Chapter 5 The macroeconomic environment

1. Chapter 5 The macroeconomic environment Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

2. Learning objectives • Describe the business cycle — the periodic fluctuations in output, employment and price levels that have characterised our economy • Examine unemployment in detail — its definition and measurement, and the structure of unemployment • Discuss the economic and social problems associated with unemployment Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

3. Learning objectives (cont.) • Understand the causes and consequences of inflation, a problem that plagued us through the 1970s and 1980s • Discuss the history and changes in structure of Australia’s balance of payments, with emphasis on the current account of the balance of payments • Discuss the relationship between the current account balance and the level of national savings Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

4. The business cycle • The recurrent, somewhat cyclical, increases and decreases in the level or rate of growth in economic activity that typify the pattern of progress of our economy’s real GDP over time Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

5. The Australian business cycle & rate of inflation Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

6. Phases of the business cycle • Peak • Temporary maximum economic activity • Recession • Decline in output and employment to low or negative levels • A depression is a severe and prolonged recession Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

7. Phases of the business cycle (cont.) • Trough • Output and employment bottom out at their lowest levels • Recovery • Output and employment expand towards the full-employment level or capacity level • Secular/growth trend • The average (or trend) rate of expansion or contraction of an economy over the long term (25, 50 or 100 years) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

8. Peak Peak TREND Peak Recovery GROWTH Recession Recovery Recession Trough Trough The business cycle Level of business activity Time Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

9. Causes of business cycle Variety of explanations/theories: • Innovation • Political events • Random events • Purely monetary phenomenon • Immediate determinant — aggregate expenditure Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

10. Business cycle Non-cyclical fluctuations • Seasonal variations in business activity are regular fluctuations in the tempo of business activity that are independent of the business cycle and occur particularly in the retail industry Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

11. Business cycle • Cyclical impact: durables and non-durables • Capital goods and consumer durables most greatly affected by business cycles • Consumer non-durables least affected • Postponability • Monopoly power Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

12. Growth in motor vehicles registrations, new dwellings approved and retails sales in Australia Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

13. Types of unemployment • Frictional • Workers ‘between jobs’, temporarily laid off due to seasonality and new entrants • Allows movement of labour from low to high productivity • Inevitable and partly desirable • Structural • Mismatch in skills and geographic location • Not employable without additional training, education and geographical movement • Arises due to changes in labour demand caused by changes in consumer demand and technology • Cyclical • Unemployment caused by the business cycle, or due to insufficient aggregate demand or total spending Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

14. Full employment • The full-employment rate of unemployment is called the ‘natural rate of unemployment’ • Equals the sum of frictional and structural unemployment • Cyclical unemployment = zero • Domestic output consistent with the natural rate of unemployment is potential output or GDP Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

15. Australia: unemployment rate Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

16. Measuring unemployment • Part-time employment • Underemployed workers, prefer more hours of work • Discouraged workers or the ‘hidden unemployed’ • Those who become discouraged and drop out of the labour force but would return if a suitable job prospect arose • Discouraged workers, participation rate and the unemployment rate Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

17. Cost of unemployment Economic costs • Output forgone, measured in terms of theGDP gap • The amount by which the actual level of GDP falls short of the potential GDP • Okun’s law shows the relationship between the unemployment rate and the GDP gap • Unequal burdens • Unemployment is borne more heavily by some groups than others Non-economic costs Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

18. Current year index – Previousyear index Current year index – Previousyear index Inflation rate Inflation rate × × = = 100 100 Previous year index Previous year index Inflation • Inflation is a continuous rise in the general price level • The inflation rate is measured as follows: Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

19. Theories of inflation Two general theories of inflation: • Demand-pull inflation • Caused by excess demand for output • Cost-push inflation • Rise in prices arising from increased cost of production due to: • Wage push • Profit push Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

20. Range 3 Range 2 Range 1 Full- employment output The price level and the level of unemployment P Price level Q Output and employment Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

21. Inflation & redistribution • Most severe when inflation is unanticipated • Fixed-nominal-income receivers • Inflation penalises people living on fixed nominal income • Savers • The value of savings will decline if inflation is higher than the interest rate • Debtors and creditors • Inflation tend to benefit borrowers at the expense of the lenders Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

22. Anticipated inflation • Real interest rate • The percentage increase in the purchasing power that a lender receives from a borrower in exchange for the borrower’s use of the lender’s funds • Nominal interest rate • The percentage increase in money that the lender receives from the borrower Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

23. Output effects of inflation • Stimulus of demand-pull inflation • High level of spending required for higher output and lower unemployment also causes some inflation • Cost-push inflation and unemployment • Hyperinflation • Wage-price inflationary spiral • A continuous cycle of money wage and price rises that feed on each other Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

24. Australia’s current account problem • Three factors • Gradual deterioration in the terms of trade • High freight and transport costs • Dependence on large levels of capital inflow • Current account problems in the 1970s, 1980s, 1990s and into the 2000s Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

25. Components of the current account Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

26. The capital and financial account balance 1959–60 to 2001–02 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

27. National savings • National savings represents savings from national income • Used to finance gross capital formation • Continuous fall in household savings in Australia in recent years: • Increases in household wealth • Replacement of direct savings with alternatives such as superannuation Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

28. Australia: net national savings, 1959–60 to 2004–05 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal