GROWTH

BUSINESS CYCLES

UNEMPLOYMENT

INFLATION

Economic Growth

• Measurement– Gross Domestic Product (GDP)– Market value of final goods and services produced– Details later

6-3

Economic Growth• Nominal GDP (OK measure)

– Goods and services valued at their current prices

• Real GDP (Better measure)– Goods and services valued in prices of a base or reference year.

• Real Per capita GDP (Best measure)– GDP divided by population

Per Capita Income by Region

RegionGrowth Rate: 1950-2009 Income: 1950 Income: 2009

China 4.4% $ 439 $ 6,050

Jqpan 4.8% $1,900 $22,500

North America 2.0% $9,500 $31,000

Latin America 1.6% $2,500 $ 6,500

Western Europe 2.6% $6,500 $21,200

Eastern Europe 2.2% $3,100 $ 7,600

Africa 1.1% $1,300 $ 1,700

World 2.1% $2,100 $ 7,300

6-4

6-5

Benefits and Costs of Growth

• Benefits– If real per capita GDP increases, everyone in society will on

average, have more.– Governments avoid hard choices

• Costs – Pollution– Resource exhaustion– Destruction of natural habitat– Materialism

6-6

Four Phases of the Business Cycle

Expansion ExpansionRecessionBoom

Secular growth trend

DownturnUpturn

Trough

Peak

0Jan.-Mar

Tota

l Out

put

Apr.-June

July-Sept.

Oct.-Dec.

Jan.-Mar

Apr.-June

July-Sept.

Oct.-Dec.

Jan.-Mar

Apr.-June

2 qtrs decline 2 qtrs rise

6-7

U.S. Business Cycles

Business Cycles • Important terms

– Recession: 6 months of declining real output 2002, 2008 to ?

– Depression: Long period of declining output and high unemployment 1930s and ???

6-9

Changes in Business Cycles Over Time Duration (in months)

Business Cycles Pre-World War II Post-World War II (1854-1945) (1945-2006)

Average length of expansions 29 57

Average length of recessions 21 10

Length of shortest recession 7 6

Length of longest recession 65 (1933-39) 16+ (2007-2009)

6-10

Leading Indicators

• Average work week

• Unemployment claims

• Index of consumer expectations

• New orders for capital goods

• Building permits

• Stock prices

Unemployment

• Types– Frictional – Structural– Cyclical– Seasonal– Underemployment

Measuring Unemployment

– Monthly interviews

– Criteria• 16 years or older• Available for work• Tried to find work

6-13

Calculating Unemployment

• Labor force – Able to work– Have a job– Don’t have a job, but looking for a job

• Number unemployed– Able to work– Don’t have a job, but looking for a job

100forcelabor

unemployednumber ratent unemployme

6-14

Unemployment Rates since 1900

6-15

Unemployment by Microeconomic Subcategories

See Text, p. 171

6-16

Accuracy of the Unemployment Rate

• Discouraged workers

• Under-employed

• Survey bias

6-17

Target Rate of Unemployment

• Target rate of unemployment – Used to be called “Full Employment”– The lowest sustainable rate achievable under existing conditions.

• Currently considered to be about 5%

• Can change due to:– Population demographics– Social and institutional structures– Government programs

6-18

Unemployment and Potential Output

• Potential output – output at:– Target rate of unemployment and – Target rate of capacity utilization

• Okun’s rule of thumb: Unemployment rate up by 1% → Output down by 2%

Inflation

• General increase in prices

• Cause: Too much money chasing too few goods

Effects of Inflation

• Unanticipated inflation: Who is harmed?– Lenders– People with fixed incomes– Anybody making decisions

• Anticipated inflation

Measurement of Inflation

• Monthly interviews

Measurement of Inflation

• Market Basket 2009 Price $3.00/gal $4.50/lb

2010 Price 4.00/gal $6.00/lb

100 gal gas 10 lbs steak Total Cost2009 Cost $300 $45 $3452010 Cost $400 $60 $460

Inflation Rate (460-345/345) = 33%

6-23

Real World Price Indexes

• GDP Deflator

• Consumer Price Index

• Producer Price Index (PPI)

6-24

Composition of CPI

Recreation (5.6%)

Food and beverage (15.0%)

Apparel (3.7%)

Transportation (17.2%)

Medical care (6.3%)

Housing (42.7%)

Other (3.5%)

Education and Communication (6.0%)

Price Indices and the “Base Year”

• Base year selected– Currently, 1982 for the CPI– Price index is always 100 for the base year

• Rate of inflation is the % change in the price index from one period to the next

6-25

Calculating the Rate of Inflation

6-26

YEAR PRICE INDEXANNUAL RATE OF INFLATION

2007 96

2008 100 4.17%

2009 104 4.00%

2010 114 9.62%

Inflation Rate = Change in Price Index Earlier Year Price Index

6-27

Real Verses Nominal Output • Nominal output is measured at current prices.

• Real output is nominal output:– Adjusted for price level changes from a “Base Year.”

100index price

output nominal output real

6-28

Real Versus Nominal Prices

Suppose that the nominal price of gasoline is $3.25 per gallon. The CPI (1982 base year) is 190%. Find the real price of a gallon of gasoline.

711100190

253.$

.$

index price

price nominalprice real

HYPERINFLATION

• Definition: > 50%/month• Jan 1.00• Feb 1.50• Mar 2.25• April 3.38• May 5.06• June 7.60

July 11.39 Aug 17.09 Sept 25.62 Oct 38.44 Nov 57.67 Dec 86.50 Jan 129.74

HYPERINFLATION (cont)

• Germany (after WWI)

• 1 egg Marks• Pre-War Price .08 • Nov/1923 Price 80,000,000,000

HYPERINFLATION (cont)

• Hungary (after WWII)– Inflation rate:

3,810,000,000,000,000,000,000,000,000,000

HYPERINFLATION (cont)

• Bolivia (1985)– 118,000%

HYPERINFLATION (cont)

• Turkey exchange rate

HYPERINFLATION (cont)

• Cause: Turning on the printing presses

• People’s reaction?

Deflation• Continuing decrease in prices• Distributional impacts (reverse of inflation)

– Borrowers lose– Those on fixed incomes gain

• Other impacts – Consumers postpone purchases– Asset values (e.g., stocks and real estate) decline

• The dangers– Demand decreases, so businesses produce less– Financial institutions may become insolvent

• Deflationary spiral