ECO120 Macroeconomics Rod Duncan

1. ECO120 MacroeconomicsRod Duncan Lecture 6- The business cycle, or why we do well in some years and worse in others

2. Business cycle and the labour market • We saw that GDP has two features over time: • The trend for GDP is upwards over time (growth); but • Growth is higher in some years than in others (the “business cycle”). • What’s the impact of the business cycle on the labour market?

3. What do we care about? • I want you to think behind the statistics and think about what the statistics represent- what do they mean? • We saw that female labour force participation has been rising over time. This means that more women are engaged in the labour market- in paid jobs or looking for a job. • Is a higher LFP rate better? Why? • Why do we think a higher LFP is better for women, but bad for others (say 12 year olds?)

4. What do we care about? • Generally we don’t say “a higher LFP is a better society”. • Not everyone can, wishes to or would be wanted to work. Should 80 year olds be forced to work if their superannuation runs out? • What we generally say is that “everyone who wishes to should be able to find a job” and “everyone who is capable and productive should work”.

5. What do we care about? • We don’t necessarily worry about everyone who doesn’t have a job, just certain types of people who don’t. • Only those people of “working age” (15 to 69 years) • Only those people not in school or university • Only those people who are actually looking for jobs • If someone satisfies those categories, do we call them “unemployed”. What about all the other people who don’t have jobs but we don’t call “unemployed”?

6. Australia’s labour force • Figure 21.2 (from the ABS in March 2006): • Australia has a population of 20.51m. • Of the 20.51m, 16.48m were of working age, and 4.03m were outside it. • Of the 16.48m, 10.61m were in the labour force, and 5.87m outside it. • Of the 10.61m, 10.07m were employed and 0.54m were unemployed. • Of the 10.07m, 7.19m had full-time jobs and 2.88m had part-time jobs. • Figure 21.2 from the McTaggart book.

7. Economists think of an Australia-wide market for labour. In this market, firms demand the labour, and households supply the labour. We use the standard market model from micro. Business cycle and the labour market Australian labour market $ Supply of labour Wage rate Demand for labour Hours Hours worked

8. Real GDP Actual GDP Trend GDP or Full-employment GDP Boom Recession 1993 2006 Year Parts of the business cycle

9. In a recession firms demand less labour than in normal times. (We use “0” to represent normal times and “1” to be the recession.) The labour demand curve is to the left of its position in normal times. Wages fall, hours/employment falls, and unemployment rises. Recessions and the labour market Australian labour market $ S W0 W1 D0 D1 Hours L1 L0

10. In a boom (such as today) firms demand more labour than in normal times. (We use “0” to represent normal times and “1” to be the boom.) The labour demand curve is to the right of its position in normal times. Wages rise, hours/employment rises, and unemployment falls. Booms and the labour market Australian labour market $ S W1 W0 D1 D0 Hours L0 L1

11. Can we see this in the data? • We should see that unemployment rises in the recessions and drops in the booms. • Figure 21.3 from the McTaggart book. • Notice that unemployment is still high even after the recession has ended because the economy has to grow back to where it would have been.

12. What data can we use?

13. Types of unemployment • Economists like to differentiate four basic types of unemployment based on the cause of the unemployment: • 1. Cyclical- unemployed because of the business cycle- a recession • 2. Frictional- unemployed because you are looking for a better/different job • 3. Structural- unemployed because the skills you have are not needed now • 4. Seasonal- unemployed because the industry you work in doesn’t need you now (ie. fruit-picking)

14. Now which do we care about? • Again you have to think behind the statistics to consider what is being presented. Are all four types of unemployment equally bad? • Cyclical • Frictional • Structural • Seasonal • No. Structural is the most concerning of the four. For the other three, the person will get re-employed in the future. • But what future is there for a maker of saddles after the car is introduced?

15. Exam question B1. (a) When the economy is at full employment, is the unemployment rate at 0 per cent? Why or why not? (b) How would a more generous unemployment benefits system affect the full employment figure?

16. Prices • We sense that prices for things in general have gone up over time. You can think of lots of things that were cheaper a long time ago. • But not all prices go up all the time. The price of petrol has been falling the last few weeks. DVD players were $1,000 each when first introduced. • And not all goods matter the same. Bananas are just a tiny part of a household’s budget, while housing is a large part. If the price of housing rises, that’s more important than a rise in banana prices.

17. Inflation • Inflation is the rate of growth of the average price level over time. • But how do we arrive at an “average price level”? • The Consumer Price Index surveys consumers and derives an average level of prices based on the importance of goods for consumers, ie. a change in the price of housing matters a lot, but a change in the price of Tim Tams does not.

18. Consumer Price Index • We measure inflation (growth in prices) in the same way we measured GDP growth. • The CPI expresses average prices each year relative to a reference year, which is a CPI of 100. CPIt = (Average prices in year t)/(Average prices in reference year) x 100 • Inflation can then be measured as the growth in CPI from the year before: • Inflationt = (CPIt – CPIt-1) / CPIt-1

19. Inflation- growth in prices

20. Is there a simple link?

21. Practice question B4. Eddie the hard-working financial planner is worried that his wages are falling behind rising prices. Is he right?