1. Introduction: Thinking Like an Economist CHAPTER 6 Economic Growth, Business Cycles, and Structural Stagnation Remember that there is nothing stable in human affairs; therefore avoid undue elation in prosperity, or undue depression in adversity. — Socrates Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-2 Chapter Goals  Discuss the history of macro, distinguishing Classical and Keynesian macroeconomists  Distinguish a business cycle from structural stagnation  Define growth and discuss its recent history  Relate unemployment to business cycles and distinguish cyclical unemployment from structural unemployment

3. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-3 The Historical Development of Macro  Classical economists believe that business cycles are temporary glitches, and generally favor laissez-faire, or nonactivist policies  Keynesian economists believe that business cycles reflect underlying problems that can be addressed with activist government policies  By the 1980s, Classical and Keynesian economics merged in a new conventional macroeconomics  Following the 2008 crash, the U.S. economy experienced structural stagnation that conventional economists did not anticipate

4. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-4 Two Frameworks: The Long Run and the Short Run  The long-run growth framework focuses on incentives for supply Sometimes called supply-side economics Issues of growth are considered in a long-run framework  The short-run business cycle focuses on demand Sometimes called demand-side economics Business cycles are generally considered in a short-run framework  Inflation and unemployment fall within both frameworks

5. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-5 Two Frameworks: The Long Run and the Short Run  The stark division between the short-run and the long-run frameworks is problematic  Both frameworks have to be blended into a composite framework in which both supply and demand influence long-run and short-run forces  The long run is just a combination of short runs that cannot be separated  The economy is simultaneously in the long run and short run

6. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-6 Growth  Economists measure growth with changes in total output over a long period of time  Even if total output is increasing, the population may be growing even faster, so per capita output would be falling  Potential output is the highest amount of output an economy can sustainably produce and sell using existing production processes and resources  Per capita output is output divided by the total population  U.S. economic output has grown at an annual 2.5 to 3.5 percent rate since World War I that represents the rise in potential output. What it will be in the future is uncertain.

7. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-7 The Benefits and Costs of Growth Per capita economic growth allows everyone in society, on average, to have more: but is this necessarily an increase in well-being? Growth, or the prediction of growth, allows governments to avoid hard questions Growth comes with costs: Pollution Resource exhaustion Destruction of natural habitat

8. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-8 Business Cycles and Structural Stagnation  A business cycle is the upward or downward movement of economic activity that occurs around the growth trend Classical economists argue that the government should just accept that business cycles occur and take a laissez-faire stance Keynesians economists argue that government can temper these fluctuations with policy actions

9. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-9 Business Cycle Phases Total Output Quarters 21342134213 Secular Growth Trend Upturn Downturn Peak Trough Boom Recession Expansion Upturn

10. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-10 The Phases of the Business Cycle  The four phases of the business cycle are: The peak The downturn The trough The upturn  A recession is a decline in real output that persists for more than two consecutive quarters of a year  An expansion is an upturn that lasts at least two consecutive quarters of a year

11. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-11 Structural Stagnation  Structural stagnation is a cyclical downturn that we do not expect to end any time soon with major changes in the structure of the economy  Unemployment is not due to temporary layoffs, but to longer-term changes  A depression is a deep and prolonged recession  The distinction between a business cycle and structural stagnation goes to the heart of the modern macro policy debates

12. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-12 Unemployment and Jobs  The unemployment rate is the percentage of people in the economy who are willing and able to work but who cannot find jobs  Cyclical unemployment is that which results from fluctuations in economic activity  Structural unemployment is that caused by the institutional structure of an economy or by economic restructuring making some skills obsolete

13. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-13 Unemployment Rate since 1900 Percentage of labor force unemployed 1900 1920 1940 1960 1980 2000 30 20 10 0 In the mid-1940s, the U.S. government started focusing on the unemployment rate as a goal, and initially chose 2%, but it was gradually increased to around 3 to 5% Target rate

14. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-14 Unemployment as a Social Problem  The Industrial Revolution changed the nature of work and introduced unemployment as a problem for society  There was a shift to wage labor and to a division of responsibilities  The Industrial Revolution created the possibility of cyclical unemployment and changed how families dealt with unemployment  Early capitalism had an unemployment solution: the fear of hunger

15. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-15 Unemployment as Government’s Problem  In the Employment Act of 1946, the U.S. government took responsibility for unemployment  Full employment is an economic climate where nearly everyone who wants a job has one  Frictional unemployment is unemployment caused by people entering the job market and people quitting a job just long enough to look for and find another job

16. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-16 Target Rate of Unemployment  The target rate of unemployment is the lowest sustainable rate of unemployment that policy makers believe is achievable under existing conditions  The appropriate target rate of unemployment was debatable until the downturn of 2008, but, for the US, most economists place it around 3 to 5%  The target rate of unemployment changes due to: Inflation rates Demographics Social and institutional structures Changing government institutions

17. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-17 CALCULATION EXAMPLES 1. Calculating Economic Growth Rates:  Annual Percentage Change in Real GDP  To calculate this growth rate, we use the formula: Growth of real GDP = Real GDP in current year Real GDP in previous year x 100 Real GDP in previous year – For example, if real GDP in the current year is $8.4 trillion and if real GDP in the previous year was $8.0 trillion, then the growth rate of real GDP is : Growth of real GDP = $8.4 trillion – $8.0 trillion $8.0 trillion x 100= 5%

18. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-18 CALCULATION EXAMPLES 2. To calculate Real GDP Per Capita (per person), we use the formula: Real GDP Population  In current year, when real GDP is $8.4 trillion, and the population is 202 million, then Real GDP per capita = $41,584 $8.4 trillion 202 million  In the previous year, when real GDP was $8.0 trillion, the population was 200 million, real GDP per capita was $8.0 trillion divided by 200 million, or $40,000.

19. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-19 CALCULATION EXAMPLES 3. To calculate growth in Real GDP Per Capita (per person): - Use the formula from (1), replacing real GDP with real GDP per person -Use the two values of real GDP per person calcluated in (2): Growth rate of real GDP per person $41,584 – $40,000 $40,000 x 100= 4% =

20. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-20 CALCULATION EXAMPLES 4. Growth in Real GDP Per can also be estimated by using the formula (accurate enough for rates of 10% or less): Growth of real GDP per person Growth rate of real GDP Growth rate of population – = Growth of population 202 million – 200 million 200 million x 100= 1 %. = Growth of real GDP per person 5 % – 1 % = 4 %. = Recall, growth rate of real GDP from (1) was 5 %, so:

21. 1 Economic Growth, Business Cycles, and Structural Stagnation 6 6-21 Links for Overview of Macro Potential output: CBO Budget Outlook GDP report from BEA: BEA-Dept of Commerce GDP Report GDP per capita: World Bank Report on global GDP Unemployment and employment: BLS-Dept of Labor Report