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Explorations in Economics

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Presentation on theme: "Explorations in Economics"— Presentation transcript:

1 Explorations in Economics
Alan B. Krueger & David A. Anderson

2 Chapter 14: Unemployment and Inflation
Module 41: Unemployment Module 42: Inflation Module 43: Unemployment, Inflation, and the Business Cycle

3 Business cycle = expansion and contraction of GDP
Summary Business cycle = expansion and contraction of GDP Recessions and depressions increase unemployment. Changes in aggregate supply and demand create cycles. Think ripples of water in a pond. External shocks include changes in technology, government taxes and spending, financial crises, natural resource discoveries, and consumer expectations. 4/17/2017 Chapter 13-Mods 38-40

Inflation is an increase in the price level. It results in a decrease in the value of money. OBJECTIVES: Define inflation To explain how inflation is measured. To explain what causes inflation and why high inflation is a problem. To identify the dangers of deflation. Recall that the price level is the broad measure of the prices for goods and services in the economy, not the measure of just one price like gasoline.

5 DEFINING INFLATION Inflation is a rise in the price level. The inflation rate is the annual percentage increase in the price level. Deflation is a decline in the price level.

6 Measuring Inflation – Basket Concept
To measure changes in the price level, economists look at the cost of a “basket” of goods and services. The consumer price index looks at: Housing Transportation Food Medical Care Education Recreation Which one do you think is the largest? Smallest? 4/17/2017 Chapter 14-Modules 41-43

7 MEASURING INFLATION The Consumer Price Index (CPI) is a measure of the overall price level faced by a typical consumer. After explaining the CPI ask students if this works for a cost of living index. Then research how social security recipients receive their cost of living adjustment. Look at for a list of the products in the CPI. This is always an interesting discussion

8 MEASURING INFLATION A market basket is a bundle of goods and services that an average consumer might buy. Calculating the CPI: Try to explain the process of collecting the prices of the market basket items. Explain that the prices are compared to a base year, currently the prices from the same market basket in Depending on your curriculum, calculating the CPI may take the students a lot of practice.

9 Measuring Price Changes of a Basket
Consumer Good Quantity 2013 Price Cost of Basket Milk 10 $ 2.50 $25 Shoes 1 $75.00 $75 Gasoline 100 $ 3.50 $350 Total Basket Cost $ 450 4/17/2017 Chapter 14-Modules 41-43

10 Measuring Price Changes of a Basket
Consumer Good Quantity 2014 Price Cost of Basket Milk 10 $ 3.00 $ 30 Shoes 1 $75.00 $ 75 Gasoline 100 $ 3.95 $395 Total Basket Cost $ 500 4/17/2017 Chapter 14-Modules 41-43

11 Calculating Inflation
2014 Basket Cost – 2013 Cost x Basket Cost $500 - $450 x 100 = 11.1% $450 Try this method using the worksheet. 4/17/2017 Chapter 14-Modules 41-43

12 What are the limitations to the way inflation is calculated?
Challenge Question What are the limitations to the way inflation is calculated? 4/17/2017 Chapter 14-Modules 41-43

13 Do Now – Inflation Experiment
Why did prices increase? What would happened to prices if the auctioneer had increased the lollipops every time the number of clips increased? What conclusions can you draw about the reasons behind inflation? 4/17/2017 Chapter 14-Modules 41-43

14 Money supply is increasing faster than real economic growth.
Reasons for Inflation Money supply is increasing faster than real economic growth. And, usually the economy is near capacity – that is labor, capital and natural resources are fully utilized. Typically happens near peak of an economic cycle. 4/17/2017 Chapter 14-Modules 41-43

15 U.S. Inflation History 4/17/2017 Chapter 14-Modules 41-43

16 Inflation Winners and Losers
History of inflation - YouTube In your notes, take a page and split between winners and losers. As you listen to the video, note who gains and who loses with inflation. 4/17/2017 Chapter 14-Modules 41-43

17 THE COSTS OF INFLATION The Inflation Myth
Price Stability exists when inflation is low—2 or 3% per year. Inflation reduces the number of goods and services we can buy with each dollar that we earn. In what years was inflation a real problem? In what years, was the goal of price stability achieved? The overall effect of inflation on your purchasing power depends on how the increase in your earnings compares with the increase in the price level.

18 THE COSTS OF INFLATION The True Costs of High Inflation
Hyperinflation is very rapid inflation. Hyperinflation usually leaves a country’s currency worthless. Be sure that students read and discuss Economics in Action, Hyperinflation in Germany and Zimbabwe found on page 506 in textbook. The story of how Brazil transitioned to their current currency is an interesting story to explain the shoe leather costs before the change in currency. Here is a link to help:

19 THE COSTS OF INFLATION The True Costs of High Inflation
The Costs of Unexpected Inflation In general, people who borrow money benefit when inflation turns out to be higher than expected. But people who lend money lose from higher- than expected inflation. Unexpected inflation makes borrowing and lending more risky. Lenders may be hesitant to lend and borrowers may not wish to borrow. Stress that the result of unexpected inflation is that it takes away the stability in the economy. When saving, borrowing and lending shuts down, spending declines and GDP falls. Unemployment increases and a contraction of the economy can easily become a severe recession. Give some examples of borrowers and lenders and how they are impacted by unanticipated inflation. Mary and Joe Jones just signed a 30 year mortgage for their new home? Fred and Frances Smith put %10,000 in a 4 year CD paying 3% interest? The Franklin Company borrowed $1M at 4% interest from the bank to build their new production facility?

20 Inflation = sustained increase in the price level. Inflation winners
Summary Inflation = sustained increase in the price level. Inflation winners People who own physical assets. People who owe money. Inflation losers People who own money. People who loan money (unless loan tied to inflation). Most workers. 4/17/2017 Chapter 14-Modules 41-43

Deflation is a decrease in the price level. Causes consumers to reduce spending Postpone major purchases Decrease in Aggregate Demand, contraction in economic activity Dollar incomes also fall More difficult to pay debts that do not change Banks’ losses mount as more bankruptcies occur Economic activity becomes risky and spending decreases Show examples of the early 1930’s in the USA and how deflation is correlated with an economic contraction. The United States suffered a serious bout of deflation during the recession of the early 1920s, but the worst deflation occurred during the early years of the Great Depression, when average prices dropped 9 percent in 1931, 9.9 percent in 1932, and 5.1 percent in Deflation during this period led to waves of bankruptcies throughout the economy, a reduction of lending and borrowing, and a decrease in spending. In short, deflation worsened the depression and made it last longer.

22 Deflation = sustained decrease in the price level. Deflation winners
Summary Deflation = sustained decrease in the price level. Deflation winners People who own money. People who loan money to others. Deflation losers People who own physical assets. People who borrow money (unless loan tied to inflation). 4/17/2017 Chapter 14-Modules 41-43

23 MODULE 42 REVIEW What is… A. Inflation? B. Inflation rate?
C. Deflation? D. Consumer price index? E. Market basket? F. Base period? G. Producer price index? H. Hyperinflation? I. Shoe leather costs? J. Menu costs?

High unemployment is costly to the economy. OBJECTIVES To explain how unemployment is measured. To explore the types of unemployment and what causes each type. To identify the economic costs of unemployment.

Total employment in an economy is the total number of employed workers, whether they work part time or full time. The labor force is the combination of the employed workers and the unemployed workers, excluding those in the military or in prison. Total unemployment in an economy is the number of workers who are actively seeking jobs but not actually working. Using the pie chart, ask the students what color represents the people not looking for work and not employed. What are the reasons they are not looking or not employed? Where are kids under 16 in this pie chart?

The unemployment rate is the percentage of the labor force without a paid job. Issues in Measuring Unemployment Discouraged workers would like to work but have given up on their job search. Underemployed workers would like to work more hours or prefer a job that better matches their skills. Some unemployed hide their status since they are trying to avoid paying income tax. How are the figures for unemployed collected? Discuss with the class why underemployment and discouraged workers are an issue.

Frictional unemployment is short-term unemployment that occurs while workers search for the jobs best suited for their skills and interests. Seasonal unemployment occurs when workers lose their jobs due to a change of seasons. Seasonal Adjustment The Bureau of Labor Statistics remove the typical and predictable changes in unemployment from each month’s unemployment numbers. Frictional Unemployment is sometimes referred to as the normal process of turnover in the labor market as new workers enter the market and search while existing workers quit one job to look for another. Who are included in the frictional unemployed category? New graduates? Leaving a job and wanting a new one? New mothers staying with their newborns? Those who have refused a job offer for monetary reasons? Those reentrants who have come back after an sick leave or children grown? In what industries would we likely find seasonal unemployment? Give the students some examples of some unemployed people and have them sort them by unemployed category.

Structural unemployment arises from a mismatch between job seekers and the types of jobs available. Cyclical unemployment is joblessness caused by an economic contraction. The natural rate of unemployment is the unemployment rate in the absence of cyclical unemployment, around which the actual unemployment rate fluctuates. Structural unemployment is a result of the imperfect labor market adjustment. Overtime, changes in demand and in technology skills will displace workers, while some workers be unwilling or unable to move freely around to keep or find a job. Cyclical unemployment is termed, “deficient-demand” unemployment. In some recovery periods after a contraction, jobs do not recover as fast as in the past. We have a jobless recovery which is a difficult problem to solve. Most economists feel that a 4-5% unemployment rate is the natural rare of unemployment. Ask them to research the current unemployment rate at and find the current cyclical rate of unemployment.

Full employment is the level of employment when there is no cyclical unemployment. Due to the existence of other types of unemployment, the achievement of full employment does not mean that every worker is employed. Have the students identify how cyclical unemployment changed during all the recessions shown above. Point out the jobless recovery of the recession of

Unemployment will affect families in financial and personal ways. Some purchases are delayed, savings are depleted or homelessness may happen. Family issues arise that include difficulty in school, family separation, abuse or crime. Unemployment is costly to the national economy Total output will be reduced. Government must pay more for unemployment insurance, and nutrition assistance. Lower income tax revenues collected. Discuss how unemployment is related to an increase in underground economy including crime.

31 How The Costs Of Unemployment Are Distributed
Not an equal distribution among groups or locations within the nation Work Experience Lack of Opportunity Discrimination Location by state Lead a discussion or activity on how discrimination makes the labor force inefficient.

32 MODULE 41 REVIEW What is… A. Total employment B. Total unemployment
C. Labor force D. Unemployment rate E. Frictional unemployment F. Seasonal unemployment G. Structural unemployment H. Cyclical unemployment I. Natural rate of unemployment J. Full employment K. Discouraged workers L. Underemployed M. Jobless recovery

KEY IDEA: Changes in unemployment and inflation are caused by changes in aggregate demand and aggregate supply. OBJECTIVES: To explain how changes in aggregate demand and aggregate supply affect both unemployment and inflation. To discuss the short- run tradeoff between unemployment and inflation. To describe stagflation.

The “norm” in the economy may be some level of unemployment and some degree of inflation. Some levels of frictional and structural unemployment are part of a dynamic labor market. As wages increase and prices increase to cover higher costs, the expected inflation becomes a reality. Wages are sticky but will eventually catch prices as labor loses purchasing power due to inflation.

The economy’s potential output is the level of real GDP that is produced when there is full employment. Note that potential output exists when the economy is at the natural rate of unemployment (no cyclical unemployment). When AD increases, economists refer to that type of inflation as demand-pull inflation. Price level increases as Real GDP grows larger. Unemployment falls.

The economy’s potential output is the level of real GDP that is produced when there is full employment. As spending declines, the aggregate demand decreases. Price level decreases as Real GDP falls. Unemployment increases. Prolonged deflation causes wages to decrease. Look at references to Japan and deflation for a modern day example.

Stagflation is a combination of sluggish economic growth, high inflation, and high unemployment. A negative supply shock causes aggregate supply to decrease. costs rise and output falls unemployment increases but price levels increase A positive supply shock causes aggregate supply to increase. costs fall and output increases unemployment decreases and price levels decrease Negative supply shocks cause a decrease in SRAS and are usually caused by commodity prices increasing, wages increasing, and/or productivity falling. Think OPEC action in the 1970’s causes stagflation. Positive supply shocks cause an increase in SRAS and are usually caused by an innovation that raises productivity. Think about the introduction of the Internet to the workplace and how it fostered a new way of doing business—e-commerce.

38 MODULE 43 REVIEW What is… A. Potential output B. Stagflation
C. Negative supply shock D. Positive supply shock

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