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Chapter 6

Chapter 6. Economic Growth, Business Cycle and Structural stagnation. Chapter Goals. Explain the difference between the long-run framework and the short-run framework. Distinguish between Classical and Keynesian Macroeconomics. Distinguish cyclical unemployment from structural unemployment.

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Chapter 6

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  1. Chapter 6 Economic Growth, Business Cycle and Structural stagnation

  2. Chapter Goals • Explain the difference between the long-run framework and the short-run framework • Distinguish between Classical and Keynesian Macroeconomics • Distinguish cyclical unemployment from structural unemployment • Distinguish a Business Cycle from Structural Stagnation • List four phases of the business cycle 7-2

  3. Historical Development Of Macro • Before doing covering the history let us talk about an Old War. • A war of ideas! • Go to PowerPoint lecture on the war of ideas.

  4. Two Frameworks: The Long Run and the Short Run • The long-run growth framework focuses on incentives for supply • Sometimes called supply-side economics • Issues of growth are considered in a long-run framework • The short-run business cycle focuses on demand • Sometimes called demand-side economics • Business cycles are generally considered in a short-run framework • Inflation and unemployment fall within both frameworks 7-4

  5. Growth • Economists measure growth as changes in real gross domestic product (real GDP) which is the market value of final goods and services produced in an economy, stated in the prices of a given year • The U.S. secular growth rate and the per capita real output growth have been less than 2.5 to 3.5 percent per year • Per capita real output is real GDP divided by the total population • Even if total output is increasing, the population may be growing even faster, so per capita real output may fall 7-5

  6. Global Experiences with Growth 7-6

  7. The Benefits and Costs of Growth • Per capita economic growth allows everyone in society, on average, to have more • Growth, or the prediction of growth, allows governments to avoid hard questions • Growth comes with costs: • Pollution • Resource exhaustion • Destruction of natural habitat 7-7

  8. Business Cycles • Sometimes GDP grows above the trend; at other times GDP falls below the trend • A business cycle is the upward or downward movement of economic activity, or real GDP, that occurs around the growth trend • Economists debate the causes of business cycles • Keynesians generally favor activist government policy • Classicals generally favor laissez-faire policies 7-8

  9. U.S. Business Cycles Business cycles have always been a part of the U.S. economic scene Percentage fluctuations in real GDP around trends 20 10 0 -10 -20 World War II World War I Recovery of 1895 Korean War Vietnam War Civil War Panic of 1907 Panic of 1863 Great Depression 1860 1800 1900 1920 1940 1960 1980 2000 7-9

  10. The Phases of the Business Cycle • The four phases of the business cycle are: • The peak • The downturn • The trough • The upturn • A recession is a decline in real output that persists for more than two consecutive quarters of a year • A depression is a large recession • An expansion is an upturn that lasts at least two consecutive quarters of a year 7-10

  11. Business Cycle Phases Total Output Boom Peak Upturn Secular Growth Trend Downturn Upturn Trough Expansion Recession Expansion 1 2 3 4 1 2 3 4 1 2 3 Quarters 7-11

  12. Why do Business Cycles Occur? 7-12

  13. Look at Phases • Go to Phases of Business Cycle power points before going to the leading indicators.

  14. Leading Indicators • Average work week • Unemployment claims • New orders for consumer goods • Vendor performance • Index of consumer expectations • New orders for capital goods • Building permits • Stock prices • Interest rate spread • Money supply, M2 7-14

  15. GDP, Cycles, Who Cares? • Why do we care about all of this fancy verbiage?

  16. Unemployment • The unemployment rate is the percentage of people who are willing and able to work but who are not working • Cyclical unemployment is that which results from fluctuations in economic activity • Structural unemployment is that caused by the institutional structure of an economy or by economic restructuring making some skills obsolete 7-16

  17. Unemployment as a Social Problem • The Industrial Revolution changed the nature of work and introduced unemployment as a problem for society • There was a shift to wage labor and to a division of responsibilities • The Industrial Revolution created the possibility of cyclical unemployment and changed how families dealt with unemployment • Early capitalism had an unemployment solution: the fear of hunger 7-17

  18. Unemployment as Government’s Problem • As capitalism evolved, the fear of hunger was no longer an acceptable answer to unemployment • In the Employment Act of 1946, the U.S. government took responsibility for unemployment • Full employment is an economic climate where nearly everyone who wants a job has one • Frictional unemployment is unemployment caused by people entering the job market and people quitting a job just long enough to look for and find another job 7-18

  19. Target Rate of Unemployment • The target rate of unemployment is the lowest sustainable rate of unemployment that policy makers believe is achievable under existing conditions • The appropriate target rate of unemployment is debatable, but most economists place it around 5% • The target rate of unemployment changes due to: • Inflation rates • Demographics • Social and institutional structures • Changing government institutions 7-19

  20. Whose Responsibility is Unemployment? • Classical economists believe that individuals are responsible for their own jobs • If people really want a job, they will find one • Keynesian economists tend to say that society owes people jobs commensurate with their training or past job experience • Jobs should be close enough to home so that people don’t have to move 7-20

  21. Unemployment Rate since 1900 In the mid-1940s, the U.S. government started focusing on the unemployment rate as a goal, and initially chose 2%, but it was gradually increased to around 5% Percentage of labor force unemployed 30 20 10 0 Target rate 1900 1920 1940 1960 1980 2000 7-21

  22. Chapter Summary • Economists use two frameworks to analyze macroeconomic problems: • The long-run growth framework focuses on supply • The short-run business cycle framework focuses on demand • Growth is measured by the change in: • Real gross domestic product (GDP) • Per capita real GDP • The secular trend growth rate of the economy is 2.5% to 3.5% 7-22

  23. Chapter Summary • Business cycles are fluctuations of real output around the secular growth trend • Phases of the business cycle are peak, downturn, trough, upturn • Unemployment is calculated as the number of unemployed people divided by the labor force • Unemployment rises during a recession and falls during an expansion 7-23

  24. Chapter Summary • The target rate of unemployment is the lowest sustainable rate of unemployment possible under existing institutions • The lower the target rate of unemployment, the higher an economy’s potential output 7-24

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