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 “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.”
Central Problems of Macroeconomics • Macroeconomics is the study of the aggregate moods of the economy. • The four central problems are growth, business cycles, unemployment, and inflation.
Two Timeframes: The Long Run and the Short Run • Issues of growth are considered in a long-run framework. • Long-run growth focuses on supply. • Supply is so important in the long run, policies that affect production such as incentives that promote work, capital, and technological change are key.
Two Timeframes: The Long Run and the Short Run • Business cycles are generally considered in a short-run framework. • The short-run fluctuation framework focuses on demand. • Much of the policy discussion of short-run fluctuations focuses on ways to increase or decrease components of aggregate expenditures.
Growth • Generally the U.S. economy is growing or expanding.
Growth • The primary measurement of growth is changes in real gross domestic product (GDP). • Real gross domestic product (GDP) – the market value of goods and services stated in the prices of a given year.
Growth • Since 1890, U.S. economic output has grown at an annual rate of 2.5 to 3.5 per annum. • This is called the secular growth rate.
Growth • Another measure of growth is changes in per capita real output. • Per capita real output is real GDP divided by the total population.
Global Experience with Growth • Global experiences with growth vary across time and among nations. • Today's growth rates are high by historical standards. • The range of growth rates among nations is wide.
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. • A growing economy creates jobs, to the joy of politicians.
The Benefits and Costs of Growth • The costs of growth include pollution, resource exhaustion, and destruction of natural habitat. • Since many believe the environmental costs of growth are important, the result is often an environmental-economic growth stalemate.
Business Cycles • There are numerous fluctuations around the secular growth trend called the business cycle. • The business cycle is the upward and downward movement of economic activity that occurs around the growth trend.
Business Cycles • There are a number of theories regarding business cycles. • Classicals generally favor laissez-faire or noninterventionist policies. • Keynesians generally favor activist policies.
20 10 0 Percentage Fluctuations in Real GDP –10 –20 1860 65 70 75 80 85 90 95 1900 05 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 2000 U. S. Business Cycles World War I World War II Recovery of 1895 Civil War Korean War Vietnam War Panic of 1893 Panic of 1907 Great Depression
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 Cycle • A recession is a decline in output that persists for more than two consecutive quarters in a year. • A depressionis a large recession. • The bottom of the recession or depression is called the trough.
The Phases of the Business Cycle • As total output starts to expand, the economy comes out of the trough into an upturn, which may turn into an expansion. • An expansion is an upturn that lasts at least two consecutive quarters of a year.
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
Recessions and expansions are caused primarily by demand-side shocks. A debate exists about whether these fluctuations can and should be reduced. Why Do Business Cycles Occur
Most economists believe that potential depressions should be offset by economic policy. Why Do Business Cycles Occur • This general view was built into economics in the Great Depression of the 1930s.
During this period there were changes in the economy's structure, with government playing a much more active role. Why Do Business Cycles Occur
Since the late 1940s, business cycles' duration has increased, while the average length of expansions has increased while the average length of contractions has decreased. Why Do Business Cycles Occur
One reasons the severity of business fluctuations has been reduced is that changes in institution's structure were made as a result of the Great Depression. Why Do Business Cycles Occur
Leading Indicators • Leading indicators are those that tell us what's likely to happen in the economy 12 to 15 months from now.
Leading Indicators • Leading indicators include the following: • Average workweek for production workers in manufacturing. • Unemployment claims. • New orders for consumer goods and materials.
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 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.
Leading Indicators • The drudge work of sifting through statistical series is the backbone of business economists' work
Unemployment • Business cycles and growth are directly related to unemployment in the U.S. economy. • Unemployment occurs when people are looking for a job and cannot find one.
Unemployment • The unemployment rate is the number of people who cannot find a job as a percent of those people in the economy who are willing and able to work.
Unemployment • Cyclical unemployment is that which results from fluctuations in economic activity. • It did not exist in pre-industrial society.
Unemployment • Structural unemployment is that caused by economic restructuring making some skills obsolete. • It existed in pre-industrial society.
Unemployment as a Social Problem • The Industrial Revolution was accompanied by a change in how families dealt with unemployment. • What had previously been a family problem, became a social problem. • The Industrial Revolution created the possibility of cyclical unemployment.
Unemployment as a Social Problem • The Industrial Revolution was accompanied by a change in how families dealt with unemployment. • What had previously been a family problem, now became a social problem.
Unemployment as a Social Problem • The early solution for unemployment -- hunger -- was not an effective answer to unemployment.
Unemployment as Government’s Problem • Government took responsibility for full employment in the Employment Act of 1946. • Full employment – an economic climate in which just about everyone who wants a job can have one.
Unemployment as Government’s Problem • Initially government regarded 2 percent unemployment as a condition of full employment. • The 2 percent was made up of frictional unemployment.
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 Problem • The target rate of unemployment (sometimes called the natural rate of unemployment) is the lowest sustainable rate of unemployment that policymakers believe is achievable under existing conditions.
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 was about 5 percent.
Why the Target Rate of Unemployment Changed • The target rate of unemployment has changed over time for the following reasons: • In the 1970s and early 1980s, a low inflation rate seemed to be incompatible with a low unemployment rate.
Why the Target Rate of Unemployment Changed • The target rate of unemployment has changed over time for the following reasons: • Demographics have changed – different age groups have different rates of unemployment.
Why the Target Rate of Unemployment Changed • The target rate of unemployment has changed over time for the following reasons: • Social and institutional structures have changed. • Governmental institutions also changed.
Whose Responsibility Is Unemployment? • The Classicals believe that individuals are responsible for their own employment.
Whose Responsibility Is Unemployment? • Keynesian economists tend to say that society owes a person a job commensurate with the individual's training or past job experience.
How Is Unemployment Measured? • The unemployment rate is published by the U.S. Department of Labor's Bureau of labor Statistics.
30 20 Percentage of labor force unemployed Target rate Average unemployment 10 0 1920 1940 1960 1980 2000 Unemployment Rate Since 1900
Calculating the Unemployment Rate • The unemployment rate is calculated by dividing the number of unemployed individuals by the number of people in the civilian labor force and multiplying by 100.