply-side economics). l Supply is so important in the long run, policies that affect production - such as incentives that promote work, capital, and technological change - are key.

4. 6 - 4 © 2003 McGraw-Hill Ryerson Limited. Two Timeframes: The Long Run and the Short Run u Business cycles are generally considered in a short-run framework. l The short-run fluctuation framework focuses on demand. l Much of the policy discussion of short-run fluctuations focuses on ways to increase or decrease components of aggregate expenditures.

5. 6 - 5 © 2003 McGraw-Hill Ryerson Limited. Growth u Generally the Canadian economy is growing or expanding. u The primary measurement of growth is change in real gross domestic product (GDP).

6. 6 - 6 © 2003 McGraw-Hill Ryerson Limited. Growth u Real gross domestic product (real GDP) – the market value of final goods and services stated in the prices of a given period.

7. 6 - 7 © 2003 McGraw-Hill Ryerson Limited. Growth u Canadian economy has grown at an annual rate of 4 percent per year over the last 130 years., but more recently it has been growing at about 2.5-3.5 percent a year. u This average annual growth rate is called the secular trend growth rate.

8. 6 - 8 © 2003 McGraw-Hill Ryerson Limited. Growth u Another measure of growth is change in per capita real output. u Per capita real output is real output divided by the total population.

9. 6 - 9 © 2003 McGraw-Hill Ryerson Limited. Global Experience with Growth u Global experiences with growth vary across time and among nations. u Today's growth rates are high by historical standards. u The range of growth rates among nations is wide.

10. 6 - 10 © 2003 McGraw-Hill Ryerson Limited. Average Annual Per Capita Income, 1820-2000, Table 6-1, p 136 Growth RatesIncome levels (1990 international Dollars) 1820-19501950-20001820-2000182019502000 The world0.91.81.16752,1085,672 Western Europe1.12.51.51,2696,54619,846 North America1.61.81.61,2339,46326,224 Japan0.84.81.96751,92720,438 Eastern Europe1.11.0 8033,1625,967 Latin America1.01.41.16712,4786,797 China-0.23.40.86004393,442 Other Asia0.32.40.95608483,269 Africa0.60.80.64001,3071,291

11. 6 - 11 © 2003 McGraw-Hill Ryerson Limited. The Benefits and Costs of Growth u Per capita economic growth allows everyone in society, on average to have more. u Growth, or predictions of growth, allows governments to avoid hard questions. u A growing economy creates jobs.

12. 6 - 12 © 2003 McGraw-Hill Ryerson Limited. u Since many believe the environmental costs of growth are important, the result is often an environmental-economic growth stalemate. The Benefits and Costs of Growth u The costs of growth include pollution, resource exhaustion, and destruction of natural habitat.

13. 6 - 13 © 2003 McGraw-Hill Ryerson Limited. Business Cycles u There are numerous fluctuations around the secular growth trend,called the business cycle. u The business cycle is the upward and downward movement of economic activity that occurs around the growth trend.

14. 6 - 14 © 2003 McGraw-Hill Ryerson Limited. Canadian Business Cycles, Fig. 6-1a, p 138

15. 6 - 15 © 2003 McGraw-Hill Ryerson Limited. U. S. Business Cycles, Fig. 6-1b, p 138

16. 6 - 16 © 2003 McGraw-Hill Ryerson Limited. Business Cycles u There are a number of theories regarding the nature and causes of business cycles. u Classicals are a group of economists who generally favour laissez-faire or noninterventionist policies. u Keynesians generally favour activist policies.

17. 6 - 17 © 2003 McGraw-Hill Ryerson Limited. Business Cycles u Classical economists argue that business cycles are to be expected in a market economy. u Keynesian economists believe that fluctuations can and should be controlled.

18. 6 - 18 © 2003 McGraw-Hill Ryerson Limited. The Phases of the Business Cycle u The peak is the top of the business cycle. u A boom is a very high peak, representing a big jump in output. u The downturn is the phenomenon of economic activity starting to fall from a peak.

19. 6 - 19 © 2003 McGraw-Hill Ryerson Limited. The Phases of the Business Cycle u A recession is a decline in real output that persists for more than two consecutive quarters in a year. u A depression is a large recession. u The bottom of the recession or depression is called the trough.

20. 6 - 20 © 2003 McGraw-Hill Ryerson Limited. The Phases of the Business Cycle u As total output starts to expand, the economy comes out of the trough into an upturn, which may turn into an expansion. u An expansion is an upturn that lasts at least two consecutive quarters of a year.

21. 6 - 21 © 2003 McGraw-Hill Ryerson Limited. Expansion Recession Business Cycle Phases, Fig. 6-2, p 140 Boom Secular growth trend Downturn Upturn Trough Peak 0 Jan.- Mar Total Output Apr.- June July- Sept. Oct.- Dec. Jan.- Mar Apr.- June July- Sept. Oct.- Dec. Jan.- Mar Apr.- June

22. 6 - 22 © 2003 McGraw-Hill Ryerson Limited. Why Do Business Cycles Occur u Recessions and expansions are caused primarily by demand-side shocks. u A debate exists about whether these fluctuations can and should be reduced.

23. 6 - 23 © 2003 McGraw-Hill Ryerson Limited. Why Do Business Cycles Occur u Most economists believe that potential depressions should be offset by economic policy. u This general view was built into economics in the Great Depression of the 1930s.

24. 6 - 24 © 2003 McGraw-Hill Ryerson Limited. Why Do Business Cycles Occur u During this period there were changes in the economy's structure, with government playing a much more active role.

25. 6 - 25 © 2003 McGraw-Hill Ryerson Limited. Leading Indicators u Leading indicators are a set of signs that indicate what is likely to happen 12 to 15 months from now.

26. 6 - 26 © 2003 McGraw-Hill Ryerson Limited. Leading Indicators u Variables that make up the leading indicator include: l Average workweek for production workers in manufacturing. l An index of housing starts. l The U.S. composite leading index.

27. 6 - 27 © 2003 McGraw-Hill Ryerson Limited. Leading Indicators u Variables that make up the leading indicator include : l The money supply M1 divided by the price index. l New orders for durable goods. l Retail trade in furniture and appliances. l Durable goods sales excluding furniture and appliances.

28. 6 - 28 © 2003 McGraw-Hill Ryerson Limited. Leading Indicators u Variables that make up the leading indicator include: l The ratio of shipments to inventories or finished products. l The TSE 300 stock price index. l Employment in business and personal service sector.

29. 6 - 29 © 2003 McGraw-Hill Ryerson Limited. Leading Indicators u Economists use indicators in making forecasts about the economy. They are indicators, not predictors.

30. 6 - 30 © 2003 McGraw-Hill Ryerson Limited. Unemployment u Business cycles and growth are directly related to unemployment in the economy. u Unemployment occurs when people are looking for a job and cannot find one.

31. 6 - 31 © 2003 McGraw-Hill Ryerson Limited. Unemployment u The unemployment rate is the percentage of people in the economy who are willing and able to work but who are not working.

32. 6 - 32 © 2003 McGraw-Hill Ryerson Limited. Unemployment u Cyclical unemployment results from fluctuations in economic activity. u It did not exist in pre-industrial society.

33. 6 - 33 © 2003 McGraw-Hill Ryerson Limited. Unemployment u Structural unemployment is caused by economic restructuring, making some skills obsolete. u It existed in pre-industrial society.

34. 6 - 34 © 2003 McGraw-Hill Ryerson Limited. Unemployment as a Social Problem u The Industrial Revolution was accompanied by a change in how families dealt with unemployment. u What had previously been a family problem, now became a social problem.

35. 6 - 35 © 2003 McGraw-Hill Ryerson Limited. Unemployment as Government’s Problem u The Federal Unemployment Insurance Act of 1940 assigned government the responsibility for providing assistance to the unemployed. u Full employment – an economic climate in which just about everyone who wants a job can have one.

36. 6 - 36 © 2003 McGraw-Hill Ryerson Limited. Unemployment as Government’s Problem u Initially government regarded 3 percent unemployment as a condition of full employment. u The 3 percent was made up of frictional unemployment.

37. 6 - 37 © 2003 McGraw-Hill Ryerson Limited. Unemployment as Government’s Problem u 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.

38. 6 - 38 © 2003 McGraw-Hill Ryerson Limited. Unemployment as Government’s Problem u The target rate of unemployment (sometimes called the natural rate of unemployment) is the lowest sustainable rate of unemployment that policymakers believe is achievable under existing conditions.

39. 6 - 39 © 2003 McGraw-Hill Ryerson Limited. Unemployment as Government’s Problem u In the 1980s and 1990s, the target rate of unemployment was been between 6 and 8 percent.

40. 6 - 40 © 2003 McGraw-Hill Ryerson Limited. Why the Target Rate of Unemployment Changed u The target rate of unemployment has changed over time for the following reasons: l In the 1970s and early 1980s, a low inflation rate seemed to be incompatible with a low unemployment rate.

41. 6 - 41 © 2003 McGraw-Hill Ryerson Limited. Why the Target Rate of Unemployment Changed u The target rate of unemployment has changed over time for the following reasons: l Demographics have changed – different age groups have different rates of unemployment.

42. 6 - 42 © 2003 McGraw-Hill Ryerson Limited. Why the Target Rate of Unemployment Changed u The target rate of unemployment has changed over time for the following reasons: l Social and institutional structures have changed. l Governmental institutions also changed.

43. 6 - 43 © 2003 McGraw-Hill Ryerson Limited. Whose Responsibility Is Unemployment? u Classical economists believe that individuals are responsible for their own employment. u They argue that every person can find some job at some wage, so all unemployment is frictional.

44. 6 - 44 © 2003 McGraw-Hill Ryerson Limited. Whose Responsibility Is Unemployment? u Keynesian economists tend to say that society owes a person a job commensurate with the individual's training or past job experience. u They argue that jobs should be closer to home, so people do not have to move. According to this view, unemployment is mainly cyclical and structural.

45. 6 - 45 © 2003 McGraw-Hill Ryerson Limited. How Is Unemployment Measured? u The unemployment rate is published by Statistics Canada.

46. 6 - 46 © 2003 McGraw-Hill Ryerson Limited. Calculating the Unemployment Rate u The unemployment rate is calculated by dividing the number of unemployed individuals by the number of people in the labour force and multiplying by 100.

47. 6 - 47 © 2003 McGraw-Hill Ryerson Limited. Calculating the Unemployment Rate u The labour force is those people in an economy who are willing and able to work. u The labour force excludes those incapable of working and those not looking for work.

48. 6 - 48 © 2003 McGraw-Hill Ryerson Limited. Unemployment Rate Since 1946, Fig. 6-3, p 146

49. 6 - 49 © 2003 McGraw-Hill Ryerson Limited. How Accurate Is the Official Unemployment Rate? u The unemployment rate does not include discouraged workers. u Discouraged workers – people who do not look for a job because they feel they do not have a chance of finding one.

50. 6 - 50 © 2003 McGraw-Hill Ryerson Limited. How Accurate Is the Official Unemployment Rate? u The unemployment rate counts as employed those who are underemployed. u Underemployed – part-time workers who would prefer full-time work.

51. 6 - 51 © 2003 McGraw-Hill Ryerson Limited. How Accurate Is the Official Unemployment Rate? u Some supplemental measures are used by economists for better accuracy of unemployment measures, such as the labour force participation rate and the employment rate.

52. 6 - 52 © 2003 McGraw-Hill Ryerson Limited. How Accurate Is the Official Unemployment Rate? u The labour force participation rate measures the labour force as a percentage of the total population at least 15 years old. u The employment rate measures the number of people who are working as a percentage of the labour force.

53. 6 - 53 © 2003 McGraw-Hill Ryerson Limited. How Accurate Is the Official Unemployment Rate? u Both Classicals and Keynesians agree that unemployment figures are imperfect, for different reasons.

54. 6 - 54 © 2003 McGraw-Hill Ryerson Limited. Unemployment/Employment Figures, Fig. 6-4, p 147 Population (31.08 million)Population 15 or older (24.6 million) Labor force (16.25 million) Employed (15.08 million)Unemployed (1.17 million)

55. 6 - 55 © 2003 McGraw-Hill Ryerson Limited. Unemployment and Potential Output u 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.

56. 6 - 56 © 2003 McGraw-Hill Ryerson Limited. Unemployment and Potential Output u The capacity utilization rate indicates how much capital is available for economic growth.

57. 6 - 57 © 2003 McGraw-Hill Ryerson Limited. Unemployment and Potential Output u Potential output is the output that would materialize at the target rate of unemployment and the target rate of capacity utilization.

58. 6 - 58 © 2003 McGraw-Hill Ryerson Limited. Unemployment and Potential Output u Potential output is defined as the output that will be achieved at the target rate of unemployment and at the target level of capacity utilization.

59. 6 - 59 © 2003 McGraw-Hill Ryerson Limited. Unemployment and Potential Output u There is debate about where the actual level of potential income is.

60. 6 - 60 © 2003 McGraw-Hill Ryerson Limited. Unemployment and Potential Output u To determine the effect changes in the unemployment rate will have on output, we use Okun's rule of thumb. l The rule states that a 1 percentage point change in unemployment will cause output to change in the opposite direction by 2 percent.

61. 6 - 61 © 2003 McGraw-Hill Ryerson Limited. Unemployment and Capacity Utilization Rates (%), Table 6-2, p 148 Capacity utilizationUnemploymentAnnual growth in real output 197519852000197519852000 1975-2000 Canada83.182.585.86.910.56.62.5 U.S.74.679.880.48.57.24.02.9 Japan81.482.574.61.92.64.42.5 Germany76.979.685.13.48.210.03.0 U.K.81.981.181.84.611.25.72.2 Mexico8592.085.7--2.01.6 Korea86.586.483.3-10.94.87.7

62. 6 - 62 © 2003 McGraw-Hill Ryerson Limited. Microeconomic Categories of Unemployment u Macroeconomic measures of unemployment may be too crude. u Different types of unemployment are susceptible to different types of policies.

63. 6 - 63 © 2003 McGraw-Hill Ryerson Limited. Microeconomic Categories of Unemployment u Some microeconomic categories of unemployment are reasons for unemployment, demographic unemployment, duration of unemployment, unemployment by industry,and unemployment by age group.

64. 6 - 64 © 2003 McGraw-Hill Ryerson Limited. Unemployment by Microeconomic Subcategories, Fig. 6-5, p 150 Total unemployment (1.17 million (7.2%)) Male (659,500 (7.5%)) 15-24 12.8% Female (510,000(6.8%) Unemployment rate by sex Unemployment by age 25 and over 6.1% Total unemployment rate 55 and over 5.5% 65 and over 3.3%

65. 6 - 65 © 2003 McGraw-Hill Ryerson Limited. Inflation u Inflation is a continual rise in the price level. u Since World War II, the Canadian inflation rate has remained positive and relatively stable.

66. 6 - 66 © 2003 McGraw-Hill Ryerson Limited. Measurement of Inflation u Inflation is measured with changes in price indexes. u A price index is a composite of prices.

67. 6 - 67 © 2003 McGraw-Hill Ryerson Limited. Measurement of Inflation u A price index is a series of numbers that summarizes what happens to a weighted composite of prices of a selection of goods (often called a market basket of goods) over time.

68. 6 - 68 © 2003 McGraw-Hill Ryerson Limited. Measurement of Inflation u A price index can be created by looking at a market basket of goods.

69. 6 - 69 © 2003 McGraw-Hill Ryerson Limited. Inflation in Canada Since 1915, Fig. 6-6, p 151

70. 6 - 70 © 2003 McGraw-Hill Ryerson Limited. Real-World Price Indexes u Real-world price indexes include the raw materials price index, the CPI, and the GDP deflator.

71. 6 - 71 © 2003 McGraw-Hill Ryerson Limited. The Raw Materials Price Index u The raw materials price index measures the prices of a number of important raw materials, such as steel.

72. 6 - 72 © 2003 McGraw-Hill Ryerson Limited. The Raw Materials Price Index u This index does not accurately measure what most consumers are interested in—final goods. u It gives an early indication of which way inflation is headed.

73. 6 - 73 © 2003 McGraw-Hill Ryerson Limited. The GDP Deflator u The GDP deflator (gross domestic product deflator) is an index of the price level of aggregate output, or the average price of the components in total output (GDP) relative to a base year.

74. 6 - 74 © 2003 McGraw-Hill Ryerson Limited. The GDP Deflator u The GDP deflator is the measure of inflation most economists favour since it includes the widest number of goods. u Since it is difficult to compute, it is published only quarterly and with a fairly substantial lag.

75. 6 - 75 © 2003 McGraw-Hill Ryerson Limited. The Consumer Price Index (CPI) u The consumer price index (CPI) measures the prices of a fixed basket of consumer goods, weighted according to each component's share of an average consumer's expenditures.

76. 6 - 76 © 2003 McGraw-Hill Ryerson Limited. The Consumer Price Index (CPI) u The CPI is the measure of inflation most often presented in news reports. u Many economists believe that the CPI as currently constituted, overstates inflation by one percentage point.

77. 6 - 77 © 2003 McGraw-Hill Ryerson Limited. Composition of CPI, Fig. 6-7, p 153

78. 6 - 78 © 2003 McGraw-Hill Ryerson Limited. Real and Nominal Concepts u Nominal output is the total amount of goods and services measured at current prices.

79. 6 - 79 © 2003 McGraw-Hill Ryerson Limited. Real and Nominal Concepts u Real output is the total amount of goods and services produced, adjusted for price level changes.

80. 6 - 80 © 2003 McGraw-Hill Ryerson Limited. Real and Nominal Concepts u The “real” amount is the nominal amount adjusted for inflation.

81. 6 - 81 © 2003 McGraw-Hill Ryerson Limited. Expected and Unexpected Inflation u Expected and unexpected inflation affect behavior differently. u Expected inflation is that which people anticipate. u Unexpected inflation is that which surprises people.

82. 6 - 82 © 2003 McGraw-Hill Ryerson Limited. Expected and Unexpected Inflation u Expectations of inflation play an important role in further exacerbating inflation.

83. 6 - 83 © 2003 McGraw-Hill Ryerson Limited. Costs of Inflation u There are two main costs of inflation: redistribution costs and blurring of price information.

84. 6 - 84 © 2003 McGraw-Hill Ryerson Limited. Costs of Inflation u Inflation causes income to be redistributed from those who do not raise their prices to those who do. u Inflation can reduce the amount of information that prices are supposed to convey.

85. 6 - 85 © 2003 McGraw-Hill Ryerson Limited. Costs of Inflation u Despite redistributive costs and a blurring of price information, inflation is usually accepted by governments as long as it stays at a low level.

86. 6 - 86 © 2003 McGraw-Hill Ryerson Limited. Costs of Inflation u The danger is when inflation becomes hyperinflation. u Hyperinflation – exceptionally high levels of inflation of, say, 100 percent or more a year. u Canada has not experienced hyperinflation.

87. © 2003 McGraw-Hill Ryerson Limited. Economic Growth, Business Cycles, Unemployment, and Inflation End of Chapter 6