CHAPTER 6Measuring GDP,
Inflation, and Economic Growth
CHAPTER 6Measuring GDP,
Inflation, and Economic Growth
Chapter 23 in EconomicsChapter 23 in EconomicsChapter 23 in EconomicsChapter 23 in Economics
TM 6-2Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving
• Explain why aggregate income, expenditure, and product are equal
• Explain how GDP is measured
TM 6-3Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how the Consumer Price Index (CPI) and GDP deflator are measured
• Explain how the shortcomings of the CPI and the GDP deflator as measures of inflation
TM 6-4Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how real GDP is measured
• Explain the shortcomings of real GDP growth as a measure of improvements in living standards
TM 6-5Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving
• Explain why aggregate income, expenditure, and product are equal
• Explain how GDP is measured
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Gross Domestic Product
• Gross domestic product (GDP) is the value of the aggregate production of goods and services in a country during a given time period.
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Gross Domestic Product
• Flows and Stocks
1) A flow is the quantities per unit of time.• GDP
2) A stock is a quantity that exists at a point in time
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Gross Domestic Product
• Flows and Stocks
• Capital is the key macroeconomic stock.
• Capital
• The plant, equipment, buildings, and inventories of raw materials and semifinished goods that are used to produce other goods and services.
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Gross Domestic Product
• Depreciation
• The decrease in the stock of capital that results from wear and tear and obsolescence.• Otherwise known as capital consumption
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Gross Domestic Product
• Gross Investment
• The total amount spent on adding to the stock of capital and on replacing depreciated capital
• Net Investment
• The amount spent on adding to the stock of capital• Gross Investment minus Depreciation
TM 6-11Copyright © 1998 Addison Wesley Longman, Inc.
Capital and Investment
0
1
2
3
4S
ewin
g m
ach
ines
Initialcapital
less depreciation
Initialcapital
TM 6-12Copyright © 1998 Addison Wesley Longman, Inc.
Capital and Investment
0
1
2
3
4S
ewin
g m
ach
ines
Initialcapital
Time
Jan. 1, 1997
Initialcapital
less depreciation
Initialcapital
TM 6-13Copyright © 1998 Addison Wesley Longman, Inc.
Capital and Investment
0
1
2
3
4S
ewin
g m
ach
ines
Initialcapital
Depreciation
Time
Jan. 1, 1997 During 1997
Initialcapital
less depreciation
Initialcapital
less depreciation
Initialcapital
TM 6-14Copyright © 1998 Addison Wesley Longman, Inc.
GrossInvestment
Capital and Investment
0
1
2
3
4S
ewin
g m
ach
ines
Initialcapital
Depreciation
Time
Jan. 1, 1997 During 1997
Initialcapital
less depreciation
Initialcapital
less depreciation
Initialcapital
TM 6-15Copyright © 1998 Addison Wesley Longman, Inc.
GrossInvestment
Capital and Investment
0
1
2
3
4S
ewin
g m
ach
ines
Initialcapital
Depreciation
Netinvestmentduring 1997
Time
Jan. 1, 1997 During 1997 Dec. 31, 1997
Initialcapital
less depreciation
Initialcapital
less depreciation
Initialcapital
TM 6-16Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving
• Explain why aggregate income, expenditure, and product are equal
• Explain how GDP is measured
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Gross Domestic Product
• Wealth is another macroeconomic stock
• Wealth
• The value of all the things that people own• Related to their earnings (a flow)
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Gross Domestic Product
• Consumption Expenditure
• The amount spent on consumption goods and services
• Saving
• The amount of an income after meeting consumption expenditures
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Gross Domestic Product
• Income, Expenditure, and the Value of Production
1) Households sell their labor, capital, land, and entrepreneurship to firms
2) Firms sell consumer goods and services
3) Firms buy and sell capital goods
4) Firms borrow to finance investment
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Gross Domestic Product
• Governments
• Government purchases are purchases of goods and services by governments• Paid for with tax revenue
• Net taxes are taxes paid to governments minus transfer payments received from governments and minus interest payments from the government on its debt.
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Gross Domestic Product
• Rest of World Sector
• Net exports is the value of exports minus the value of imports
• Gross Domestic Product
• Production can be valued by what:• Buyers pay for it
• It costs producers to make it
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The Circular Flow ofIncome and Expenditure
TM 6-23Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving
• Explain why aggregate income, expenditure, and product are equal
• Explain how GDP is measured
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Gross Domestic Product
• Expenditure Equals Income
Y = C + I + G + NX
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Gross Domestic Product
• How Investment is Financed
1) National saving is the amount of saving by households and businesses plus
government saving
National saving = S + (T – G)
2) Borrowing from the rest of the world
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Gross Domestic Product
• Measuring U.S. GDP
1) Expenditure Approach
2) Income Approach
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Gross Domestic Product
• Expenditure Approach
• Uses data on consumption expenditure, investment, government purchases, and net exports
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Gross Domestic Product
• Expenditure Approach
• Personal consumption expenditures are the expenditures by households on goods and services produced in the United States and the rest of the world
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Gross Domestic Product
• Expenditure Approach
• Gross domestic investment is expenditure on capital equipment and buildings by firms and expenditure on new homes by households. Also, it includes the change in inventories.
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Gross Domestic Product
• Expenditure Approach
• Government purchases of goods and services are the purchases of goods and services by all levels of government.• Does not include transfer payments
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Gross Domestic Product
• Expenditure Approach
• Net exports of goods and services are the value of exports minus the value of imports
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GDP: The Expenditure Approach
Personal consumptionexpenditures C 5, 152 68.0
Gross private domesticinvestment I 1,116 14.7
Government purchaseof goods and services G 1,407 18.6
Net exports of goodand services NX –99 – 1.3
Gross domestic
product Y 7,576 100.0
Amountin 1996(billions of Percentage
Item Symbol dollars of GDP
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Gross Domestic Product
• Expenditures Not in GDP
1) Intermediate goods and services
2) Used goods
3) Financial assets
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Gross Domestic Product
• Income Approach
• Measures GDP by summing the incomes that firms pay households for the resources they hire
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Gross Domestic Product
• Income Approach
• Compensation of employees is the payment for labor services• Includes net wages and salaries plus taxes withheld
on earnings plus fringe benefits such as social security and pension fund contributions
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Gross Domestic Product
• Income Approach
• Net interest is the interest households receive on loans they make minus the interest households pay on their own borrowing
• Rental income is the payment for the use of land and other rented inputs.
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Gross Domestic Product
• Income Approach
• Corporate profits are the profits of corporations.
• Proprietors’ income is a combination of all of these.
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Gross Domestic Product
• Net Domestic Income at Factor Cost
• The sum of the five categories of income
We must convert factor cost to market prices.
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Gross Domestic Product
• Income Approach
• Indirect taxes are taxes paid by consumers when they buy goods and services• Due to this additional cost, the market price is
greater than the factor cost value for measuring GDP.
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Gross Domestic Product
• Income Approach
• Subsidies are payments by the government to a producer.• Due to this payment, the factor cost is greater than the
market price for measuring GDP.
We must convert from Net Domestic Product to Gross Domestic Product.
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Gross Domestic Product
• Income Approach
• Net profit of businesses--profit after subtracting depreciation—is a component of aggregate incomes.
• To get gross domestic product, we must add depreciation to aggregate income.
TM 6-42Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how the Consumer Price Index (CPI) and GDP deflator are measured
• Explain how the shortcomings of the CPI and the GDP deflator as measures of inflation
TM 6-43Copyright © 1998 Addison Wesley Longman, Inc.
Aggregate Expenditure,Output, and Income
0
40
60
80
100P
erce
nta
ge o
f G
DP
20
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Aggregate Expenditure,Output, and Income
0
40
60
80
100P
erce
nta
ge o
f G
DP
Aggregateexpenditure
20
NX G
I
C
GDP
GDP
TM 6-45Copyright © 1998 Addison Wesley Longman, Inc.
Aggregate Expenditure,Output, and Income
0
40
60
80
100P
erce
nta
ge o
f G
DP
Aggregateexpenditure
20
NX G
I
C
TM 6-46Copyright © 1998 Addison Wesley Longman, Inc.
GDP: The Income Approach
Compensation ofemployees 4,449 58.7
Net Interest 405 5.4
Rental Income 127 1.7
Corporate Profits 650 8.6
Proprietors’ income 518 6.8Indirect taxesless subsidies 569 7.5
Capital consumption(depreciation) 858 11.3
Gross domestic 7,576 100.0product
Amount in 1996 Percentage
Item (billions of dollars of GDP
TM 6-47Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how the Consumer Price Index (CPI) and GDP deflator are measured
• Explain how the shortcomings of the CPI and the GDP deflator as measures of inflation
TM 6-48Copyright © 1998 Addison Wesley Longman, Inc.
Aggregate Expenditure,Output, and Income
0
40
60
80
100P
erce
nta
ge o
f G
DP
Aggregateexpenditure
20
NX G
I
C
GDP
GDP
Depreciation
Indirect taxesless subsidiesProprietor’sincomesInterestProfitsRent
Wages and otherlabor income
Aggregateincome
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Gross Domestic Product
• Valuing the Output of Industries
• Value added is the value of a firm's production minus the value of the intermediate goods that the firm buys from other firms.
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Value Added andFinal Expenditure
Value addedFarmer Farmer’s
value added
Final expenditure
Intermediate expenditure
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Value Added andFinal Expenditure
Value addedFarmer
Miller
Farmer’svalue added
Value of wheat
Miller’svalue added Final
expenditure
Intermediate expenditure
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Value Added andFinal Expenditure
Value addedFarmer
Miller
Baker
Farmer’svalue added
Value of wheat
Valueof flour
Miller’svalue added
Bakersvalue added
Final expenditure
Intermediate expenditure
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Value Added andFinal Expenditure
Value addedFarmer
Miller
Baker
Grocer
Farmer’svalue added
Value of wheat
Valueof flour
Wholesalevalue of bread
Miller’svalue added
Bakersvalue added
Grocer’s value added
Final expenditure
Intermediate expenditure
TM 6-54Copyright © 1998 Addison Wesley Longman, Inc.
Value Added andFinal Expenditure
Value addedFarmer
Miller
Baker
Grocer
Consumer
Farmer’svalue added
Value of wheat
Valueof flour
Wholesalevalue of bread
Retail value of bread;Final Expenditure on bread
Miller’svalue added
Bakersvalue added
Grocer’s value added
Final expenditure
Intermediate expenditure
TM 6-55Copyright © 1998 Addison Wesley Longman, Inc.
The Price Level and Inflation
• The inflation rate is the percentage change in the price level from one year to the next.
• Two Main Price Indexes
• Consumer Price Index
• GDP Deflator
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The Price Level and Inflation
• Consumer Price Index
• Measures the average level of prices of the goods and services that a typical urban family buys.
• Published monthly by the Bureau of Labor Statistics
• Must use a base period (1982-1984)
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The CPI: A Simplified Calculation
5 pounds of oranges$0.80/pound $4
6 haircuts $11.00 each $66
100 bus rides $1.40 each $140
Total expenditure $210
Base Period Current period
Base-period basket Price Expenditure Price Expenditure
TM 6-58Copyright © 1998 Addison Wesley Longman, Inc.
The CPI: A Simplified Calculation
5 pounds of oranges$0.80/pound $4 $1.20/pound $6
6 haircuts $11.00 each $66 $12.50 each $75
100 bus rides $1.40 each $140 $1.50 $150
Total expenditure $210 $231
Base Period Current period
Base-period basket Price Expenditure Price Expenditure
TM 6-59Copyright © 1998 Addison Wesley Longman, Inc.
The CPI: A Simplified Calculation
5 pounds of oranges$0.80/pound $4 $1.20/pound $6
6 haircuts $11.00 each $66 $12.50 each $75
100 bus rides $1.40 each $140 $1.50 $150
Total expenditure $210 $231
CPI $210.00$210.00
100 = 100$231.00$210.00
100 = 110
Base Period Current period
Base-period basket Price Expenditure Price Expenditure
TM 6-60Copyright © 1998 Addison Wesley Longman, Inc.
The Price Level and Inflation
• The GDP Deflator
• Measures the average level of prices of all the goods and services that are included in GDP
GDP deflator =Nominal GDP
Real GDP 100
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The Price Level and Inflation
• Nominal GDP is GDP valued in the current year’s prices.
• Real GDP is GDP in a base year (1992) scaled up by the growth rate of real GDP since the base year.
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The Price Level and Inflation
• The GDP Deflator can now be calculated.
GDP deflator = $146
$109.5 100 = 133.33
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The U.S. GDP Balloon
1996
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The U.S. GDP Balloon
GDPdeflator
1996
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The U.S. GDP Balloon
GDPdeflator
19961992
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The Biased CPI
• The sources of bias are:
1) New goods bias
2) Quality change bias
3) Commodity substitution bias
4) Outlet substitution bias
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The Biased CPI
• In 1996, a Congressional Advisory Commission on the CPI said the CPI overstates inflation by 1.1 percentage points.
• The GDP deflator uses price indexes to estimate quantities, so it too is somewhat biased.
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The Biased CPI
• The three primary consequences of the bias are:
1) It distorts private contracts
2) It increases government outlays
3) It biases estimates or real earnings
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Two Measures of Inflation
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CHAPTER 8Employment and Unemployment
CHAPTER 8Employment and Unemployment
Chapter 25 in EconomicsChapter 25 in EconomicsChapter 25 in EconomicsChapter 25 in Economics
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Employment and Wages
• Population Survey
• Every month, the U.S. Census Bureau surveys 60,000 households and asks a series of questions about the age and job market status of its members.
• Called the Current Population Survey
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Employment and Wages
• Population Survey
• The working age population is the total number of people aged 16 years an over who are not in a jail, hospital, or some other form of institutional care.
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Employment and Wages
• Population Survey
• The working age population is divided into those in the labor force and those not in the labor force.
• The labor force is divided into the employed and the unemployed.
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Employment and Wages
• To be counted as unemployed, a person must be available for work and must be in one of three categories:
1) Without work but has made specific efforts to find a job within the
previous four weeks
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Employment and Wages
• To be counted as unemployed, a person must be available for work and must be in one of three categories:
2) Waiting to be called back to a job from which he or she has been laid off
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Employment and Wages
• To be counted as unemployed, a person must be available for work and must be in one of three categories:
3) Waiting to start a new job within 30 days
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Population Labor Force Categories
0 90 180 270Population (millions)
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Population Labor Force Categories
0 90 180 270
Population
Population (millions)
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Population Labor Force Categories
0 90 180 270
Young andinstitution-
alized
Population
Working-age population
Population (millions)
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Population Labor Force Categories
0 90 180 270
Young andinstitution-
alized
Population
Working-age population
Population (millions)
Not in labor forceLabor force
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Population Labor Force Categories
0 90 180 270
Not in labor force
Young andinstitution-
alized
Population
Working-age population
Labor force
EmploymentUnemployment
Population (millions)
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Employment and Wages
• Three Labor Market Indicators
• The unemployment rate
• The labor force participation rate
• The employment-to-population ratio
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Employment and Wages
• The unemployment rate is the percentage of the people in the labor force who are unemployed.
Unemployment rate =
Number ofpeople unemployed
Labor force 100
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Employment and Wages
• The unemployment rate is the percentage of the people in the labor force who are unemployed.
Labor force = Number of people employed + Number of people unemployed
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Employment and Wages
• The labor force participation rate is the percentage of the working-age population who are members of the labor force.
Labor forceparticipation rate
=Labor force
Working age population 100
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Employment and Wages
• Discouraged Workers
• People who are available and willing to work but have made not made specific efforts to find a job within the previous four weeks.
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Employment and Wages
• The employment-to-population ratio is the percentage of people of working age who have jobs.
Employment-to-population ratio
=
Number of people employed
Working-agepopulation
100
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Employment, Unemployment, and the Labor Force: 1960–1996
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Unemployment andFull Employment
• People become unemployed if they:
1) Lose their jobs and search for another job.
2) Leave their jobs and search for another job.
3) Enter or reenter the labor force to search for a job.
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Unemployment andFull Employment
• Job losers are people who are laid off, either permanently or temporarily.
• Biggest source of unemployment
• Numbers fluctuate considerably
• Job leavers are people who voluntarily quit their jobs.
• Smallest and most stable source of unemployment
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Unemployment andFull Employment
• Entrants are people who are entering the labor force.
• Reentrants are people who have previously withdrawn from the labor force.
• Reentrants/entrants are a large component of the unemployed
• Numbers fluctuate mildly
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Unemployment by Demographic Group
0 20 30Unemployment rate
10 40
Business cycle peak
Business cycle trough
Black males 16-19
Black females 16-19
White males 16-19
White females 16-19
Black males 20 and over
Black females 20 and over
White males 20 and over
White females 20 and over
TM 6-93Copyright © 1998 Addison Wesley Longman, Inc.
Homework Solutions
Prices per unit Output
Production 1990 1998 1990 1998
Light Bulb $1 $2 20 25
Wine 3 4 40 50
Meat 6 8 50 65
Table I: Production Data
a. 1990 nominal GDP = $440 1998 nominal GDP = $770
b. Price index 1990 = 100 Price index for 1998 = 136.36
c. Inflation rate = 136.36 - 100 = 36.36%
d. Real GDP 1990 = 440/1.00 = $440 Real GDP 1998 = 770/1.36 = $566
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Unemployment andFull Employment
• There are three(four) types of unemployment:
1) Frictional
2) Structural
3) Cyclical
4) Seasonal
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Unemployment andFull Employment
• Frictional Unemployment
• Arises from normal labor turnover — people entering and leaving the labor force and the creation and destruction of jobs
• Influenced by unemployment benefits
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Unemployment andFull Employment
• Structural Unemployment
• Arises when changes in technology or international competition change the skills needed to perform jobs or change the locations of jobs
• Typically lasts longer than frictional
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Unemployment andFull Employment
• Cyclical Unemployment
• Arises from the fluctuations of the business cycle
• Increases during a recession and decreases during and expansion
• The natural rate of unemployment excludes cyclical unemployment
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Unemployment andFull Employment
• Full employment exists when the unemployment rate equals the natural rate of unemployment.
• It fluctuates periodically
• Economists disagree about the size of the natural rate and the extent to which it fluctuates
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Aggregate Supply
• Natural Rate of Unemployment
• The unemployment rate that exists at full employment
• In 1997 it was about 5.5%
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Aggregate Supply
• Potential GDP is the quantity of real GDP supplied when unemployment is at its natural rate and there is full employment.
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Types of Inflation-Demand Pull-
Price Level
Output (GDP)
AD1
AD2
AS
PL1
PL2
TM 6-102Copyright © 1998 Addison Wesley Longman, Inc.
Types of Inflation-Cost Push-
Price Level
Output (GDP)
AD
AS1
PL1
PL2
AS2
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