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 2 Chapter Six Learning Objectives You 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 3 Macroeconomics is the study of the aggregate moods of the economy. First major macroeconomist: John Maynard Keynes The General Theory of Employment, Interest and Money (1936)

Maclachlan, Macroeconomics, 9/20/04 4 Four Topics 1.Business Cycles 2.Growth 3.Unemployment 4.Inflation

Maclachlan, Macroeconomics, 9/20/04 5 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 6 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 7 Expansion Recession The Phases of the Business Cycle Boom Secular growth trend Downturn Upturn Trough Peak 0 Jan.- Mar Total Output 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 8 U. S. Business Cycles McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Civil War Recovery of 1895 World War I Panic of 1893 Panic of 1907 Great Depression Korean War Vietnam War World War II

Maclachlan, Macroeconomics, 9/20/04 9 Growth Real output growth in the U.S. has been 2.5 to 3.5 percent per year since the late 19 th 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 10 Unemployment Cyclical unemployment is that which results from fluctuations in economic activity. Structural unemployment is that caused by economic restructuring making some skills obsolete.

Maclachlan, Macroeconomics, 9/20/04 11 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.

Maclachlan, Macroeconomics, 9/20/04 12 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.

Maclachlan, Macroeconomics, 9/20/04 13 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 14 Unemployment Rate Since 1900 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved Target rate

Maclachlan, Macroeconomics, 9/20/04 15 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.

Maclachlan, Macroeconomics, 9/20/04 16 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 17 Inflation Since 1900 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved –10 –

Maclachlan, Macroeconomics, 9/20/04 18 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.

Maclachlan, Macroeconomics, 9/20/04 19 A Simple Year-to-Year Market Basket Comparison

Maclachlan, Macroeconomics, 9/20/04 20 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 21 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 22 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 23 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.

Maclachlan, Macroeconomics, 9/20/04 24 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

Maclachlan, Macroeconomics, 9/20/04 25 Hyperinflation Money as fuel. Germany,

Maclachlan, Macroeconomics, 9/20/04 26 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 27 Prob. 6-2 a)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) b)260.9 c)7% d)4%

Maclachlan, Macroeconomics, 9/20/04 28 Prob. 6.5 Nominal output 2005 $12.5 billion 2006 $13 billion GDP deflator a) Nominal output increases by 4%. b) Price index increases by 5%. c) Real output from $12.5 to $ Decreased by $.12 billion or $120 million. d) –0.96% e) 4%