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Economic Growth, Business Cycles, Unemployment, and Inflation. Chapter 6. Laugher Curve. An Indian-born economist once explained his personal theory of reincarnation to his graduate economics class. Laugher Curve.

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laugher curve
Laugher Curve

An Indian-born economist once explained his personal theory of reincarnation to his graduate economics class.

laugher curve3
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.”

introduction
Introduction
  • Macroeconomics is the study of the aggregate moods of the economy.
  • The four central problems are growth, business cycles, unemployment, and inflation.
two frameworks the long run and the short run
Two Frameworks: The Long Run and the Short Run
  • Issues of growth are considered in a long-run framework.
  • Business cycles are generally considered in a short-run framework.
  • Inflation and unemployment fall within both frameworks.
growth
Growth
  • The primary measurement of growth is changes in real gross domestic product.
  • Real gross domestic product (realGDP) – the market value of goods and services stated in the prices of a given year.
growth7
Growth
  • The U.S. secular growth rate is between 2.5 to 3.5 percent per year.
growth8
Growth
  • Per capita real output growth has been 2.5 to 3.5 percent per year.
  • Per capita real output is real GDP divided by the total population.
global experience with growth
Global Experience with Growth
  • Today's growth rates are high by historical standards.
  • The range of growth rates among nations is wide.
  • African countries have consistently grown below the world average.
global experience with growth10
Global Experience with Growth
  • The growth trend we now take for granted started at the end of the of the18th century.
  • At about the same time, markets and democracies became the primary organizing structures of society.
the benefits and costs of growth
The Benefits and Costs of Growth
  • Per capita economic growth allows everyone in society, on average to have more.
  • Growth, or predictions of growth, allows governments to avoid hard questions.
the benefits and costs of growth12
The Benefits and Costs of Growth
  • The costs of growth include pollution, resource exhaustion, and destruction of natural habitat.
business cycles
Business Cycles
  • The business cycle is the upward and downward movement of economic activity that occurs around the growth trend.
business cycles14
Business Cycles
  • There are a number of policies regarding business cycles.
  • Classical economists generally favor laissez-faire or noninterventionist policies.
  • Keynesians generally favor activist policies.
u s business cycles

20

10

0

–10

–20

1860

‘70

‘80

‘90

1900

‘10

‘20

‘30

‘40

‘50

‘60

‘70

‘80

‘90

2000

‘10

U. S. Business Cycles

World War II

World War I

Recovery

of 1895

Civil War

Korean War

Vietnam War

Panic

of 1893

Panic

of 1907

Great

Depression

McGraw-Hill/Irwin

© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

the phases of the business cycle
The Phases of the Business Cycle
  • The peak is the top of the business cycle.
  • A boom is a very high peak, representing a big jump in output.
  • The downturn is the phenomenon of economic activity starting to fall from a peak.
the phases of the business cycle17
The Phases of the Business Cycle
  • A recession is a decline in output that persists for more than two consecutive quarters in a year.
  • A depressionis a large recession.
  • A trough is the bottom of the recession or depression.
the phases of the business cycle18
The Phases of the Business Cycle
  • An expansion is an upturn that lasts at least two consecutive quarters of a year.
the phases of the business cycle19

Expansion

Recession

Expansion

Boom

Peak

Upturn

Downturn

Total Output

Secular growth trend

Trough

0

Jan.-

Mar

Apr.-

June

July-

Sept.

Oct.-

Dec.

Jan.-

Mar

Apr.-

June

July-

Sept.

Oct.-

Dec.

Jan.-

Mar

Apr.-

June

The Phases of the Business Cycle

McGraw-Hill/Irwin

© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

why do business cycles occur
Recessions and expansions are caused primarily by demand-side of the economy.

A debate exists about whether these fluctuations can and should be reduced.

Why Do Business Cycles Occur
why do business cycles occur22
Since the late 1940s, compared to prior years:Why Do Business Cycles Occur
  • Downturns and panics have generally been less severe.
  • The duration of business cycles has increased.
  • The average length of expansions has increased while the average length of contractions has decreased.
why do business cycles occur23
Most economists believe that business fluctuations have become less severe because of the stronger role of government in the economy.Why Do Business Cycles Occur
leading indicators
Leading Indicators
  • Leading indicators tell us what's likely to happen in the economy 12 to 15 months from now.
leading indicators25
Leading Indicators
  • Leading indicators include the following:
  • Average workweek for production workers in manufacturing.
  • Unemployment claims.
  • New orders for consumer goods and materials.
leading indicators26
Leading Indicators
  • Leading indicators include the following:
    • Vendor performance, measured as a percentage of companies reporting slower deliveries from suppliers.
  • Index of consumer expectations.
  • New orders for plant and equipment.
leading indicators27
Leading Indicators
  • Leading indicators include the following:
    • Number of new building permits issued for private housing units.
  • Change in stock prices.
  • Interest rate spread.
  • Changes in the money supply.
unemployment
Unemployment
  • The unemployment rate is the number of people who are willing and able to work but are not working.
unemployment29
Unemployment
  • Cyclical unemployment is that which results from fluctuations in economic activity.
  • Structural unemployment is that caused by economic restructuring making some skills obsolete.
unemployment as a social problem
Unemployment as a Social Problem
  • The Industrial Revolution created the possibility of cyclical unemployment.
  • It brought a change in how families dealt with unemployment.
  • What had previously been a family problem, became a social problem.
unemployment as government s problem
Unemployment as Government’s Problem
  • As capitalism evolved, capitalist societies no longer saw the fear of hunger as an acceptable answer to unemployment.
unemployment as government s problem32
Unemployment as Government’s Problem
  • Full employment – an economic climate in which just about everyone who wants a job can have one.
unemployment as government s problem33
Unemployment as Government’s Problem
  • 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.
unemployment as government s problem34
Unemployment as Government’s Problem
  • The target rate of unemployment is the lowest sustainable rate of unemployment that policymakers believe is achievable under existing conditions.
  • It is sometimes called the natural rate of unemployment.
unemployment as government s problem35
Unemployment as Government’s Problem
  • In the 1980s and 1990s, the target rate of unemployment was been between 5 and 7 percent.
  • Today, the target rate of unemployment is about 5 percent.
why the target rate of unemployment changed
Why the Target Rate of Unemployment Changed
  • In the 1970s and early 1980s, a low inflation rate seemed to be incompatible with a low unemployment rate.
  • Demographics have changed – different age groups have different rates of unemployment.
why the target rate of unemployment changed37
Why the Target Rate of Unemployment Changed
  • Social and institutional structures have changed.
  • Governmental institutions also changed.
whose responsibility is unemployment
Whose Responsibility Is Unemployment?
  • Classical economists believe that individuals are responsible for their own jobs.
  • Keynesian economists tend to say that society owes people jobs commensurate with their training or past job experience.
how is unemployment measured
How Is Unemployment Measured?
  • The unemployment rate is published by the U.S. Department of Labor's Bureau of labor Statistics.
unemployment rate since 1900

30

20

10

0

1910

1920

1930

1940

1950

1960

1970

1980

1990

2000

2010

Unemployment Rate Since 1900

Target rate

McGraw-Hill/Irwin

© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

calculating the unemployment rate
Calculating the Unemployment Rate
  • The unemployment rate – the number of unemployed individuals divided by the number of people in the civilian labor force then multiplied by 100.
calculating the unemployment rate42
Calculating the Unemployment Rate
  • The labor force – those people in an economy who are willing and able to work.
  • The labor force excludes those incapable of working and those not looking for work.
unemployment employment figures in millions

Total civilian population (288.4 million)

Noninstitutional population (214.0 million)

Incapable of working (74.4 million)

Labor force (142.5 million)

Not in labor force (71.4 million)

Employed (134.3 million)

Unemployed (8.3 million)

Unemployment/Employment Figures (in millions)

McGraw-Hill/Irwin

© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

how accurate is the official unemployment rate
How Accurate Is the Official Unemployment Rate?
  • The unemployment rate does not include discouraged workers.
  • Discouraged workers –people who do not look for a job because they feel they do not have a chance of getting one.
how accurate is the official unemployment rate45
How Accurate Is the Official Unemployment Rate?
  • The unemployment rate counts as employed those who are underemployed.
  • Underemployed –part-time workers who would prefer full-time work.
how accurate is the official unemployment rate46
How Accurate Is the Official Unemployment Rate?
  • The unemployment rate includes as unemployed, people who say they are looking for a job who are really not.
  • Many are “working off the books, others are vacationing.
how accurate is the official unemployment rate47
How Accurate Is the Official Unemployment Rate?
  • The Bureau of Labor Statistics uses the labor force participation rate and the employment rate to gauge the state of the labor market.
how accurate is the official unemployment rate48
How Accurate Is the Official Unemployment Rate?
  • The labor force participation rate measures the labor force as a percentage of the total population at least 16 years old.
  • The employment rate measures the number of people who are working as a percentage of the labor force.
unemployment and potential output
Unemployment and Potential Output
  • The capacity utilization rate indicates how much capital is available for economic growth.
    • Capacity utilization rate – the rate at which factories and machines are operating compared to the maximum sustainable rate at which they could be used.
unemployment and potential output50
Unemployment and Potential Output
  • Potential output – output that would be achieved at the target rates of unemployment and of capacity utilization.
unemployment and potential output51
Unemployment and Potential Output
  • Okum's rule of thumb is used to determine the effect changes in the unemployment rate will have on income.
  • A one percent change in unemployment will cause output to change in the opposite direction by two percent.
microeconomic categories of unemployment
Microeconomic Categories of Unemployment
  • Microeconomic policies are sometimes used to supplement macroeconomic policies for dealing with unemployment.
microeconomic categories of unemployment53
Microeconomic Categories of Unemployment
  • The following categories of unemployment are analyzed by economists:
  • How people become unemployed.
  • Demographic unemployment.
  • Duration of unemployment.
  • Unemployment by industry.
unemployment by microeconomic subcategories 2002

Total unemployment rate

Total unemployment–8.3 million (5.8%)

Unemployment rate by sex

Male – 4.5 million (6.0%)

Female–3.7 million (5.6%)

Unemployment rate by age

20-24

1.0 million

(9.2%)

55 and over

0.8 million

(3.8%)

16-19

1.2 million

(15.4%)

25-54–4.8 million (4.7%)

Unemployment by Microeconomic Subcategories, 2002

McGraw-Hill/Irwin

© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

unemployment by microeconomic subcategories 200255

Unemployment rate by race*

White–6.1 million (5.1%)

Black–2.2 million (9.1%)

Duration of unemployment

More than 15 weeks

2.9 million

Less than 5 weeks–2.8 million

5-14 weeks – 2.5 million

Reason for unemployment

New

entrants

0.5 million

Job leavers

0.9 million

Job losers – 4.5 million

Re-entrants – 2.4 million

Unemployment by Microeconomic Subcategories, 2002

McGraw-Hill/Irwin

© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

inflation
Inflation
  • Inflation is a continual rise in the price level.
    • From 1800 until World War II, the U.S. inflation rate and price level fluctuated.
    • Since World War II, the rate fluctuated, but the movement of the price level has been consistently upward.
inflation since 1900

25

20

15

10

5

0

–5

–10

1900

10

20

30

40

50

60

70

80

90

2000

Inflation Since 1900

McGraw-Hill/Irwin

© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

measurement of inflation
Measurement of Inflation
  • Inflation is measured with changes in price indexes.
  • Price index – a number that summarizes what happens to a weighted composite of prices of a selection of goods over time.
creating a price index
Creating a Price Index
  • A price index is calculated by dividing the current price of a basket of goods by the price of the basket in a base year then multiplying by 100.
real world price indexes
Real-World Price Indexes
  • Real-world price indexes include the PPI, the CPI, and the GDP deflator.
the gdp deflator
The GDP Deflator
  • 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 GDP relative to a base year.
the gdp deflator63
The GDP Deflator
  • Another price index is the chain-type price index for GDP which uses a GDP deflator with a constantly moving base year.
the gdp deflator64
The GDP Deflator
  • The GDP deflator is the measure of inflation most economists favor since it includes the widest number of goods.
the consumer price index cpi
The Consumer Price Index (CPI)
  • The consumer price index (CPI) measures the prices of a fixed "basket" of consumer goods.
  • It is weighed according to each component's share of an average consumer's expenditures.
the consumer price index cpi66
The Consumer Price Index (CPI)
  • Many economists believe that the CPI as currently constituted, overstates inflation by one percentage point.
  • To avoid some of the problems of the CPI, some policymakers have been focusing on the personal consumption expenditure (PCE) deflator.
the consumer price index cpi67
The Consumer Price Index (CPI)
  • Personal consumption expenditure (PCE) deflator – a measure of prices of goods that consumers buy that allows yearly changes in the basket of goods that reflect actual consumer purchasing habits.
composition of cpi
Composition of CPI

Food and beverage (16.4%)

Housing (40.5%)

Apparel (4.2%)

Transportation (16.6%)

Other (5.0%)

Medical care (6.0%)

Recreation (5.9%)

Education and Communication (5.4%)

the producer price index ppi
The Producer Price Index (PPI)
  • The producer price index (PPI) is an index of prices that measures average change in selling prices received by domestic producers of goods and services over time.
  • It gives an early indication as to where inflation is headed.
real and nominal concepts
Real and Nominal Concepts
  • Nominal output is the total amount of goods and services measured at current prices.
  • Real output is the total amount of goods and services produced, adjusted for price level changes.
real and nominal concepts71
Real and Nominal Concepts
  • The “real” amount is the nominal amount divided by the price index.
  • It is the nominal amount adjusted for inflation.
expected and unexpected inflation
Expected and Unexpected Inflation
  • Expected and unexpected inflation affects behavior differently.
  • Expected inflation is inflation people expect to occur.
  • Unexpected inflation is inflation that surprises people.
expected and unexpected inflation73
Expected and Unexpected Inflation
  • Expectations of inflation play an important role in the inflation process.
  • Inflationary expectations can accelerate large inflation.
costs of inflation
Costs of Inflation
  • Inflation may not make a nation poorer.
  • It can redistribute income from those who do not raise their prices to those who do.
  • It can reduce the amount of information that prices are supposed to convey.
costs of inflation75
Costs of Inflation
  • Inflation is usually accepted by governments as long as it stays at a low level.
  • What worries policymakers is hyperinflation.
costs of inflation76
Costs of Inflation
  • Hyperinflation – exceptionally high levels of inflation of, say, 100 percent or more a year.
  • The U.S. has not experienced hyperinflation since the Civil War (1861-65).