1. Ch13 Economic Challenges

2. Unemployment Frictional Unemployment – Looking for new work
Seasonal Unemployment – Farm work, Holiday Seasons
Structural Unemployment – Changing workplace
Cyclical Unemployment – Business Cycles
Underemployed – More qualified than job requires
Discouraged workers

3. Inflation Inflation is the general increase in prices over time
Inflation vs. Purchasing Power – How much do you get?
Inflation is usually measured by looking at groups of common goods in a price index

4. Causes of Inflation
Quantity Theory – Too much money in the supply
Demand-Pull Theory – Demand for goods exceeds supply
Cost-Push Theory – Costs for making goods increases
Wage–Price Spiral – The wage price spiral is where wages increase, causing increased demand, causing prices to go up, leading to a need for higher wages, etc.

5. Short-Run Trade-Off between Inflation and Unemployment
Unemployment and Inflation
Society faces a short-run tradeoff between unemployment and inflation.
If policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher inflation.
If they contract aggregate demand, they can lower inflation, but at the cost of temporarily higher unemployment.
The Phillips Curve shows the short-run trade off between inflation and unemployment.

6. The Phillips Curve Inflation Rate (percent Phillips curve per year) 4B 6 7 A 2
Unemployment
Rate (percent)

7. How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply
(a) The Model of Aggregate Demand and Aggregate Supply
(b) The Phillips Curve
Price
Inflation
Level
Short-run
aggregate
supply
High
aggregate demand
Rate
(percent
Phillips curve
per year)
Low aggregate
demand
(output is
8,000) B 4 6
8,000
(unemployment
is 4%)
106 B
(unemployment
is 7%)
7,500
102 A
(output is
7,500) A 7 2
Quantity
Unemployment
of Output
Rate (percent)

8. An Adverse Shock to Aggregate Supply
(a) The Model of Aggregate Demand and Aggregate Supply
(b) The Phillips Curve
Price
Inflation
giving policymakers
a less favorable tradeoff
between unemployment
and inflation.
Level
AS2
Rate
Aggregate
PC2 B
supply, AS
1. An adverse
shift in aggregate
supply . . . B P2 Y2
and
raises
the price
level . . . P A Y A
Aggregate
demand
Phillips curve, P C
Quantity
Unemployment
lowers output . . .
of Output
Rate

9. Disinflationary Monetary Policy in the Short Run and the Long Run
1. Contractionary policy moves
the economy down along the
short-run Phillips curve . . .
Inflation
Long-run
Rate
Phillips curve
Short-run Phillips curve
with high expected
inflation A
Short-run Phillips curve
with low expected
inflation C B
but in the long run, expected
inflation falls, and the short-run
Phillips curve shifts to the left.
Natural rate of
Unemployment
unemployment
Rate

10. The Long-Run Phillips Curve
Inflation
Rate
Long-run
Phillips curve B
High
inflation
1. When the
Fed increases
the growth rate
of the money
supply, the
rate of inflation
increases . . .
but unemployment
remains at its natural rate
in the long run.
Low
inflation A
Natural rate of
Unemployment
unemployment
Rate

11. How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply
(a) The Model of Aggregate Demand and Aggregate Supply
(b) The Phillips Curve
Price
Long-run aggregate
Inflation
Long-run Phillips
Level
Rate
supply
curve
1. An increase in
the money supply
increases aggregate
demand . . .
and
increases the
inflation rate . . .
AD2 P2 B B
raises
the price
level . . . A P A
Aggregate
demand, AD
Natural rate
Quantity
Natural rate of
Unemployment
of output
of Output
unemployment
Rate
but leaves output and unemployment
at their natural rates.

12. SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS
Historical events have shown that the short-run Phillips curve can shift due to changes in expectations.
The short-run Phillips curve also shifts because of shocks to aggregate supply.
Major adverse changes in aggregate supply can worsen the short-run trade-off between unemployment and inflation.
An adverse supply shock gives policymakers a less favorable trade-off between inflation and unemployment.

13. The Phillips Curve in the 1960s
Inflation Rate
(percent per year) 10 8 6
1968 4
1966
1967 2
1965
1962
1964
1961
1963 1 2 3 4 5 6 7 8 9 10
Unemployment
Rate (percent)

14. The Breakdown of the Phillips Curve
Inflation Rate
(percent per year) 10 8 6
1973
1970
1971
1969 4
1968
1972
1966
1967 2
1965
1962
1964
1961
1963 1 2 3 4 5 6 7 8 9 10
Unemployment
Rate (percent)

15. The Supply Shocks of the 1970s
Inflation Rate
(percent per year) 10
1981
1980
1975
1974
1979 8
1978 6
1977
1976
1973 4
1972 2 1 2 3 4 5 6 7 8 9 10
Unemployment
Rate (percent)

16. The Volcker Disinflation
Inflation Rate
(percent per year) 10
1980
1981
1979 A 8
1982 6
1984
1983 B 4
1987 C
1985
1986 2 1 2 3 4 5 6 7 8 9 10
Unemployment
Rate (percent)

17. The Greenspan Era 10 8 6 4 2 1 2 3 4 5 6 7 8 9 10 Inflation Rate
(percent per year) 10 8 6
1990 4
1991
1989
1984
1988
1985
1987
2001
1995
2000
1992
1993 2
1994
1986
1997
1996
1999
1998
2002 1 2 3 4 5 6 7 8 9 10
Unemployment
Rate (percent)

18. Poverty
The poverty threshold is the income level needed to support a families minimum needs
Family of 4 (2 adults, 2 children) $18,850/yr (2004)
Poverty depends on family size and location

19. Reasons for poverty Lack of education Location
Racial and Gender Discrimination
Economic Shifts
Family Problems
Health
Greed

20. Income Distribution
In 2003, median family income was $43,318 (half earned more, half less)
The Lorenz Curve shows that the wealthiest 20% made as much as the other 80% of Americans
The GDP (Gross Domestic Product) of the poorest 48 nations (i.e. a quarter of the world’s countries) is less than the wealth of the world’s three richest people combined.
In the 1970, the top 1% made less than 9% of all income, in 2007, the top 1% took in more than 27% of all income

22. Welfare Reform
Many poor receive Federal Aid, in the form of housing subsidies, food stamps, direct cash payments, and health related services. In 1996, welfare reform was enacted because there was a growing perception that the poor were living off of the state, creating a tax burden for everyone else. This welfare reform reduced payments, and gave some training assistance, to get people into the work force.

23. End