Chapter 5: Economic Growth, Business Cycles, Unemployment, and Inflation

1. Chapter 5:Economic Growth, Business Cycles, Unemployment, and Inflation Prepared by: Kevin Richter, Douglas College Charlene Richter, British Columbia Institute of Technology © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

2. Introduction • Macroeconomics is the study of the aggregate economy. • The four central issues are: • growth • business cycles • unemployment • inflation. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

3. Two Frameworks: The Long Run and the Short Run • Issues of growth are considered in a long-run framework. • Business cycles are generally considered in a short-run framework. • Inflation and unemployment fall within both frameworks. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

4. Growth • Generally the Canadian economy is growing or expanding. • The primary measurement of growth is change in real gross domestic product (realGDP) – the market value of goods and services stated in the prices of a given year. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

5. Growth • The Canadian economy has grown at an annual rate of 4 percent over the last 130 years, but most recently it has been growing at about 2.5 -3.5 percent per year. • This average annual growth rate is called the secular growth rate. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

6. Growth • Since an economy’s population is increasing, a useful measure of growth is change in per capita real output. • Per capita real output is real GDP divided by the total population. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

7. Global Experience with Growth • Today's growth rates are high by historical standards. • Global experiences with growth vary across time and among nations. • African countries have consistently grown below the world average. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

8. Global Experience with Growth • The growth trend we now take for granted started at the end of the of the18th century. • At about the same time, markets and democracies became the primary organizing structures of society. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

9. Benefits and Costs of Growth • Per capita economic growth allows everyone in society, on average to have more. • Growth, or predictions of growth, allows governments to avoid hard questions. • A growing economy creates jobs. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

10. Benefits and Costs of Growth • The costs of growth include pollution, resource exhaustion, and destruction of natural habitat. • Since many believe the environmental costs of growth are important, the result is often an environmental-economic growth stalemate. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

11. Average Annual Per Capita Income, 1820-2000 © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

12. Business Cycles • The business cycle is the upward and downward movement of economic activity that occurs around the growth trend. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

13. Business Cycles • There are a number of policies regarding business cycles. • Classical economists generally favour laissez-faire or noninterventionist policies. • Keynesians generally favour activist policies. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

14. Canadian Business Cycles © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

15. Phases of the Business Cycle • The top of the business cycle is called the peak. • A boom is a very high peak, representing a big jump in output. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

16. Phases of the Business Cycle • The downturn is the phenomenon of economic activity starting to fall from a peak. • A recession is a decline in output that persists for more than two consecutive quarters in a year. • A depressionis a large recession. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

17. Phases of the Business Cycle • A trough is the bottom of the recession or depression. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

18. Phases of the Business Cycle • As total output starts to expand, the economy comes out of the trough into an upturn, which may turn into an expansion. • An expansion is an upturn that lasts at least two consecutive quarters of a year. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

19. Expansion Recession Expansion Boom Peak Upturn Downturn Total Output Secular growth trend Trough 0 Jan.- Mar Apr.- June July- Sept. Oct.- Dec. Jan.- Mar Apr.- June July- Sept. Oct.- Dec. Jan.- Mar Apr.- June Phases of the Business Cycle McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

20. Recessions and expansions are caused primarily by the demand side of the economy. A debate exists about whether these fluctuations can and should be reduced. Why Business Cycles Occur © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

21. Most economists believe that potential depressions should be offset by economic policy. This general view was built into economic policy after the Great Depression of the 1930s. Why Business Cycles Occur © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

22. Since the late 1940s, compared to prior years: Downturns and panics have generally been less severe. The duration of business cycles has increased. The average length of expansions has increased while the average length of contractions has decreased. Why Business Cycles Occur © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

23. Most economists believe that business fluctuations have become less severe because of the stronger role of government in the economy. Why Business Cycles Occur © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

24. Leading Indicators • Leading indicators tell us what's likely to happen in the economy 12 to 15 months from now. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

25. Leading Indicators • To be a leading indicator, a variable must reflect economic agents’ view of the future. • e.g.. Stock prices. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

26. Leading Indicators • Leading indicators include: • Average workweek for production workers in manufacturing. • Index of housing starts. • U.S. composite leading indicators. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

27. Leading Indicators • Leading indicators include: • Money supply (M1) divided by the price index. • New orders for durable goods. • Retail orders for durable goods. • Durable goods sales, excluding furniture and appliances. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

28. Leading Indicators • Leading indicators include: • Ratio of shipments to inventories or finished goods. • S&P / TSX Composite index. • Employment in business and personal service sector. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

29. Unemployment • The unemployment rate is the number of people who are willing and able to work but are not working. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

30. Unemployment • Cyclical unemployment results from fluctuations in economic activity. • Structural unemployment is caused by economic restructuring making some skills obsolete. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

31. Unemployment as a Social Problem • The Industrial Revolution created the possibility of cyclical unemployment. • It changed how society dealt with unemployment. • What had previously been a family problem, became a social problem. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

32. Unemployment as Government’s Problem • As capitalism evolved, capitalist societies no longer saw the fear of hunger as an acceptable answer to unemployment. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

33. Unemployment as Government’s Problem • Full employment – an economic climate in which just about everyone who wants a job can have one. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

34. Unemployment as Government’s Problem • The Federal Unemployment Insurance Act of 1940 assigned government the responsibility for providing assistance to the unemployed. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

35. Unemployment as Government’s Problem • Initially government regarded 3 percent unemployment as full employment. • The 3 percent was made up of frictional unemployment. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

36. Unemployment as Government’s Problem • Frictional unemployment is the unemployment caused by new entrants into the job market and people quitting a job just long enough to look for and find another one. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

37. Unemployment as Government’s Problem • The target rate of unemployment is the lowest sustainable rate of unemployment that policymakers believe is achievable under existing conditions. • Also called the natural rate of unemployment. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

38. Unemployment as Government’s Problem • Since the 1980s the target rate of unemployment has been between 6 and 8 percent. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

39. Why the Target Rate of Unemployment Changed • The target rate of unemployment has changed over time for the following reasons: • Demographics have changed – different age groups have different rates of unemployment. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

40. Why the Target Rate of Unemployment Changed • The target rate of unemployment has changed over time for the following reasons: • Social and institutional structures have changed. • Governmental institutions also changed. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

41. Whose Responsibility Is Unemployment? • Classical economists believe that individuals are responsible for their own jobs. • Classical economists believe the equilibrium wage adjusts to supply and demand imbalances, so anyone not working at the current wage is voluntarily unemployed. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

42. Whose Responsibility Is Unemployment? • According to Classical economists, a person is unemployed because the equilibrium wage is below his or her reservation wage. • Reservation wage is the minimum wage required to induce a person to work. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

43. Whose Responsibility Is Unemployment? • Keynesian economists believe that if wages do not adjust quickly enough involuntary unemployment may result. • Wages are sticky. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

44. Whose Responsibility Is Unemployment? • In Canada wages are sticky because of: • Implicit contracts. • Efficiency wages. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

45. How Is Unemployment Measured? • The unemployment rate is published by Statistics Canada. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

46. 30 20 10 0 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 Unemployment Rate Since 1900 Target rate McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

47. Calculating the Unemployment Rate • The unemployment rate – the number of unemployed individuals divided by the number of people in the labour force then multiplied by 100. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

48. Calculating the Unemployment Rate • The labour force – those people in an economy who are willing and able to work. • The labour force excludes those incapable of working and those not looking for work. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

49. Unemployment/Employment Figures (in millions) © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

50. How Accurate Is the Official Unemployment Rate? • The unemployment rate does not include discouraged workers. • Discouraged workers –people who do not look for a job because they feel they do not have a chance of getting one. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.