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Economic Growth, Economic Growth, Business Cycles, Business Cycles,
Unemployment, and Unemployment, and InflationInflation
Chapter 6
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Laugher CurveLaugher Curve
An Indian-born economist once explained his personal theory of reincarnation to his graduate economics class.
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Laugher CurveLaugher 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.”
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IntroductionIntroduction
Macroeconomics is the study of the aggregate moods of the economy.
The four central problems are growth, business cycles, unemployment, and inflation.
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Two Frameworks: The Two Frameworks: The Long Run and the Short Long Run and the Short RunRun 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.
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GrowthGrowth
The primary measurement of growth is changes in real gross domestic product.
Real gross domestic product (real GDP) – the market value of goods and services stated in the prices of a given year.
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GrowthGrowth
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.
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Global Experience with Global Experience with GrowthGrowth 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.
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Global Experience with Global Experience with GrowthGrowth 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.
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The Benefits and Costs of The Benefits and Costs of GrowthGrowth Per capita economic growth allows
everyone in society, on average to have more.
Growth, or predictions of growth, allows governments to avoid hard questions.
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The Benefits and Costs of The Benefits and Costs of GrowthGrowth The costs of growth include pollution,
resource exhaustion, and destruction of natural habitat.
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Business CyclesBusiness Cycles
The business cycle is the upward and downward movement of economic activity that occurs around the growth trend.
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Business CyclesBusiness 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 CyclesU. S. Business Cycles
20
10
0
–10
–20
‘90‘801860 ‘70 1900 ‘10 ‘20 ‘30 ‘40 ‘50 ‘60 ‘70 ‘80 ‘90 ‘102000
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Civil War
Recoveryof 1895
World War I
Panicof 1893 Panic
of 1907Great
Depression
Korean War Vietnam War
World War II
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The Phases of the The Phases of the Business CycleBusiness 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.
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The Phases of the The Phases of the Business CycleBusiness Cycle A recession is a decline in output that
persists for more than two consecutive quarters in a year.
A depression is a large recession. A trough is the bottom of the recession or
depression.
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The Phases of the The Phases of the Business CycleBusiness Cycle An expansion is an upturn that lasts at
least two consecutive quarters of a year.
Expansion ExpansionRecession
The Phases of the The Phases of the Business CycleBusiness Cycle
Boom
Secular growth trend
DownturnUptu
rn
Trough
Peak
0Jan.-Mar
Tot
al O
utpu
t
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.
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Why Do Business Cycles Why Do Business Cycles OccurOccur Recessions and expansions are caused
primarily by demand-side of the economy. A debate exists about whether these
fluctuations can and should be reduced.
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Why Do Business Cycles Why Do Business Cycles OccurOccur Most economists believe that potential
depressions should be offset by economic policy.
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Why Do Business Cycles Why Do Business Cycles OccurOccur Since the late 1940s, compared to prior
years: 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.
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Why Do Business Cycles Why Do Business Cycles OccurOccur Most economists believe that business
fluctuations have become less severe because of the stronger role of government in the economy.
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Leading IndicatorsLeading Indicators
Leading indicators tell us what's likely to happen in the economy 12 to 15 months from now.
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Leading IndicatorsLeading Indicators
Leading indicators include the following: Average workweek for production
workers in manufacturing. Unemployment claims. New orders for consumer goods and
materials.
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Leading IndicatorsLeading 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.
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Leading IndicatorsLeading 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.
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UnemploymentUnemployment
The unemployment rate is the number of people who are willing and able to work but are not working.
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UnemploymentUnemployment
Cyclical unemployment is that which results from fluctuations in economic activity.
Structural unemployment is that caused by economic restructuring making some skills obsolete.
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Unemployment as a Unemployment as a Social ProblemSocial 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.
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Unemployment as Unemployment as Government’s ProblemGovernment’s Problem As capitalism evolved, capitalist societies
no longer saw the fear of hunger as an acceptable answer to unemployment.
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Unemployment as Unemployment as Government’s ProblemGovernment’s Problem Full employment – an economic climate
in which just about everyone who wants a job can have one.
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Unemployment as Unemployment as Government’s ProblemGovernment’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.
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Unemployment as Unemployment as Government’s ProblemGovernment’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.
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Unemployment as Unemployment as Government’s ProblemGovernment’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.
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Why the Target Rate of Why the Target Rate of Unemployment ChangedUnemployment 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.
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Why the Target Rate of Why the Target Rate of Unemployment ChangedUnemployment Changed Social and institutional structures have
changed. Governmental institutions also changed.
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Whose Responsibility Is Whose Responsibility Is Unemployment?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.
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How Is Unemployment How Is Unemployment Measured?Measured? The unemployment rate is published by the
U.S. Department of Labor's Bureau of labor Statistics.
Unemployment Rate Unemployment Rate Since 1900Since 1900
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30
20
10
01910 1920 1940 1950 1960 1980 1990 2000 201019701930
Target rate
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Calculating the Calculating the Unemployment RateUnemployment Rate The unemployment rate – the number of
unemployed individuals divided by the number of people in the civilian labor force then multiplied by 100.
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Calculating the Calculating the Unemployment RateUnemployment 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/Unemployment/Employment Figures (in Employment Figures (in millions)millions)
Total civilian population (288.4 million)
Noninstitutional population (214.0 million)
Labor force (142.5 million)
Employed (134.3 million)
Not in labor force (71.4 million)
Unemployed (8.3 million)
Incapable of working (74.4 million)
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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How Accurate Is the How Accurate Is the Official Unemployment Official Unemployment Rate?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.
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How Accurate Is the How Accurate Is the Official Unemployment Official Unemployment Rate?Rate? The unemployment rate counts as
employed those who are underemployed. Underemployed – part-time workers who
would prefer full-time work.
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How Accurate Is the How Accurate Is the Official Unemployment Official Unemployment Rate?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.
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How Accurate Is the How Accurate Is the Official Unemployment Official Unemployment Rate?Rate? The Bureau of Labor Statistics uses the
labor force participation rate and the employment rate to gauge the state of the labor market.
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How Accurate Is the How Accurate Is the Official Unemployment Official Unemployment Rate?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.
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Unemployment and Unemployment and Potential OutputPotential 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.
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Unemployment and Unemployment and Potential OutputPotential Output Potential output – output that would be
achieved at the target rates of unemployment and of capacity utilization.
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Unemployment and Unemployment and Potential OutputPotential 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.
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Microeconomic Microeconomic Categories of Categories of UnemploymentUnemployment Microeconomic policies are sometimes
used to supplement macroeconomic policies for dealing with unemployment.
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Microeconomic Microeconomic Categories of Categories of UnemploymentUnemployment The following categories of unemployment
are analyzed by economists: How people become unemployed. Demographic unemployment. Duration of unemployment. Unemployment by industry.
Unemployment by Unemployment by Microeconomic Microeconomic Subcategories, 2002Subcategories, 2002
16-191.2 million(15.4%)
20-241.0 million
(9.2%)
Male – 4.5 million (6.0%)
Unemployment rate by age
25-54 – 4.8 million (4.7%)55 and over0.8 million
(3.8%)
Female – 3.7 million (5.6%)
Unemployment rate by sex
Total unemployment – 8.3 million (5.8%)
Total unemployment rate
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Unemployment by Unemployment by Microeconomic Microeconomic Subcategories, 2002Subcategories, 2002
Job losers – 4.5 million
Less than 5 weeks – 2.8 million
White – 6.1 million (5.1%)
Duration of unemployment
Unemployment rate by race*
Black – 2.2 million (9.1%)
5-14 weeks – 2.5 million
Reason for unemployment
Job leavers0.9 million
Re-entrants – 2.4 million
More than 15 weeks2.9 million
Newentrants
0.5 million
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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InflationInflation
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 1900Inflation Since 1900
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3020101900 40 50 60 70 80 90 2000
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15
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Measurement of InflationMeasurement 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.
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Creating a Price IndexCreating 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.
100 X yearbase in basket of Price
yearcurrent in basket of Priceindex Price
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A Simple Year-to-Year A Simple Year-to-Year Market Basket Market Basket ComparisonComparison
125 100 X $540
$6752003 in index Price
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Real-World Price IndexesReal-World Price Indexes
Real-world price indexes include the PPI, the CPI, and the GDP deflator.
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The GDP DeflatorThe 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.
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The GDP DeflatorThe GDP Deflator
Another price index is the chain-type price index for GDP which uses a GDP deflator with a constantly moving base year.
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The GDP DeflatorThe GDP Deflator
The GDP deflator is the measure of inflation most economists favor since it includes the widest number of goods.
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The Consumer Price The Consumer Price Index (CPI)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.
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The Consumer Price The Consumer Price Index (CPI)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.
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The Consumer Price The Consumer Price Index (CPI)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.
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Composition of CPIComposition of CPI
Recreation (5.9%)
Food and beverage (16.4%)
Apparel (4.2%)
Transportation (16.6%)
Medical care (6.0%)
Housing (40.5%)
Other (5.0%)
Education and Communication (5.4%)
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The Producer Price Index The Producer Price Index (PPI)(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.
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Real and Nominal Real and Nominal ConceptsConcepts 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.
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Real and Nominal Real and Nominal ConceptsConcepts The “real” amount is the nominal amount
divided by the price index. It is the nominal amount adjusted for
inflation.
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Expected and Expected and Unexpected InflationUnexpected Inflation Expected and unexpected inflation affects
behavior differently. Expected inflation is inflation people
expect to occur. Unexpected inflation is inflation that
surprises people.
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Expected and Expected and Unexpected InflationUnexpected Inflation Expectations of inflation play an important
role in the inflation process. Inflationary expectations can accelerate
large inflation.
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Costs of InflationCosts 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.
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Costs of InflationCosts of Inflation
Inflation is usually accepted by governments as long as it stays at a low level.
What worries policymakers is hyperinflation.
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Costs of InflationCosts 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).