1 © ©1999 South-Western College Publishing PowerPoint Slides prepared by Ken Long Principles of Economics 2nd edition by Fred M Gottheil

2 Chapter 23 Fiscal Policy: Coping with Inflation and Unemployment 1/14/2016 © ©1999 South-Western College Publishing

3 This chapter discusses principles associated with Fiscal Policy Options The Balanced Budget Multiplier © ©1999 South-Western College Publishing The Tax Multiplier Recessionary and Inflationary Gaps Winners and Losers from Inflation The Natural Rate of Unemployment Discouraged and Underemployed Workers Frictional, Structural, and Cyclical Unemployment

4 What is the purpose of this chapter? To discuss why the economy can be in equilibrium and at the same time still be unable to provide full employment © ©1999 South-Western College Publishing

5 Who is unemployed? Anyone who is at least 16 years of age and is actively seeking employment © ©1999 South-Western College Publishing

6 Who makes up the Labor Force? All non-institutionalized people 16 years of age and older who are either working or actively looking for work © ©1999 South-Western College Publishing

7 What is the Unemployment rate? The number of unemployed people expressed as a percentage of the labor force © ©1999 South-Western College Publishing

8 How do we measure unemployment? The number of unemployed divided by the labor force © ©1999 South-Western College Publishing

9 Who measures unemployment? The Bureau of Labor Statistics surveys about 60,000 households each month © ©1999 South-Western College Publishing

10 For current data on unemployment: © ©1999 South-Western College Publishing

11 Who is a Discouraged Worker? A person who drops out of the work force because he cannot find a job © ©1999 South-Western College Publishing

12 Are Discouraged Workers counted in the labor force? No! People who have quit looking for work are not counted as part of the labor force © ©1999 South-Western College Publishing

13 What about part- time workers? Part time workers are counted as fully employed © ©1999 South-Western College Publishing

14 What about people who are over-qualified for their jobs? They are still considered fully employed © ©1999 South-Western College Publishing

15 Can the unemployment rate increase without anyone losing a job? If more people enter the work force than the number of new jobs generated, the unemployment rate increases © ©1999 South-Western College Publishing

16 Have more women entered the work force? Since the 1950’s there has been a large increase in the number of women in the work force © ©1999 South-Western College Publishing

17 What percentage of the work force today is female? Almost half

18 Is the unemployment rate valid? Yes! As long as we are consistent, we can get an accurate comparison from one time period to the next © ©1999 South-Western College Publishing

19 What is considered Full Employment? An employment level at which the actual rate of employment is equal to the natural rate of unemployment © ©1999 South-Western College Publishing

20 What is considered Full Employment? About 3.5% unemployment is considered full employment © ©1999 South-Western College Publishing

21 Why 3.5%? Because even in the best of times some people will always be looking for work © ©1999 South-Western College Publishing

22 Which people will be looking for work even in the best of times? Recent school grads Those seeking job advancement Victims of downsizing Those in weak fields/markets © ©1999 South-Western College Publishing

23 What was the unemployment rate during the worst of the Great Depression? In 1933, 25% of the labor force was unemployed © ©1999 South-Western College Publishing

24 What are different types of unemployment? Frictional Structural Cyclical Seasonal © ©1999 South-Western College Publishing

25 Will an increase in Aggregate Demand bring about more employment? That all depends It depends on where the aggregate demand curve is on the aggregate supply curve © ©1999 South-Western College Publishing

26 Aggregate Supply Curve S d1 d2 d3 d4 d5 P Q 26 d6 © ©1999 South-Western College Publishing

27 What is Inflation? The general upward movement in the average level of prices © ©1999 South-Western College Publishing

28 What is Deflation? The general decrease in the average level of prices © ©1999 South-Western College Publishing

29 What is the Consumer Price Index (CPI)? A measure of the cost of a fixed “market basket” of consumer goods and services © ©1999 South-Western College Publishing

30 Does the makeup of the CPI change? As people’s tastes and preferences change, what goes into the basket will change © ©1999 South-Western College Publishing

31 Who measures inflation? The Bureau of Labor Statistics © ©1999 South-Western College Publishing

32 For current data on inflation: © ©1999 South-Western College Publishing

33 Who loses from Inflation? Anyone living on a relatively fixed income © ©1999 South-Western College Publishing

34 Do Savers lose from inflation? If the inflation rate is greater than the interest rate they earn on their money, they lose © ©1999 South-Western College Publishing

35 Who gains from Inflation? Borrowers can gain if the inflation rate is greater than the interest they pay for the borrowed money © ©1999 South-Western College Publishing

36 What is a Recessionary Gap? The amount by which aggregate expenditure falls short of a full employment equilibrium © ©1999 South-Western College Publishing

37 The Recessionary Gap C 1 +I 1 +G 1 +(x-m) 1 45 o less than full employment C 2 +I 2 +G 2 +(x-m) 2 full employment 37 Aggregate Expenditure Real GDP (income) © ©1999 South-Western College Publishing

38 What is an Inflationary Gap? The amount by which aggregate expenditure exceeds the full employment equilibrium © ©1999 South-Western College Publishing

39 The Inflationary Gap C 1 +I 1 +G 1 +(x-m) 1 45 o full employment C 2 +I 2 +G 2 +(x-m) 2 new equilibrium 39 Aggregate Expenditure Real GDP (income) © ©1999 South-Western College Publishing

40 What is a Fiscal Policy? Government spending and taxation to achieve full employment without inflation © ©1999 South-Western College Publishing

41 What can we do about Recessionary & Inflationary Gaps? The government can intervene with Fiscal Policies to raise or lower aggregate expenditure © ©1999 South-Western College Publishing

42 Why are Fiscal Policies to stem a Recessionary Gap not problem free? Spending becomes permanent Can be disruptive It can be very expensive © ©1999 South-Western College Publishing

43 Why are Fiscal Policies to stem an Inflationary Gap not problem free? To cut government spending can be politically unpopular © ©1999 South-Western College Publishing

44 For information on government spending: /budget/index.html © ©1999 South-Western College Publishing

45 What is a Balanced Budget? Government spending equals tax revenues © ©1999 South-Western College Publishing

46 What is the Balanced Budget Multiplier? When the government increases spending by a dollar and increases taxes by a dollar, aggregate expenditure increases © ©1999 South-Western College Publishing

47 How does the Balanced Budget Multiplier work? When citizens have a dollar, they will save a part of it; when the government has a dollar, it spends all of it © ©1999 South-Western College Publishing

48 48 © ©1999 South-Western College Publishing Balanced Budget Multiplier MPC + - MPC 1 - MPC

49 What does the Balanced Budget Multiplier always equal? ONE © ©1999 South-Western College Publishing

50 What is a Budget Deficit? Government spending exceeds tax revenues © ©1999 South-Western College Publishing

51 What is a Budget Surplus? Tax revenues exceed government spending © ©1999 South-Western College Publishing

52 Who is unemployed? Who makes up the labor force? Can the unemployment rate increase without anyone losing a job?Can the unemployment rate increase without anyone losing a job? What is Full Employment? Which people will be looking for work even in the best of times?Which people will be looking for work even in the best of times? What is Inflation?

53 Who loses from Inflation? Who gains from Inflation? What is a Recessionary Gap? What is an Inflationary Gap? What is a Fiscal Policy? What is a Balanced Budget? What is the Balanced Budget Multiplier? What is a Budget Deficit? What is a Budget Surplus?

54 ENDEND © ©1999 South-Western College Publishing