Economic Growth, Business Cycles, Unemployment, and Inflation

Economic Growth, Business Cycles, Unemployment, and Inflation Chapter 6

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Central Problems of Macroeconomics Macroeconomics is the study of the aggregate moods of the economy.  The four central issues of macroeconomics are growth, business cycles, unemployment, and inflation. 

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Two Timeframes: The Long Run and the Short Run 

Issues of growth are considered in a long-run framework.  Long-run

growth focuses on supply (also called supply-side economics).  Supply is so important in the long run, policies that affect production - such as incentives that promote work, capital, and technological change - are key.

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Two Timeframes: The Long Run and the Short Run 

Business cycles are generally considered in a short-run framework.  The

short-run fluctuation framework focuses on demand.  Much of the policy discussion of short-run fluctuations focuses on ways to increase or decrease components of aggregate expenditures.

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Growth Generally the Canadian economy is growing or expanding.  The primary measurement of growth is change in real gross domestic product (GDP). 

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Growth 

Real gross domestic product (real GDP) – the market value of final goods and services stated in the prices of a given period.

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Growth 

Canadian economy has grown at an annual rate of 4 percent per year over the last 130 years., but more recently it has been growing at about 2.5-3.5 percent a year.



This average annual growth rate is called the secular trend growth rate.

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Growth Another measure of growth is change in per capita real output.  Per capita real output is real output divided by the total population. 

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Global Experience with Growth Global experiences with growth vary across time and among nations.  Today's growth rates are high by historical standards.  The range of growth rates among nations is wide. 

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Average Annual Per Capita Income, 1820-2000, Table 6-1, p 136 Growth Rates

Income levels (1990 international Dollars)

1820-1950

1950-2000

1820-2000

1820

1950

2000

The world

0.9

1.8

1.1

675

2,108

5,672

Western Europe

1.1

2.5

1.5

1,269

6,546

19,846

North America

1.6

1.8

1.6

1,233

9,463

26,224

Japan

0.8

4.8

1.9

675

1,927

20,438

Eastern Europe

1.1

1.0

1.0

803

3,162

5,967

Latin America

1.0

1.4

1.1

671

2,478

6,797

China

-0.2

3.4

0.8

600

439

3,442

Other Asia

0.3

2.4

0.9

560

848

3,269

Africa

0.6

0.8

0.6

400

1,307

1,291

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The Benefits and Costs of Growth Per capita economic growth allows everyone in society, on average to have more.  Growth, or predictions of growth, allows governments to avoid hard questions.  A growing economy creates jobs. 

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The Benefits and Costs of Growth The costs of growth include pollution, resource exhaustion, and destruction of natural habitat.  Since many believe the environmental costs of growth are important, the result is often an environmental-economic growth stalemate. 

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Business Cycles There are numerous fluctuations around the secular growth trend,called the business cycle.  The business cycle is the upward and downward movement of economic activity that occurs around the growth trend. 

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Canadian Business Cycles, Fig. 6-1a, p 138

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U. S. Business Cycles, Fig. 6-1b, p 138

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Business Cycles 

There are a number of theories regarding the nature and causes of business cycles.

Classicals are a group of economists who generally favour laissez-faire or noninterventionist policies.  Keynesians generally favour activist policies. 

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Business Cycles Classical economists argue that business cycles are to be expected in a market economy.  Keynesian economists believe that fluctuations can and should be controlled. 

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The Phases of the Business Cycle The peak is the top of the business cycle.  A boom is a very high peak, representing a big jump in output.  The downturn is the phenomenon of economic activity starting to fall from a peak. 

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The Phases of the Business Cycle A recession is a decline in real output that persists for more than two consecutive quarters in a year.  A depression is a large recession.  The bottom of the recession or depression is called the trough. 

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The Phases of the Business Cycle As total output starts to expand, the economy comes out of the trough into an upturn, which may turn into an expansion.  An expansion is an upturn that lasts at least two consecutive quarters of a year. 

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Business Cycle Phases, Fig. 6-2, p 140 Expansion

Recession

Expansion

Total Output

Peak

0

Trough

Secular growth trend

Jan.- Apr.- July- Oct.- Jan.- Apr.- July- Oct.- Jan.- Apr.Mar June Sept. Dec. Mar June Sept. Dec. Mar June

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Why Do Business Cycles Occur Recessions and expansions are caused primarily by demand-side shocks.  A debate exists about whether these fluctuations can and should be reduced. 

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Why Do Business Cycles Occur Most economists believe that potential depressions should be offset by economic policy.  This general view was built into economics in the Great Depression of the 1930s.



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Why Do Business Cycles Occur 

During this period there were changes in the economy's structure, with government playing a much more active role.

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Leading Indicators 

Leading indicators are a set of signs that indicate what is likely to happen 12 to 15 months from now.

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Leading Indicators 

Variables that make up the leading indicator include:  Average

workweek for production workers in manufacturing.  An index of housing starts.  The U.S. composite leading index.

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Leading Indicators 

Variables that make up the leading indicator include :  The

money supply M1 divided by the price index.  New orders for durable goods.  Retail trade in furniture and appliances.  Durable goods sales excluding furniture and appliances. © 2003 McGraw-Hill Ryerson Limited.

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Leading Indicators 

Variables that make up the leading indicator include:  The

ratio of shipments to inventories or finished products.  The TSE 300 stock price index.  Employment in business and personal service sector.

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Leading Indicators 

Economists use indicators in making forecasts about the economy. They are indicators, not predictors.

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Unemployment Business cycles and growth are directly related to unemployment in the economy.  Unemployment occurs when people are looking for a job and cannot find one. 

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Unemployment 

The unemployment rate is the percentage of people in the economy who are willing and able to work but who are not working.

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Unemployment 

Cyclical unemployment results from fluctuations in economic activity.



It did not exist in pre-industrial society.

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Unemployment Structural unemployment is caused by economic restructuring, making some skills obsolete.  It existed in pre-industrial society. 

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Unemployment as a Social Problem The Industrial Revolution was accompanied by a change in how families dealt with unemployment.  What had previously been a family problem, now became a social problem. 

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Unemployment as Government’s Problem The Federal Unemployment Insurance Act of 1940 assigned government the responsibility for providing assistance to the unemployed.  Full employment – an economic climate in which just about everyone who wants a job can have one. 

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Unemployment as Government’s Problem Initially government regarded 3 percent unemployment as a condition of full employment.  The 3 percent was made up of frictional unemployment. 

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Unemployment as Government’s Problem 

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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Unemployment as Government’s Problem 

The target rate of unemployment (sometimes called the natural rate of unemployment) is the lowest sustainable rate of unemployment that policymakers believe is achievable under existing conditions.

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Unemployment as Government’s Problem 

In the 1980s and 1990s, the target rate of unemployment was been between 6 and 8 percent.

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Why the Target Rate of Unemployment Changed 

The target rate of unemployment has changed over time for the following reasons:  In

the 1970s and early 1980s, a low inflation rate seemed to be incompatible with a low unemployment rate.

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Why the Target Rate of Unemployment Changed 

The target rate of unemployment has changed over time for the following reasons:  Demographics

have changed – different age groups have different rates of unemployment.

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Why the Target Rate of Unemployment Changed 

The target rate of unemployment has changed over time for the following reasons:  Social

and institutional structures have changed.  Governmental institutions also changed.

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Whose Responsibility Is Unemployment? Classical economists believe that individuals are responsible for their own employment.  They argue that every person can find some job at some wage, so all unemployment is frictional. 

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Whose Responsibility Is Unemployment? Keynesian economists tend to say that society owes a person a job commensurate with the individual's training or past job experience.  They argue that jobs should be closer to home, so people do not have to move. According to this view, unemployment is mainly cyclical and structural. 

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How Is Unemployment Measured? 

The unemployment rate is published by Statistics Canada.

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Calculating the Unemployment Rate 

The unemployment rate is calculated by dividing the number of unemployed individuals by the number of people in the labour force and multiplying by 100. number unemployed unemployme nt rate = ×100 labour force

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Calculating the Unemployment Rate The labour force is those people in an economy who are willing and able to work.  The labour force excludes those incapable of working and those not looking for work. 

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Unemployment Rate Since 1946, Fig. 6-3, p 146 Percentage fluctuations in unemployment rates

14 12 10 8 6 4 2 0 1946

1956

1966

1976

1986

1996

Years

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How Accurate Is the Official Unemployment Rate? The unemployment rate does not include discouraged workers.  Discouraged workers – people who do not look for a job because they feel they do not have a chance of finding one. 

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How Accurate Is the Official Unemployment Rate? The unemployment rate counts as employed those who are underemployed.  Underemployed – part-time workers who would prefer full-time work. 

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How Accurate Is the Official Unemployment Rate? 

Some supplemental measures are used by economists for better accuracy of unemployment measures, such as the labour force participation rate and the employment rate.

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How Accurate Is the Official Unemployment Rate? The labour force participation rate measures the labour force as a percentage of the total population at least 15 years old.  The employment rate measures the number of people who are working as a percentage of the labour force. 

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How Accurate Is the Official Unemployment Rate? 

Both Classicals and Keynesians agree that unemployment figures are imperfect, for different reasons.

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Unemployment/Employment Figures, Fig. 6-4, p 147 Population (31.08 million) Population 15 or older (24.6 million) Labor force (16.25 million)

Employed (15.08 million)

Unemployed (1.17 million) © 2003 McGraw-Hill Ryerson Limited.

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Unemployment and Potential Output 

The capacity utilization rate is the rate at which factories and machines are operating compared to the maximum sustainable rate at which they could be used.

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Unemployment and Potential Output 

The capacity utilization rate indicates how much capital is available for economic growth.

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Unemployment and Potential Output 

Potential output is the output that would materialize at the target rate of unemployment and the target rate of capacity utilization.

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Unemployment and Potential Output 

Potential output is defined as the output that will be achieved at the target rate of unemployment and at the target level of capacity utilization.

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Unemployment and Potential Output 

There is debate about where the actual level of potential income is.

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Unemployment and Potential Output 

To determine the effect changes in the unemployment rate will have on output, we use Okun's rule of thumb.  The

rule states that a 1 percentage point change in unemployment will cause output to change in the opposite direction by 2 percent.

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Unemployment and Capacity Utilization Rates (%), Table 6-2, p 148 Capacity utilization

Unemployment

Annual growth in real output

1975

1985

2000

1975

1985

2000

1975-2000

Canada

83.1

82.5

85.8

6.9

10.5

6.6

2.5

U.S.

74.6

79.8

80.4

8.5

7.2

4.0

2.9

Japan

81.4

82.5

74.6

1.9

2.6

4.4

2.5

Germany

76.9

79.6

85.1

3.4

8.2

10.0

3.0

U.K.

81.9

81.1

81.8

4.6

11.2

5.7

2.2

Mexico

85

92.0

85.7

-

-

2.0

1.6

Korea

86.5

86.4

83.3

-

10.9

4.8

7.7

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Microeconomic Categories of Unemployment Macroeconomic measures of unemployment may be too crude.  Different types of unemployment are susceptible to different types of policies. 

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Microeconomic Categories of Unemployment 

Some microeconomic categories of unemployment are reasons for unemployment, demographic unemployment, duration of unemployment, unemployment by industry,and unemployment by age group.

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Unemployment by Microeconomic Subcategories, Fig. 6-5, p 150

Total unemployment rate Total unemployment (1.17 million (7.2%)) Unemployment rate by sex Male (659,500 (7.5%))

Female (510,000(6.8%)

Unemployment by age

15-24 12.8%

25 and over 6.1%

55 and over 5.5%

65 and over 3.3%

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Inflation Inflation is a continual rise in the price level.  Since World War II, the Canadian inflation rate has remained positive and relatively stable. 

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Measurement of Inflation Inflation is measured with changes in price indexes.  A price index is a composite of prices. 

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Measurement of Inflation 

A price index is a series of numbers that summarizes what happens to a weighted composite of prices of a selection of goods (often called a market basket of goods) over time.

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Measurement of Inflation 

A price index can be created by looking at a market basket of goods.

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Inflation in Canada Since 1915, Fig. 6-6, p 151

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Real-World Price Indexes 

Real-world price indexes include the raw materials price index, the CPI, and the GDP deflator.

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The Raw Materials Price Index 

The raw materials price index measures the prices of a number of important raw materials, such as steel.

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The Raw Materials Price Index This index does not accurately measure what most consumers are interested in—final goods.  It gives an early indication of which way inflation is headed. 

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The GDP Deflator 

The GDP deflator (gross domestic product deflator) is an index of the price level of aggregate output, or the average price of the components in total output (GDP) relative to a base year.

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The GDP Deflator The GDP deflator is the measure of inflation most economists favour since it includes the widest number of goods.  Since it is difficult to compute, it is published only quarterly and with a fairly substantial lag. 

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The Consumer Price Index (CPI) 

The consumer price index (CPI) measures the prices of a fixed basket of consumer goods, weighted according to each component's share of an average consumer's expenditures.

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The Consumer Price Index (CPI) The CPI is the measure of inflation most often presented in news reports.  Many economists believe that the CPI as currently constituted, overstates inflation by one percentage point. 

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Composition of CPI, Fig. 6-7, p 153

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Real and Nominal Concepts 

Nominal output is the total amount of goods and services measured at current prices.

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Real and Nominal Concepts 

Real output is the total amount of goods and services produced, adjusted for price level changes. nominal output real output = X 100 price index

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Real and Nominal Concepts 

The “real” amount is the nominal amount adjusted for inflation.

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Expected and Unexpected Inflation Expected and unexpected inflation affect behavior differently.  Expected inflation is that which people anticipate.  Unexpected inflation is that which surprises people. 

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Expected and Unexpected Inflation 

Expectations of inflation play an important role in further exacerbating inflation.

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Costs of Inflation 

There are two main costs of inflation: redistribution costs and blurring of price information.

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Costs of Inflation Inflation causes income to be redistributed from those who do not raise their prices to those who do.  Inflation can reduce the amount of information that prices are supposed to convey. 

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Costs of Inflation 

Despite redistributive costs and a blurring of price information, inflation is usually accepted by governments as long as it stays at a low level.

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Costs of Inflation The danger is when inflation becomes hyperinflation.  Hyperinflation – exceptionally high levels of inflation of, say, 100 percent or more a year.  Canada has not experienced hyperinflation. 

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Economic Growth, Business Cycles, Unemployment, and Inflation End of Chapter 6

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