copyright © 2007, nelson, a division of thomson canada ltd.. a lecture presentation in powerpoint...

Copyright © 2007, Nelson, a division of Thomson Canada Ltd..

A Lecture Presentation in PowerPoint

to accompanyExploring Economics

by Robert L. Sextonand Peter Fortura


Chapter 11Introduction to the

Macroeconomy


11.1 Macroeconomic Goals

Three major macroeconomic goals maintain unemployment of human

resources at a low level meaning that jobs are relatively plentiful and financial suffering from lack of work is relatively

uncommon maintain relatively stable price level,

so that consumers and producers can make better decisions; and

achieve a high rate of economic growth, with growth in real, per-capita total output over

time.



We use the term real gross domestic product (RGDP) to measure output or production.

It is the total value of all final goods and services produced in a given time period.

The term real is used to indicate that the output is adjusted for the general increases in prices over time.


Economic Growth, Unemployment Rates and Inflation Rates, 1990–2003



In addition to these primary goals, concern has been expressed at various times and places about other economic issues: the "quality of life," reducing “bads” such as pollution, fairness in the distribution of income or

wealth, or becoming self‑sufficient in the production

of certain goods or services.



Individuals differ considerably in evaluating the issues, or whether certain "problems" are really problems. Economic growth is viewed positively by

most people but negatively by some. Some think the income distribution is about

right; others think the poorer members of society have insufficient incomes.

Others think confiscation of the income of the relatively rich reduces incentives to income-producing activities.



Many economic problems are pressing concerns for the Canadian government, particularly unemployment, price instability, and economic stagnation.


11.2 Employment and Unemployment

The concern over both unemployment and price instability led the various levels of government to commit to policies designed to reduce unemployment in a manner consistent with price stability. The government began holding itself responsible for short-run economic fluctuations.



Nearly everyone agrees that it is unfortunate when a person who wants a job cannot find one.

A loss of a job can mean financial insecurity and a great deal of anxiety.

High rates of unemployment in a society can lead to increased tensions and despair.



Society loses some potential output of goods when some of its productive resources—human or non‑human— remain idle, and potential consumption is also reduced.

Clearly, there is a loss in efficiency when people are willing to work but productive equipment remains idle.



Hence, other things equal, relatively high rates of unemployment are almost universally viewed as bad.

The unemployment rate is one measure of labour market conditions.

The unemployment rate is the number of people officially unemployed divided by the labour force.



Official unemployment measures those over the age of 15 who are able and available for employment, but are unable to obtain a job.

The labour force is the number of people over the age of 15 who are either employed or unemployed.



The labour force figure excludes The infirm homemakers, retirees, and full-time students because

they are not considered currently available for employment. Any individual who is not working and not looking for work is NOT in the labour force.


The Canadian Labour Force, 2002

labour Force (Employed + Unemployed)

17.046 Million

Employed(15.746 million)

Employed(15.746 million)

Unemployed(1.300 million)

Unemployed(1.300 million)

Out oflabour Force(8.204 million)

Out oflabour Force(8.204 million)

Total Adult Population25.250 Million



By far the worst employment downturn in history was the Great Depression, which began in Canada in 1929 and continued until 1939. Unemployment fell from only 2.9 percent of

the labour force to more than 19 percent in the early 1930s, and

double-digit unemployment persisted through 1939.



The debilitating impact of having millions of productive persons out of work led Canadians (and people in other countries too) to say "Never again."



Some economists would argue that modern macroeconomics, with its emphasis on the determinants of unemployment and its elimination, truly began in the 1930s.



Unemployment since 1976 has ranged from a low of 6.8 percent in 2000 to a high of 11.9 percent in 1983.

Unemployment in the worst years is twice or more what it is in good years.

Before 1960, variations tended to be even more pronounced.


Canada Unemployment rate for both sexes, 15 years and over



In periods of prolonged recession, some individuals feel that the chances of landing a job are so bleak that they quit looking.

These "discouraged workers," who have not actively sought work, are not counted as unemployed; instead they fall out of the labour force.



Also, people looking for full-time work who grudgingly settle for a part-time job are counted as “fully” employed, yet they are only “partly” employed.



However, at least partially balancing these biases in government employment statistics is the number of people who are over employed—that is, working overtime or extra jobs.

Also, there are a number of jobs in the underground economy that are not reported at all.



In addition, there may be many people who claim they are actually seeking work when, in fact, they may just be going through the motions so that they can continue to collect employment insurance or receive other government benefits.



Unemployment usually varies greatly between different segments of the population and over time. unemployment rate is significantly

lower for university and college graduates than

those without a high-school diploma across sex and race, or

for those with some post secondary education, but did not complete the requirements.



Unemployment tends to be greater among Those in certain regions of the

country the very young, women less-skilled workers.



Considering the great variations in unemployment for different groups in the population, we calculate separate unemployment rates for groups classified by gender, age, province, family status, and type of occupation.


Unemployment in Canada by Age, Sex, and Region



There are four main categories of unemployed workers job losers (temporarily laid off or fired), job leavers (quit), re-entrants (worked before and now

reentering labour force) new entrants (entering the labour force for

first time—primarily teenagers).



Job losers typically account for 50 to 60 percent of the unemployed, but sizeable fractions are also due to,new entrants, and re-entrants. Job leavers make up the smallest source of unemployment.



While unemployment is painful, reducing unemployment is not without costs. In the short run, reducing unemployment

may generate a higher inflation rate, especially if resources are fully employed.

Matching employees with jobs quickly may lead to mismatches between the worker’s skill level and that required for a job.



The duration of unemployment is equally as important as the amount of unemployment in determining its financial consequences.

Therefore, it is useful to look at the average duration of unemployment.



The duration of unemployment tends to be greater when the amount of

unemployment is high, and be smaller when the amount of

unemployment is low. Unemployment of any duration, of

course, means a potential loss of output that is permanent; it is not made up when unemployment starts falling again.



The percentage of the population that is in the labour force is called the labour force participation rate. Since 1976 it has increased from 61.5

percent to 67.5 percent. The increase can be attributed in large part

to the entry of the baby boom into the labour force and a 15.9 percentage point increase in women’s labour force participation rate.


11.3 Different Types of Unemployment

Types of unemployment. Frictional unemployment

people are temporarily between jobs is short term and results from the normal

turnover in the labour market Structural unemployment

people lack the necessary skills for available jobs

Cyclical unemployment results from short-term cyclical fluctuations in

the economy



With frictional unemployment, geographic and occupational mobility are considered good for the economy, generally leading human resources from activities of relatively low productivity or value to areas of higher productivity, increasing output in society as well as the wage income of the mover.



Hence, frictional unemployment, while not good in itself, is a by-product of a healthy phenomenon, and because it is short-lived, it is therefore not generally viewed as a serious problem.

It tends to be somewhat greater in periods of low unemployment, when job opportunities are plentiful.



Structural employment makes it wise to look at both unemployment and job vacancy statistics in assessing labour market conditions.

Like frictional unemployment, it reflects the dynamic dimension of a changing economy.

Over time, new jobs open up that require new skills, while old jobs that required different skills disappear.



Many persons advocate government-subsidized retraining programs as a means of reducing structural unemployment.

The dimensions of structural unemployment are debatable, in part because of the difficulty in precisely defining the term in an operational sense. Structural unemployment varies considerably.



To a considerable extent, one can view both frictional and structural unemployment as phenomena resulting from imperfections in the labour market.



If individuals seeking jobs and employers seeking workers had better information about each other, the amount of frictional unemployment would be considerably lower.

But because information and job search are costly, the coordination of demanders and suppliers of labour services does not occur instantaneously.



In years of relatively high unemployment, cyclical unemployment may result from the short-term cyclical fluctuations in the economy.

During a recession, or whenever the unemployment rate is greater than what is considered to be a natural rate of unemployment, there is cyclical unemployment.



Given its volatility and dimensions, governments have viewed unemployment resulting from inadequate demand to be especially correctable through government policies.

Most attempts to solve the unemployment problem have placed an emphasis on increasing aggregate demand.



The median, or typical annual unemployment rate has been at or slightly above 7.4 percent since 1999. Some economists call this the natural rate

of unemployment. When unemployment rises well above 7.4

percent, we have abnormally high unemployment; when it falls below 7.4 percent, we have abnormally low unemployment.



The 7.4 percent natural rate of unemployment roughly equals the sum of frictional and structural unemployment at a maximum. Thus, unemployment rates below the

natural rate reflect a below-average level of frictional and structural unemployment.

Unemployment above the natural rate, however, reflects cyclical unemployment.



Today most economists estimate the natural rate of unemployment to lie in the range of 6.5 to 7.5 percent.

The natural rate of unemployment may change over time as technological, demographic, institutional, and other conditions vary.



When all of the economy’s labour resources, and other resources like capital are fully employed, the economy is said to be producing at its potential level of output.

That is, at the natural rate of unemployment, all resources are fully employed and the economy is producing its potential output.



The economy can also temporarily exceed potential output as workers take on overtime or moonlight by taking on extra employment.

When the economy is experiencing cyclical unemployment: unemployment rate > the natural rate.


11.4 Inflation

Overall stable price level increases security. Inflation is a continuing rise in the overall

price level. Deflation is a falling overall price level. In both cases, a country’s currency unit

changes in purchasing power. Without price stability, consumers and

producers will experience more difficulty in coordinating their plans and decisions.


11.4 Inflation

In general, the only thing that can cause a sustained increase in the rate of inflation is a high rate of growth in money.

Unanticipated and sharp price changes are almost universally considered to be a "bad" thing that needs to be remedied by some policy.


11.4 Inflation

The Consumer Price Index (CPI) is the standard measure of inflation.

The CPI from 1915 to 2003 is presented in the next slide.


The Consumer Price Level in Canada, 1920–2002


11.4 Inflation

Effects of Inflation Erodes the purchasing power of retirees on

fixed pensions, creditors, and those whose incomes are tied to long-term contracts.

Debtors and those who can quickly raise the prices on their goods can gain from inflation.

Wage earners can lose if wages rise more slowly than the price level.

Inflation’s uncertainties discourages investment and economic growth.


11.4 Inflation

Inflation brings about changes in real incomes of persons, and these changes may be either desirable or undesirable.

The redistributional impact of inflation is not the result of conscious public policy; it just happens.


11.4 Inflation

Inflation can raise one nation's price level relative to price levels in other countries, which can lead to difficulties in financing the purchase of

foreign goods or to a decline in the value of the national

currency relative to that of other countries.


11.4 Inflation

In its extreme form, inflation can lead to a complete erosion of faith in the value of money. as in Germany after both world wars,

or hyperinflation, as in Argentina in the 1980s and Brazil in the 1990s.


11.4 Inflation

In periods of high and variable inflation, households and firms have a difficult time distinguishing changes in relative prices from changes in the general price level, distorting the information that flows from price signals.

This undermines good decision-making.


11.4 Inflation

Another cost of inflation is the cost that firms incur as a result of being forced to change their prices more often. menu costs—the costs of changing posted

prices shoe-leather costs—the costs of checking

on your assets. These costs are modest with low

inflation rates, but can be quite large where inflation is substantial.


11.4 Inflation

The real interest rate equals the nominal interest rate minus the inflation rate. Real interest rate—the increase in

purchasing power per year Nominal interest rate—the amount you

have to pay in dollars and cents


11.4 Inflation

If people correctly anticipate inflation, they will behave in a manner that will largely protect them against loss.

To protect themselves, creditors will demand a rate of interest that is large enough to compensate for the deteriorating value of the dollar.


11.4 Inflation

An interest rate is, in effect, the price that one pays for the use of funds. Like other prices, interest rates are determined by the interaction of demand and supply forces.

The lower (higher) the interest rate, the greater (fewer) the quantity of loanable funds demanded, ceteris paribus.


r1

r0

Quantity of Loanable Funds

S1

D1

S0

0

Nominal Interest Rates

D0

No

min

al I

nte

rest

s R

ate


11.4 Inflation

The higher (lower) the interest rate, the greater (fewer) the quantity of loanable funds supplied by individuals and institutions like banks, ceteris paribus.

The equilibrium price, or interest rate, will be where the quantity demanded equals the quantity supplied.


11.4 Inflation

When people start expecting future inflation, creditors become less willing to lend funds at any given interest rate because they fear they will be repaid in dollars of lesser value than those they loaned.

This is depicted by a leftward shift in the supply curve of loanable funds (a decrease in supply).


11.4 Inflation

Likewise, demanders of funds (borrowers) are more anxious to borrow because they think they will pay their loans back in dollars of lesser purchasing power than the dollars they borrowed. Thus, the demand for funds increases.

Whether the equilibrium quantity of loanable funds will increase or decrease depends on the relative sizes of the shifts in the respective curves.


11.4 Inflation

Both the decrease in supply and the increase in demand push up the interest rate to a new, higher equilibrium level.

Often, lenders are able to anticipate inflation with reasonable accuracy.

If the inflation rate is accurately anticipated, new creditors do not lose, nor do debtors gain, from inflation.


11.4 Inflation

Nominal interest rates and real interest rates do not always move together. In periods of high unexpected inflation, the

nominal interest rates can be very high while the real interest rates are low or even negative.


11.4 Inflation

Increasingly, labourers, pensioners, etc. try to protect themselves from inflation by using cost-of-living (COLA) clauses in contracts. Personal income taxes are also now indexed for inflation.


11.4 Inflation

Some have argued that we should go one step further and index everything. All contractual arrangements would be

adjusted frequently to take account of changing prices.

Such an arrangement might reduce the impact of inflation, but it would also entail additional contracting costs (and not every good—notably currency—can be indexed).


11.4 Inflation

Approaches to try to stop inflation include various policies relating to the amount of government spending, tax rates, or the amount of money created.


11.5 Economic Fluctuations

Business cycles refer to the short‑term fluctuations in economic activity, not to the long‑term trend in output, which in modern times has usually been upward.


Time0

Business Cycles and Economic Growth

Rea

l G

DP

per

Yea

r

Growth

Trend



A business cycle has four phases: expansion, peak, contraction, and trough.


Time0

Four Phases of a Business Cycle

Rea

l G

DP

per

Yea

r

Growth

Trend

RecoveryRecession

Peak

Peak

Trough

Exp

ansi

on

Contraction



Expansion phase Usually is longer than the contraction. In a growing economy, output (real GDP)

will rise from one business cycle peak to the next.

When output is rising significantly, unemployment is falling and both consumer and business confidence is high.

Investment is rising, as well as expenditures for expensive durable consumer goods, such as automobiles and household appliances.



Peak when the expansion comes to an end when output is at the highest point in the

cycle. Contraction

a period of falling real output rising unemployment and declining

business and consumer confidence investment spending and consumer

durable expenditures fall sharply



Contraction phase can also be called a recession.

Usually a recession is said to occur if there are two quarters of declining real GDP.



Trough the point in time when output stops

declining the moment when business activity is at its

lowest point in the cycle Unemployment is relatively high at the

trough, although the actual maximum amount of unemployment may not occur exactly at the trough.



Often, unemployment remains fairly high well into the expansion phase.

There is no uniformity to a business cycle's length.

Severe recessions are called depressions . Such as the 1930’s

A prolonged expansion is sometimes referred to as a boom. This happened in the 1960’s when the RGDP grew by about 6% a year.



The contraction phase is one of recession, a decline in business activity.

Contractions seem to be getting shorter over time.


Growth in Canadian Real GDP 1962-2003



Businesses, government agencies, and to a lesser extent, consumers, rely on economic forecasts to learn of forthcoming developments in the business cycles.

Economists gather statistics on economic activity in the immediate past,



These past historical relationship factors and the overall level of economic activity (which form the basis of the economic theories used)are then used to formulate econometric models

Statistics from the immediate past are plugged into the models and forecasts are made.



Because human behaviour changes, we cannot correctly make assumptions

about certain future developments, economists’ numbers are imperfect and econometric forecasts are not always

accurate. But while they are not perfect, they are

helpful.



Some types of economic activity can be useful in predicting change. These are known as Economic Indicators a less sophisticated but very useful

forecasting tool is watching trends in areas that tend to change before the economy as a whole changes.



Statistics Canada identified about 10 such indicators: Furniture and Appliance sales Durable Goods sales Length of Average work week New orders in manufacturing Shipments-to-inventory ratio Housing Starts Business and Personal services employment Index of stock prices Money supply U.S. leading indicators

If the index rises sharply for two or three months, it is likely (but not certain) that increases in the overall level of activity will follow.



Since the development of the index of leading economic indicators, it has never failed to give some warning of an economic downturn.

Unfortunately, the lead time has varied widely, which makes it less accurate and can cause timing and expectation problems with policy.



While the economic indicators do provide a warning of a likely downturn, they do not provide accurate information on the depth or duration of the downturn.

copyright © 2007, nelson, a division of thomson canada ltd.. a lecture presentation in powerpoint...

Documents

division of thomson

macroeconomy slide

unemployment rates

economic problems

major macroeconomic

economic issues

high rates of unemployment

peter fortura slide