1. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Economic Growth, Business Cycles, Unemployment, and Inflation Chapter 6 – Part 1

2. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Laugher Curve An Indian-born economist once explained his personal theory of reincarnation to his graduate economics class.

3. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Laugher Curve “If you are a good economist, a virtuous economist,” he said, “you are reborn as a physicist.” “But if you are an evil, wicked economist, you are reborn as a sociologist.”

4. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Introduction n Macroeconomics is the study of the aggregate states of the economy. n The four central problems are growth, business cycles, unemployment, and inflation.

5. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Two Frameworks: The Long Run and the Short Run n Issues of growth are considered in a long- run framework. n Business cycles are generally considered in a short-run framework. n Inflation and unemployment fall within both frameworks.

6. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Growth n The primary measurement of growth is changes in real gross domestic product. n Real gross domestic product (real GDP) – the market value of final goods and services produced in the economy stated in the prices of a given year.

7. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Growth n The U.S. historical or secular growth rate is between 2.5 to 3.5 percent per year. n Per capita real output is real GDP divided by the total population. n The U.S. capita real output growth has been 1.5 to 2.5 percent per year since 1950.

8. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Global Experience with Growth n Today's growth rates are high by historical standards. n The range of growth rates among nations is wide. n African countries have consistently grown below the world average.

9. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Global Experience with Growth n The growth trend we now take for granted started at the end of the of the18th century. n At about the same time, markets and democracies became the primary organizing structures of society.

10. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Benefits and Costs of Growth n Per capita economic growth allows everyone in society, on average, to have more. n Growth, or predictions of growth, allows governments to avoid hard questions. n The costs of growth include pollution, resource exhaustion, and destruction of natural habitat.

11. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Business Cycles n The business cycle is the upward and downward movement of economic activity or real GDP that occurs around the growth trend. n See Figure 6.1 for the U.S. historical experience.

12. U. S. Business Cycles McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Civil War Recovery of 1895 World War I Panic of 1893 Panic of 1907 Great Depression Korean War Vietnam War World War II

13. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Business Cycles n There are a number of policies regarding business cycles. n Classical economists generally favor laissez-faire or noninterventionist policies. n Keynesians generally favor activist or interventionist policies.

14. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Phases of the Business Cycle n A peak is the top of the business cycle. n A trough is the bottom of the business cycle. n A boom is a very high peak. n A downturn is when economic activity starts to fall from a peak. n A upturn is when economic activity starts to rise from a trough.

15. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Phases of the Business Cycle n A recession is a decline in output that persists for more than two consecutive quarters in a year. n A depression is a large recession. n A trough is also the bottom of the recession or depression. n An expansion is an upturn that lasts at least two consecutive quarters of a year.

16. Expansion Recession The Phases of the Business Cycle 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 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

17. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Why Do Business Cycles Occur n Recessions and expansions are caused primarily by demand-side of the economy. n A debate exists about whether these fluctuations can and should be reduced. n Most economists believe that potential depressions can and should be offset by economic policy.

18. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Why Do Business Cycles Occur n Since the late 1940s, compared to prior years: l Downturns and panics have generally been less severe. l The duration of business cycles has increased. l The average length of expansions has increased while the average length of contractions has decreased.

19. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Why Do Business Cycles Occur n Most economists believe that business fluctuations have become less severe because of the stronger role of government in the economy.

20. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Leading Indicators n Leading indicators tell us what's likely to happen in the economy 12 to 15 months from now. n The are indicators rather than predictors because they are only rough approximations of what’s likely to happen in the future.

21. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Leading Indicators n Leading indicators include the following: l Average workweek for production workers in manufacturing. l Unemployment claims. l New orders for consumer goods and materials.

22. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Leading Indicators n Leading indicators include the following: l Vendor performance, measured as a percentage of companies reporting slower deliveries from suppliers. l Index of consumer expectations. l New orders for plant and equipment.

23. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Leading Indicators n Leading indicators include the following: l Number of new building permits issued for private housing units. l Change in stock prices. l Interest rate spread. l Changes in the money supply.