1. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-1 Chapter 5 The Macroeconomic Environment

2. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 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.

3. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 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.

4. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 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

5. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-5 The Australian Business Cycle & Rate of Inflation

6. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 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

7. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 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

8. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-8 Phases of the Business Cycle (cont.) RECOVERY Level of business activity Time TROUGH RECESSION PEAK GROWTH TREND

9. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-9 Causes of Business Cycle Variety of explanations/theories: Innovation Political events Random events Purely monetary phenomenon Immediate determinant: aggregate expenditure

10. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-10 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

11. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-11 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

12. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-12 Types of Unemployment (cont.) Cyclical – unemployment caused by the business cycle, or due to insufficient aggregate demand or total spending

13. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-13 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

14. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-14 Australia: Unemployment Rate

15. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-15 Measuring Unemployment Part-time employment 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

16. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-16 Cost of Unemployment Economic costs – output forgone, measured in terms of the GDP gap – Okun’s law shows the relationship between the unemployment rate and the GDP gap – Unequal burdens Non-economic costs

17. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-17 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 =

18. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-18 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

19. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-19 Demand-Pull Inflation Range 1 Price level Output and employment Q Range 2 Range 3 Full-employmentoutput P

20. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-20 Inflation & Redistribution Most severe when inflation is unanticipated Fixed-nominal-income receivers Savers Debtors and creditors

21. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-21 Evaluation of Inflation Distribution of output Impact on real output Hyperinflation

22. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 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

23. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-23 Output Effects of Inflation Stimulus of demand-pull 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

24. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 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 and 1990s

25. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-25 Components of the Current Account

26. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-26 The Capital and Financial Account Balance 1959–60 to 2001–02

27. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 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

28. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-28 Australia: National Savings

29. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 5-29 Next Chapter: The Aggregate Expenditures Model