Chapter 8

Economic Growth & Instability

3 economic goals of the U.S. economy

• Low unemployment,• Price stability, • High, sustained

economic growth.

Low unemployment (not zero Unemployment)

Price stability

Prices in an economy don't change much over time.

Price stability would mean that an economy would not have inflation or deflation.

High, sustained economic growth

The rate of economic growth is influenced by natural resources, human resources, capital resources, and technological development in the economy.

real GDP growth rates

The 4 phases of the business cycle.

• Contraction (A slowdown in the pace of economic activity) recession/depression

• Trough (The lower turning point of a business cycle, where a contraction turns into an expansion)

• Expansion (A speedup in the pace of economic activity)

• Peak (The upper turning of a business cycle)

Recession vs Depression

• Recession: A period of general economic decline; typically defined as a decline in real GDP for 2+ consecutive quarters.

• A recession is typically accompanied by a drop in the stock market, an increase in unemployment, and a decline in the housing market.

• Depression: a sustained, long-term downturn in economic activity ( > 10%) for 2+ years. It is a more severe downturn than a recession, which is seen as part of a normal business cycle.

3 theories that help to explain fluctuations in the business cycle

• Innovations: (Industrial Revolution) change productivity

• Monetary: caused by changes in the Money Supply

• Over production & under consumption

Business cycle’s impact on durable goods vs. non-durable goods

• Non Durable Goods market not as sensitive to changes in the Business Cycle (Doctors, food, clothes)

• Durable Good Market sensitive to the changes in the Business Cycle (cars, houses etc)

• With some Durable goods like cars & houses people fix rather than replace

four types of Unemployment

1. Frictional: “between Jobs” or between college & work. Planned, even desirable.

2. Structural: an absence of demand for the workers that are available. (causes: change in technology, tastes, job out sourced)

four types of Unemployment

• 3. Cyclical: (caused by business cycle) Recession depression

• 4. Seasonal: Job ends with season: farming, construction, ski slopes, life guards

Full Employment

• all available labor resources are being used in the most economically efficient way. (no cyclical unemployment)

2-8% Unemployment Frictional is normal, people will always

leave college for work. Structural is normal, innovations will always happen.

Natural Rate of Unemployment

• Is Full Employment

• Includes Frictional And Structural Unemployment

• 2-8%

How do we determine the unemployment rate?

The Government conducts a monthly sample survey called the Current Population Survey (CPS) to measure the extent of unemployment in the country.

All citizens who are or are actively trying to be part of the Labor Force are counted as the Civilian Labor Force.

Unemployment Rate = Unemployed___ Civilian Labor Force

3 criticisms of the statistics used to determine the unemployment rate.

1. It counts as employed all people who are working part time but who would like to work full time.

2. Discouraged workers (those who cannot find a job and gave up) are not counted

3. People who work in their home taking care of their children &/or elderly are not counted as employed or unemployed

Okun’s Law.

The relationship between increases in unemployment and decreases in GDP (gross domestic product).

The relationship between the GDP and Okun’s Law.

For every 1% increase in unemployment above a "natural" level, that GDP will decrease by anywhere from 2 - 4% from its potential.

composition of unemployment :Unemployment inequality

• Unskilled workers

• Teenagers

• Race

Household Income Unemployment Level Level

under 12,500 30.8% 12,500-20,000 19.1

40,001-49,000 9.0 50,000-59,000 7.8 60,000-75,000 6.4

100,000-149,999 4.0 over 150,000 3.2

the noneconomic costs associated with unemployment

Morale in the working population

Work satisfaction

Mental depression to the work force

People not so inclined to seek work after long periods of unemployment

More crime due more youths out of work and petty crime for money

Inflation:

The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling.

deflation

how to measure inflation

Consumer Price Index(CPI) - A measure of price changes in consumer goods and services such as gasoline, food, clothing and automobiles.

Demand Pull inflation:

inflation that is a result of strong consumer demand that is in excess of supply.

Consumers pull (tug of war) prices up by demanding more.

Demand Pull inflation:

• “A rising tide tends to lift all boats”.

• From AD1 to AD2 Prices Constant; Output Increases • From AD2 to AD3 Both Prices & Output Increase• Above AD4 Prices Increase, Output is constant

Demand Pull inflation: Long term

AD = Aggregate demand

AS = Aggregate SupplyHorizontal Range is Keynesian, Vertical Range isClassicalIn Between is Intermediate is actualSupply

Supply Side (Cost Push) inflation:

Inflation is caused by increases in the cost of wages and raw materials.

Supply pushes inflation onto consumers

Supply Side (Cost Push) inflation

• AS prices Increase, Demand decreases.

• Firms respond to decrease Demand by lowering Supply.

• Supply decreases.

production possibility curveShifts to the left (inward)

The difference between Nominal and Real income

• Nominal: the effects of inflation have not been accounted for.

Real means the effects of inflation have been factored in.

Real Income = Nominal Income/ 1 + % Increase in Prices Since Base Year

unanticipated inflation hurts:

• A) Fixed Income Groups:B) Savers:C) Creditors (Banks):

Who wants Inflation?

• Debtors

• People whose income is flexible (no contracts)

Define Hyperinflation:

A sustained very high inflation. ( when the monthly inflation rate is greater than 50 percent)

http://www.youtube.com/watch?v=Jt15F21jpN8

http://www.youtube.com/watch?v=kOGwsQOCBAM