ECN 212 Chapter 19, Spring 2007

Introduction to Macroeconomics The Business Cycle 1 Two Key Features of GDP: It grows over time The long run trend in GDP is positive 2 Two Key Features of GDP: It grows over time The long run trend in GDP is positive It fluctuates as it grows GDP exhibits business cycle movements 3 Real GDP 1959 - 1994 1,500.0 2,000.0 2,500.0 3,000.0 3,500.0 4,000.0 4,500.0 5,000.0 5,500.0 1959 1963 1967 1971 1975 1979 1983 1987 1991 Year Real GDP Trend Line 1994 4 1,500.0 2,000.0 2,500.0 3,000.0 3,500.0 4,000.0 4,500.0 5,000.0 5,500.0 1959 1963 1967 1971 1975 1979 1983 1987 1991 Year Real GDP 1994 5 T F The following graph demonstrates the long-run trend in GDP. T Business Cycle Periodic movements in output, prices, and employment Business cycles are not created equal. Duration Severity 6 Recessions, Depressions, and Unemployment 7 Macroeconomic Problems Recessions A period in which real GDP declines for at least two consecutive quarters Depression: a prolonged and deep recession 8 Characteristics Declining real GDP Rising unemployment 9 Types of Unemployment Cyclical due to business cycle movements in GDP Frictional due to job search activities Structural due to changes in economic institutions geographic displacement, technological change, discrimination 10 CYCLICAL UNEMPLOYMENT DUE TO BUSINESS CYCLE, AD MIGHT FALL AS AD FALLS, THE DEMAND FOR LABOR FALLS AS THE DEMAND FOR LABOR FALLS, UNEMPLOYMENT RISES 11 FALL IN AGGREGATE DEMAND PL AS AD AD’ 0 Y2 Y1 GDP 12 RISE IN UNEMPLOYMENT EMPLOYMENT WAGE 0 DL SL E1 DL’ E2 13 FRICTIONAL UNEMPLOYMENT VOLUNTARY “BETWEEN JOB” WORKERS MOVING FROM LOW-PAY TO HIGH-PAY JOBS INCOME RISES DESIRABLE 14 STRUCTURAL UNEMPLOYMENT TECHNOLOGY DEMAND FOR LABOR FALLS 15 DEFINING FULL-EMPLOYMENT FRICTIONAL AND STRUCTURAL UNEMPLOYMENTS ARE UNAVOIDABLE 100% FULL-EMPLOYMENT IS IMPOSSIBLE A GIVEN UNEMPLOYMENT IS CONSIDERED TO BE FULL- EMPLOYMENT 16 Full employment does not mean ……. Unemployment. 0% 17 Economists regard frictional and ……………………. Unemployment unavoidable; hence “full employment” is defined as something ………….. than employment of 100% of the labor force structural less Defining Unemployment Labor Force = Employed + Unemployed Population = Labor Force + Not in Labor Force Unemployment Rate = Unemployed Labor Force 18 NOT IN LABOR FORCE NOT CAPABLE OF BEING EMPLOYED - UNDER 16 YEARS - ARMED FORCES - INSTITUTIONALIZED CAPABLE BUT NOT WILLING TO BE EMPLOYED - ADULTS IN SCHOOLS - RETIRED PEOPLE - NOT LOOKING FOR EMPLOYMENT 19 Unemployment Unemployment rate: the percentage of people in the labor force who can’t find a job Labor Force: people who are actively seeking or are currently holding a job Labor Force: people who are actively seeking or are currently holding a job 20 Unemployment Pool Entrants 7% Unemployment 1. Job Finders 2. Discouraged Workers 3. Labor Force Leavers 1. New Entrants 2. Re-entrants 3. Job Leavers 4. Job Losers 21 CRITICISMS PART-TIME EMPLOYMENT DISCOURAGED WORKERS FALSE INFORMATION 22 PART-TIME EMPLOYMENT SOME ARE EMPLOYED PART-TIME BECAUSE THEY DO NOT FIND FULL-TIME JOBS, BUT THEY ARE COUNTED AS EMPLOYED UNEMPLOYMENT RATE IS UNDERSTATED 23 EXAMPLE LABOR FORCE = 1,000 WORKERS DAILY WORKING TIME = 8 HOURS FULL-TIME WORKERS = 500 WORKERS HALF-TIME WORKERS = 300 WORKERS REQUIRED FULL-TIME JOB-HOURS = 1,000 x 8 = 8,000 HR TIME EMPLOYED = ( 500 x 8 ) + ( 300 x 4 ) = 5,200 HR TRUE UNEMPLOYMENT RATE = 8,000-5,200 = 35% 8,000 CALCULATED UNEMPLOYMENT RATE = 1,000-(500+300) = 20% < 35% 1,000 24 DISCOURAGED WORKERS SOME WORKERS SEEK EMPLOYMENT FOR A LONG PERIOD STOP SEEKING ARE COUNTED AS NOT IN LABOR FORCE UNEMPLOYMENT RATE UNDERSTATED 25 EXAMPLE LABOR FORCE = 800 WORKERS FULL-TIME WORKERS = 600 WORKERS DISCOURAGED WORKERS = 200 W. TRUE UNEMPLOYMENT RATE = 1,000-600 = 40% 1,000 CALCULATED UNEMPLOYMENT RATE = 800-600 = 25% < 40% 800 26 Which of the following will lead to a decrease in the unemployment rate? a. Discouraged workers drop out of the labor force. b. More women enter the labor force and seek jobs. c. Young people leave summer jobs and return to college. d. The practice of not counting military personnel as part of the labor force. The correct answer is “a” 27 FALSE INFORMATION PEOPLE NOT IN LABOR FORCE MIGHT CLAIM THEY ARE SEEKING FOR EMPLOYMENT TO GET UNEMPLOYMENT COMPENSATION UNEMPLOYMENT RATE OVERSTATED 28 EXAMPLE LABOR FORCE = 1,000 WORKERS FULL-TIME WORKERS = 600 WORKERS FALSE LABOR = 200 WORKERS TRUE UNEMPLOYMENT RATE = 800-600 = 25% 800 CALCULATED UNEMPLOYMENT RATE = 1,000-600 = 40% > 25% 1,000 29 Costs of Unemployment Personal costs Social costs Economic costs Why is 0% unemployment undesirable? Why is 0% unemployment undesirable? 30 SOCIAL COSTS OF UNEMPLOYMENT UNEMPLOYMENT IS A SOCIAL CATASTROPHE DEPRESSION MEANS IDLENESS IDLENESS MEANS LOSS OF SKILLS, SELF RESPECT, MORALE, FAMILY DISINTEGRATION AND SOCIOPOLITICAL UNREST 31 ECONOMIC COSTS OF UNEMPLOYMENT GNP GAP UNEQUAL BURDENS 32 GNP GAP WHEN THE ECONOMY FAILS TO GENERATE ENOUGH JOBS FOR ALL WHO ARE WILLING AND ABLE TO WORK, POTENTIAL PRODUCTION OF GOODS AND SERVICES IS LOST OKUN’S LAW: FOR EVERY 1% ABOVE NORMAL UNEMPLOYMENT RATE, THERE SHALL BE A 2.5% GNP GAP 33 EXAMPLE ASSUME THE FOLLOWING: FULL-EMPLOYMENT UNEMPLOYMENT RATE = 9% UNEMPLOYMENT RATE = 18% POTENTIAL OUTPUT = $5,000,000 ABOVE NORMAL UNEMPLOYMENT RATE = 18% - 9% = 9% GNP GAP = 9% x 2.5% = 22.5% GNP = 5,000,000 ( 1 - 0.225 ) = $3,875,000 34 EXPENDITURES 0 GNP ($MILLION) 45º LINE AD E 3.875 5 GNP GAP 35 a. If full employment output is $4 million, and equilibrium national output is $3 million, what shall be the GNP gap? GNP gap = 4 - 3 = $1 million b. What is the rate of GNP gap? Rate of GNP gap = 1/4 = 25% c. If the natural rate of unemployment is 9%, what is the actual unemployment rate in the economy? Above normal unemployment rate = 25 ÷ 2.5 = 10 Unemployment rate = 10 + 9 = 19% d. If the actual unemployment rate falls by 4% in the coming year, what shall be the rate of GNP gap? New unemployment rate = 19 - 4 = 15% Above normal unemployment rate = 15 - 9 = 6% Rate of GNP gap = 6 x 2.5 = 15% UNEQUAL BURDENS IF AS UNEMPLOYMENT RISES, WORKING HOURS OF ALL LABOR FALLS  EQUAL BURDEN BUT AS UNEMPLOYMENT RISES, GROUPS OF PEOPLE ARE ENTIRELY UNEMPLOYED  UNEQUAL BURDEN 38 EXAMPLE LABOR FORCE = 1,000 WORKERS DAILY WORKING TIME = 8 HOURS UNEMPLOYMENT RATE = 25% SHARING THE BURDEN OF UNEMPLOYMENT WOULD MEAN ALL 1,000 WORKERS HAD TO BE EMPLOYED 6 HOURS EACH BUT THE REAL LIFE PRACTICE IS NOT SO, RATHER 250 WORKERS WOULD BE 100% UNEMPLOYED, AND 750 WORKERS WOULD BE 100% EMPLOYED 39 Macroeconomic Problems Inflation 40 How Do We Measure the Price Level? GDP deflator: a measure of the prices of all goods produced CPI: Consumer Price Index: a measure of the price of a market basket of goods 41 The Price Level in Cicely In Cicely, three goods are produced: meat Coffee shoes A market basket is 2 meats, 5 Coffees, and 1 pair of shoes. 42 Production in Cicely Meat Coffee Shoes 1992 Price Quantity $4 20 $4 10 $20 15 What is the price level in Cicely? 43 1991 Price Quantity $3 10 $5 15 $7 20 CPI Multiply the price of the good by the quantity in the market basket and add over all goods. In 1991: $3(2) + $5(5) + $7(1) = $38 In 1992: $4(2) + $4(5) + $20(1) = $48 Rate of Inflation (48_-_38) = 26%. 38 44 GDP Deflator Nominal GDP: GDP measured in current year prices Real GDP: GDP measured in constant prices (prices derived from a base year) 45 T F GNP in constant dollars refers to the value of all goods and services produced in an economy per year deflated for price changes. The statement is TRUE. 46 GDP in Cicely Nominal GDP Real GDP GDP deflator 1991 $245 1992 $245 = $3(10) + $5(15) + $7(20) 47 GDP in Cicely Nominal GDP Real GDP GDP deflator 1991 $245 1992 $420 $420 = $4(20) + $4(10) + $20(15) 48 GDP in Cicely Nominal GDP Real GDP GDP deflator 1991 $245 $245 1992 $420 $245 = $3(10) + $5(15) + $7(20) 49 GDP in Cicely Nominal GDP Real GDP GDP deflator 1991 $245 $245 1992 $420 $215 $215 = $3(20) + $5(10) + $7(15) Note that we have used 1991 prices. 50 GDP in Cicely Nominal GDP Real GDP GDP deflator 1991 $245 $245 100 1992 $420 $215 100 = 100 * $245/$245 51 GDP in Cicely Nominal GDP Real GDP GDP deflator 1991 $245 $245 100 1992 $420 $215 195 195 = 100*$420/$215 52 GDP in Cicely Nominal GDP Real GDP GDP deflator 1991 $245 $245 100 1992 $420 $215 195 Rate of Inflation = (195 - 100)/100 = 95% 53 Real GDP = Nominal GDP Price Level/100 54 Inflation and Prices Price level: a measure of the behavior of all prices in the economy A tool for comparison of prices over time Inflation: the rate of change in the price level 55 If GNP increased from $80 billion in 1996 to $133.12 billion in 2000, a. Find the average annual increase. 56 Increase = 133.12 - 80 = $53.12 billion Average annual increase = 53.12 ÷ 4 = $13.28 billion If GNP increased from $80 billion in 1996 to $133.12 billion in 2000, Increase = 133.12 - 80 = $53.12 billion Average annual rate of increase = 66.4 ÷ 4 = 16.6% b. What was the annual rate of increase? 57 Rate of increase = 53.12 ÷ 80 = 66.4% Total increase in the price level = (1 + 0.07)4 - 1 = 31% c. Suppose that between 1996 and 2000 the average price level rose by 7% per year. Find the total increase in the price level along the four-year period. 58 d. What was the price index in 2000, assuming 1996 to be the base year? Price index = 1 + 0.31 = 1.31 e. What was the real GNP in 2000? Real GNP = 133.12 ÷ 1.31 = $101.62 If GNP increased from $80 billion in 1996 to $133.12 billion in 2000, RULE OF 70 PRICES DOUBLE IN ____________70_____________ YEARS ANNUAL RATE OF INFLATION EXAMPLE: IF THE ANNUAL RATE OF INFLATION IS 14%, THEN PRICES WILL DOUBLE IN 70 = 5 YEARS 14 59 TYPES OF INFLATION DEMAND PULL INFLATION COST PUSH INFLATION WAGE PUSH VARIANT PROFIT PUSH VARIANT COMMODITY VARIANT STRUCTURAL INFLATION 60