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Introduction to Economic Growth and Instability

“When more and more people are thrown out of work, unemployment results.” Calvin Coolidge 30th US President. Introduction to Economic Growth and Instability. Chapter Objectives. The Business Cycle and its Primary Phases How Economic Growth is Measured and Why is it Important

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Introduction to Economic Growth and Instability

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  1. “When more and more people are thrown out of work, unemployment results.”Calvin Coolidge30th US President Introduction to Economic Growth and Instability

  2. Chapter Objectives • The Business Cycle and its Primary Phases • How Economic Growth is Measured and Why is it Important • How Unemployment and Inflation are Measured • The Types of Unemployment and Inflation and their Various Economic Impacts

  3. Economic GrowthChange in Real GDP Example: Real GDP2004 = $10,755.7 billion Real GDP2005 = $11,134.8 billion Rate of economic growth = ($11,134.8 billion – $10,755.7 billion) $10,755.7 billion = 3.5% growth rate

  4. Economic GrowthChange in Real GDP Per Capita Real GDP per capita is GDP per person Real Per Capita GDP2004== $36,596 Real Per Capita GDP2005 = = $37,541 Growth in Per Capita GDP = $10,755.7 billion 293.9 million $11,134.8 billion 296.6 million ($37,541 - $36,596) $36,596 X 100 = 2.6%

  5. Economic GrowthChange in Real GDP Per Capita Per capita is more useful than percentage change in GDP for understanding changes and comparisons in standard of living. • Poverty is not caused by population growth, but by population growth rates greater than GDP growth rates. • If population increases faster than real GDP, per capita GDP falls. • US family income at poverty level shown below for 2008

  6. Economic GrowthChange in Real GDP Per Capita • International comparisons * Number deaths of infants under 1 year old per year per 1,000 live births Source: CIA World Factbook, Jan 2008 (www.indexmundi.com)

  7. Economic GrowthRule of 70 Approximate number of years required to double real GDP 70 annual percentagerate of growth = • Examples: • At annual growth rate of 3%, real GDP will double in 70/3, or 23.3 years (assuming no change in growth rate). • Rule of 70 can also be used to estimate time to double in compounding savings account. • If you deposit $100,000 in a savings account earning 4% interest, you will have $200,000 in that account in 70/4, or 17.5 years. • Will your purchasing power have doubled? Why or why not?

  8. Economic GrowthRule of 70 Approximate number of years required to double real GDP 70 annual percentagerate of growth = • Examples: • China: Average annual growth rate 2001 – 2007 = 10% • At this rate, China’s GDP doubled in about 70/10 = 7 years. • US: Average annual growth rate 2001 – 2007 = 2.58% • At this rate, US GDP will double in about 70/2.58 = 27 years.

  9. Economic GrowthWhat Causes Growth? • Main Sources of Growth • Increases in inputs (⅓ of US growth) • Increases in productivity of those inputs (⅔ of US growth) Productivity = output per unit of input • Productivity increases when: • Health, training, education and motivation of workers increase • Machinery, resources, technology that workers use improve • Production is better organized and managed • Labor is reallocated from less efficient industries to more efficient industries

  10. Economic GrowthThe U. S. Record • Real GDP grew at average annual rate of about 3.5% between 1950 and 2005. • Real GDP per capita increased 2.3% per year over the same time period. • Raw growth numbers understate or overstate improvements in economic well-being during this time period for a variety of reasons.

  11. Economic GrowthInterpretation • Under or overstatement of economic well-being. • No accounting for improvement in goods and services (ice boxes and record albums vs refrigerators and CD’s) • Standard workweek decreased from average of 50 hours to current average 35 hours (excluding overtime), giving us more leisure time, but leisure is not included in GDP or in growth calculations. • GDP growth does not account for impact of growth on environment and quality of life (stress at work, pollution, crowding, etc).

  12. The Business Cycle A business cycle is periodic expansion or contraction of the economy. • Disturbs the economy from its long-term growth trend. Peak Peak Expansion Trend Peak Recession Expansion Growth Level of Real Output Recession Trough Trough Time

  13. The Business CyclePhases Phases of the business cycle • PeakTemporary maximum, at or near full employment, production; the economy is operating at or near full capacity. • RecessionGDP and income decrease; unemployment increases. Two consecutive quarters of negative growth. • TroughOutput and employment “bottom out” at lowest levels; this is the beginning of the recovery. • ExpansionGDP and income rise; unemployment falls, and inflation may occur.

  14. Business CyclesCauses of Expansions C  Expansions are usually led by increased consumer spending • Households demand more goods and services • Firms increase production to meet higher demand • Firms hire more workers or pay overtime • Incomes increase, setting off another cycle of rising consumer demand, increased sales, and increased employment.

  15. Business CyclesCauses of Expansions Consumer spending begins a cycle of expanding output, employment, and income.

  16. Business CyclesCauses of Expansions I Business and government spending change in an expansion. • Firms • Firms increase investment to increase productive capacity to meet increased consumer demand (create more capital) • New capital creates more employment, more income, etc. • Government • Higher income and production yields higher tax revenue • Government purchases increase G 

  17. Business CyclesCauses of Expansions

  18. Business CyclesCauses of Recessions C Generally led by decreased consumer activity. • Expansion pushed prices up so households demand fewer goods and services. • Firms reduce production and layoff workers, no overtime • Falling incomes set off cycle of further reduced consumer demand as production decreases and unemployment rate increases. • Increased unemployment yields decreased incomes. • Decreased incomes yield even less consumer demand .

  19. Business CyclesCauses of Recessions Consumer spending begins a cycle of decreased output, employment, and income.

  20. Business CyclesCauses of Recessions I • Firms • Firms decrease investment AND employment • Government • Lower income and production yields less tax revenue • Government spending does not generally decrease – spending likely to continue in spite of reduction in tax revenue G?

  21. Business CyclesCauses of Recessions

  22. Business CyclesCauses of Recession

  23. Business CyclesRecession Ends

  24. The Business CycleTwin Problems of the Cycle Peak Peak Expansion Trend Recession brings higher unemployment. Peak Recession Expansion Growth Recession Level of Real Output Trough Trough Time Expansion brings inflation.

  25. UnemploymentMeasuring Unemployment US Bureau of Labor Statistics (BLS) conducts survey of 60,000 households/month • Divides population into three groups: • Under 16 or institutionalized - not considered potential members of labor force (military, prisons, hospitals etc.) • Not in labor force – adults who are potential workers but are not employed and not looking for work (homemakers, full-time students, retirees, etc) • Labor Force – People who are able and willing to work. This group contains both the employed and the unemployed.

  26. UnemploymentMeasuring Unemployment • Labor force = employed + unemployed • Unemployment rate = unemployed / labor force • Participation rate = labor force / population 16+ Population Ages 16+ Out of the Labor Force Unemployed Employed Labor Force

  27. Unemployment US Unemployment Rate, 1960 - 2007

  28. UnemploymentMeasuring Unemployment • To be unemployed, one must be in labor force, not working, and either actively seeking work, waiting to start a job, or waiting to be called back from a temporary lay-off. • If you choose to attend school full-time and do not work a job, you are NOT unemployed (your moms would be happy to know that). • You are NOT in the labor force. • When you graduate and start sending your resume out, THEN you will be counted among the unemployed.

  29. UnemploymentMeasuring Unemployment people in labor force + people NOT in labor force Working-age population people employed + people NOT employed Labor Force • Anyone who does not meet criteria for being classified as “employed” or “unemployed” is NOT in the labor force. • Examples: • Homemaker • Retired w/o job • Disabled • FT student

  30. Must be IN LABOR FORCE to be counted as unemployed! • Example: My parents do not work paying jobs, they don’t want to work paying jobs, and they aren’t looking for paying jobs. Are they in the labor force? Are they unemployed? • Not in Labor Force: • 16 and under • Armed forces • Disabled, retired, hospitalized • Those that choose not to work or look for work for pay: • Homemakers • College students • Already rich enough • Me when I win Powerball

  31. Must be IN LABOR FORCE to be counted as unemployed! • Example: My uncle was fired from his job last month for burning the fries. He has been putting applications in all over town every day since. Is he in the labor force? Is he unemployed? • Not in Labor Force: • 16 and under • Armed forces • Disabled, retired, hospitalized • Those that choose not to work or look for work for pay: • Homemakers • College students • Already rich enough • Me when I win Powerball

  32. Must be IN LABOR FORCE to be counted as unemployed! • Example: My cousin quit her job because she thought her boss was mean. She looked for a job for a day or two but got tired and stopped. That was 3 months ago. Is she in the labor force? Is she unemployed? • Not in Labor Force: • 16 and under • Armed forces • Disabled, retired, hospitalized • Those that choose not to work or look for work for pay: • Homemakers • College students • Already rich enough • Me when I win Powerball

  33. UnemploymentUS Labor Force Data Source: Bureau of Labor Statistics

  34. Statistics for June 2009 (in thousands) Unemployment rate = #4 / #2 Source: www.bls.gov

  35. Statistics for June 2009 (in thousands) Unemployment rate = #4 / #2 Source: www.bls.gov

  36. Number of people unemployed Unemploymentrate = x 100 Labor force UnemploymentMeasuring Unemployment Calculating Unemployment Rate • Unemployment rate - percentage of people in the labor force who are unemployed. In June 2009, the unemployment rate was 9.5 %. 14.8 mill/ 154.9 mill= 0.095 x 100 = 9.5%

  37. UnemploymentAugust 2009 • US population was 304.0 million Employed139.6 million Unemployed14.9 million Not in the Labor Force81.5 million Under 16 or Institutionalized 68.3 million

  38. UnemploymentMeasuring Unemployment • Unemployment rate is not a perfect measure. • Understates unemployment because part-time employees are counted as employed, though about 16% want to work full-time but cannot find full-time work. • The workers are called under-employed.

  39. UnemploymentMeasuring Unemployment • Unemployment rate is not a perfect measure. • Understates unemployment because of discouraged worker effect – workers who have actively sought work drop out of labor force (stop looking) because they cannot find work. • Dropping out decreases the size of the labor force, decreases the number of unemployed, and decreases unemployment rate. • Excluding discouraged workers makes economy look better than it is. • What happens to unemployment rate when discouraged workers start feeling hopeful again?

  40. UnemploymentMeasuring Unemployment • Unemployment rate is not a perfect measure. Under-employed + Discouraged workers Hidden Unemployed

  41. UnemploymentMeasuring Unemployment How many discouraged workers are there? “About 2.2 million persons (not seasonally adjusted) were marginally attached to the labor force in June, 618,000 more than a year earlier. These individuals wanted and were available for work and had looked for a job sometime in the past 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.Among the marginally attached, there were 793,000 discouraged workers in June, up by 373,000 from a year earlier. Discouraged workers are persons not currently looking for work because they believe no jobs are available for them.” Source: Bureau of Labor Statistics, June Release

  42. UnemploymentCategories of Unemployment Frictional Unemployment Structural Unemployment • Caused by workers voluntarily changing jobs, between jobs, or temporarily laid off • This type of unemployment is inevitable, and usually desirable, as people voluntarily move to better jobs. • Example, a college student who starts looking for work after graduation. • Workers whose skills are not demanded by employers, who lack sufficient job skills, or who cannot move to where the jobs are. • Example, auto workers in Detroit. Cyclical Unemployment • Unemployment caused by recessions, business cycles, decline in spending.

  43. UnemploymentFull Employment • Economy can NEVER be at 0% unemployment because we always have some frictional and structural. • Full employment (fully employed) is when economy experiences only frictional and structural unemployment (no cyclical unemployment). • Also called “natural rate of unemployment” (NRU). • When economy is fully employed, real GDP = potential GDP (all resources are fully employed). • Today, full employment rate is 4%-5%.

  44. UnemploymentInternational Comparisons, 1998 - 2007 Source: Bureau of Labor Statistics

  45. InflationThe Basics • Inflation is a rise in the general price level. • Does not mean every single price increases, just prices in general (on average). • Inflation reduces “purchasing power” of money, as each dollar of income buys fewer goods and services than before. • Value of money decreased.

  46. Price of the Most Recent Market Basket in the Particular Year CPI = x 100 Price of the Same Market Basket in base year,1982-1984 InflationMeasurement • Consumer Price Index (CPI) • Reports the price of “market basket” of goods and services purchased by typical consumer • Remember that the GDP price index in Ch 6 also includes price of capital and government purchases along with consumer goods and services. • Market basket is kept constant, prices are allowed to change • With real GDP, prices are kept constant while market basket is allowed to change.

  47. Price of the Most Recent Market Basket in the Particular Year CPI = x 100 Price of the Same Market Basket in base year,1982-1984 InflationMeasurement • Consumer Price Index (CPI) • Goods in market basket are not allowed to change much so price comparisons will make sense. • For example, to compare prices between Harris Teeter and Lowe's Foods, you would need the shopping carts to have EXACTLY THE SAME ITEMS, then measure the price difference.

  48. InflationCalculate the CPI Calculate the CPI for 2008 using 1982 as the base year: $6,500 $2,863 $5,109 $2,863 CPI2008 = CPI2008 = x 100 = 1.78 x 100 = 178 x 100 = 2.27 x 100 = 227 Calculate the CPI for 2000 using 1982 as the base year:

  49. CPI2008 - CPI2000 227 - 178 x 100 = 0.275 x 100 = 178 CPI2000 InflationCalculation Calculate the inflation rate between 2000 and 2008: = 27.5%

  50. InflationUS, 1914 - 2008 1918 1947 1980 1942 1975 1951 1990 1938 1949 1932 1921 Source: Bureau of Labor Statistics

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