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Maclachlan, Macroeconomics, 9/20/04
1
Principles and Policies I: Macroeconomics
Chapter 6:Economic Growth, Business Cycles, Unemployment, and
Inflation
Maclachlan, Macroeconomics, 9/20/04
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Chapter Six Learning ObjectivesYou should be able to:
• Explain the difference between the short-run and the long-run.
• Summarize some relevant statistics about growth, business cycles, unemployment, and inflation.
• List the four phases of the business cycle.• Explain how unemployment is measured and state the
microeconomic categories of unemployment.• Relate the target rate of unemployment to potential
income.• Define inflation and distinguish a real concept from a
nominal concept.• State two important costs of inflation.
Maclachlan, Macroeconomics, 9/20/04
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Macroeconomics is the study of the aggregate moods of the economy.
First major macroeconomist:
John Maynard KeynesThe General Theory of
Employment, Interest and Money (1936)
Maclachlan, Macroeconomics, 9/20/04
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Four Topics
1. Business Cycles
2. Growth
3. Unemployment
4. Inflation
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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.
Maclachlan, Macroeconomics, 9/20/04
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In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm
is long past the ocean is flat again.--John Maynard Keynes
Maclachlan, Macroeconomics, 9/20/04
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Expansion ExpansionRecession
The Phases of the Business Cycle
Boom
Secular growth trend
DownturnUpturn
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.
Maclachlan, Macroeconomics, 9/20/04
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U. S. Business Cycles
20
10
0
–10
–20
‘90‘801860 ‘70 1900 ‘10 ‘20 ‘30 ‘40 ‘50 ‘60 ‘70 ‘80 ‘90 ‘102000
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Civil War
Recoveryof 1895
World War I
Panicof 1893 Panic
of 1907Great
Depression
Korean War Vietnam War
World War II
Maclachlan, Macroeconomics, 9/20/04
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Growth
Real output growth in the U.S. has been 2.5 to 3.5 percent per year since the late 19th century.
Per capita real output is real GDP divided by the total population.
What was the rate of growth of per capita real output since the late19th century?
Maclachlan, Macroeconomics, 9/20/04
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Unemployment
• 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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• 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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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.
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Unemployment/Employment Figures (in 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.
Maclachlan, Macroeconomics, 9/20/04
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Unemployment Rate Since 1900
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
30
20
10
01910 1920 1940 1950 1960 1980 1990 2000 201019701930
Target rate
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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.
• But does not include discouraged workers who have left the labor force.
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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.
– If unemployment rises from 5% to 6% then GDP ____ from $10 trillion to $____trillion.
Maclachlan, Macroeconomics, 9/20/04
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Inflation Since 1900
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
3020101900 40 50 60 70 80 90 2000
–10
–5
0
5
10
15
20
25
Maclachlan, Macroeconomics, 9/20/04
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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.
100 X yearbase in basket of Price
yearcurrent in basket of Priceindex Price
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A Simple Year-to-Year Market Basket Comparison
125 100 X $540
$6752003 in index Price
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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.
Maclachlan, Macroeconomics, 9/20/04
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Composition 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%)
Maclachlan, Macroeconomics, 9/20/04
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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.
Maclachlan, Macroeconomics, 9/20/04
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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.
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Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become 'profiteers,' who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery. ---J.M. Keynes, 1919
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Hyperinflation
Money as fuel.
Germany, 1923-24.
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Prob. 6-1
Total labor force:
142, 542,000
Working age adults:
214,967,000
Unemployed:
8,590,000
a) Labor force participation
= 66.31%
b) Unemployment rate
= 6.03%
c) Employment rate
= 93.97%
Maclachlan, Macroeconomics, 9/20/04
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Prob. 6-2
a) 2002 $64
2003 $68
2002 base year.
b) Nominal output $300 billion. Price index 115.
c) Inflation 5%, real output rises by 2%.
d) Real output rose by 3%, nominal output rose by 7%. Inflation?
a) 106.25
b) 260.9
c) 7%
d) 4%
Maclachlan, Macroeconomics, 9/20/04
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Prob. 6.5
Nominal output
2005 $12.5 billion
2006 $13 billion
GDP deflator
2005 100
2006 105
a) Nominal output increases by
4%.
b) Price index increases by 5%.
c) Real output from $12.5 to $12.38. Decreased by $.12 billion or $120 million.
d) –0.96%
e) 4%