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Introduction to Macroeconomics

This text provides an overview of macroeconomics, focusing on the business cycle and its impact on GDP and unemployment. It discusses the different types of unemployment and their effects on the economy. The text also explores the costs of unemployment and why a 0% unemployment rate is undesirable.

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Introduction to Macroeconomics

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  1. Introduction to Macroeconomics The Business Cycle 1

  2. Two Key Features of GDP: • It grows over time • The long run trend in GDP is positive 2

  3. Two Key Features of GDP: • It grows over time • The long run trend in GDP is positive • It fluctuates as it grows • GDP exhibits business cycle movements 3

  4. Real GDP 1959 - 1994 5,500.0 5,000.0 4,500.0 4,000.0 3,500.0 Real GDP 3,000.0 Trend Line 2,500.0 2,000.0 1,500.0 1959 1963 1967 1971 1975 1979 1983 1987 1991 1994 Year 4

  5. EXAM TYPE QUESTION T T F The following graph demonstrates the long-run trend in GDP. 5,500.0 5,000.0 4,500.0 4,000.0 3,500.0 Real GDP 3,000.0 2,500.0 2,000.0 1,500.0 1959 1963 1967 1971 1975 1979 1983 1987 1991 1994 Year 5

  6. Business Cycle • Periodic movements in output, prices, and employment • Business cycles are not created equal. • Duration • Severity 6

  7. Macroeconomic Problems Recessions, Depressions, and Unemployment 7

  8. Recessions • A period in which real GDP declines for at least two consecutive quarters • Depression: a prolonged and deep recession 8

  9. Characteristics • Declining real GDP • Rising unemployment 9

  10. Types of Unemployment • Cyclical • due to business cycle movements in GDP • Frictional • due to job search activities • Structural • due to changes in economic institutions • geographic displacement, technological change, discrimination 10

  11. CYCLICAL UNEMPLOYMENT • DUE TO BUSINESS CYCLE, AD MIGHT FALL • AS AD FALLS, THE DEMAND FOR LABOR FALLS • AS THE DEMAND FOR LABOR FALLS, UNEMPLOYMENT RISES 11

  12. FALL IN AGGREGATE DEMAND PL AS AD AD’ 0 Y2 Y1 GDP 12

  13. RISE IN UNEMPLOYMENT SL WAGE DL DL’ 0 EMPLOYMENT E2 E1 13

  14. FRICTIONAL UNEMPLOYMENT • VOLUNTARY “BETWEEN JOB” WORKERS • MOVING FROM LOW-PAY TO HIGH-PAY JOBS • INCOME RISES • DESIRABLE 14

  15. STRUCTURAL UNEMPLOYMENT • TECHNOLOGY • DEMAND FOR LABOR FALLS 15

  16. DEFINING FULL-EMPLOYMENT • FRICTIONAL AND STRUCTURAL UNEMPLOYMENTS ARE UNAVOIDABLE • 100% FULL-EMPLOYMENT IS IMPOSSIBLE • A GIVEN UNEMPLOYMENT IS CONSIDERED TO BE FULL-EMPLOYMENT 16

  17. EXAM-TYPE QUESTION Full employment does not mean ……. Unemployment. 0% Economists regard frictional and ……………………. Unemployment unavoidable; hence “full employment” is defined as something ………….. than employment of 100% of the labor force structural less 17

  18. Defining Unemployment • Labor Force = Employed + Unemployed • Population = Labor Force + Not in Labor Force • Unemployment Rate = Unemployed Labor Force 18

  19. NOT IN LABOR FORCE • NOT CAPABLE OF BEING EMPLOYED - UNDER 16 YEARS - ARMED FORCES - INSTITUTIONALIZED • CAPABLE BUT NOT WILLING TO BE EMPLOYED - ADULTS IN SCHOOLS - RETIRED PEOPLE - NOT LOOKING FOR EMPLOYMENT 19

  20. Unemployment • Unemployment rate: the percentage of people in the labor force who can’t find a job Labor Force: people who are actively seeking or are currently holding a job 20

  21. Unemployment Pool Entrants New Entrants Re-entrants Job Leavers Job Losers 7% Unemployment • Job Finders • Discouraged • Workers • Labor Force • Leavers 21

  22. CRITICISMS • PART-TIME EMPLOYMENT • DISCOURAGED WORKERS • FALSE INFORMATION 22

  23. PART-TIME EMPLOYMENT • SOME ARE EMPLOYED PART-TIME BECAUSE THEY DO NOT FIND FULL-TIME JOBS, BUT THEY ARE COUNTED AS EMPLOYED • UNEMPLOYMENT RATE IS UNDERSTATED 23

  24. EXAMPLE • LABOR FORCE = 1,000 WORKERS • DAILY WORKING TIME = 8 HOURS • FULL-TIME WORKERS = 500 WORKERS • HALF-TIME WORKERS = 300 WORKERS • REQUIRED FULL-TIME JOB-HOURS = 1,000 x 8 = 8,000 HR • TIME EMPLOYED = ( 500 x 8 ) + ( 300 x 4 ) = 5,200 HR • TRUE UNEMPLOYMENT RATE = 8,000-5,200 = 35% 8,000 • CALCULATED UNEMPLOYMENT RATE = 1,000-(500+300) = 20% < 35% 1,000 24

  25. DISCOURAGED WORKERS • SOME WORKERS SEEK EMPLOYMENT FOR A LONG PERIOD • STOP SEEKING • ARE COUNTED AS NOT IN LABOR FORCE • UNEMPLOYMENT RATE UNDERSTATED 25

  26. EXAMPLE • LABOR FORCE = 800 WORKERS • FULL-TIME WORKERS = 600 WORKERS • DISCOURAGED WORKERS = 200 W. • TRUE UNEMPLOYMENT RATE = 1,000-600 = 40% 1,000 • CALCULATED UNEMPLOYMENT RATE = 800-600 = 25% < 40% 800 26

  27. EXAM-LIKE QUESTION Which of the following will lead to a decrease in the unemployment rate? a. Discouraged workers drop out of the labor force. b. More women enter the labor force and seek jobs. c. Young people leave summer jobs and return to college. d. The practice of not counting military personnel as part of the labor force. The correct answer is “a” 27

  28. FALSE INFORMATION • PEOPLE NOT IN LABOR FORCE MIGHT CLAIM THEY ARE SEEKING FOR EMPLOYMENT TO GET UNEMPLOYMENT COMPENSATION • UNEMPLOYMENT RATE OVERSTATED 28

  29. EXAMPLE • LABOR FORCE = 1,000 WORKERS • FULL-TIME WORKERS = 600 WORKERS • FALSE LABOR = 200 WORKERS • TRUE UNEMPLOYMENT RATE = 800-600 = 25% 800 • CALCULATED UNEMPLOYMENT RATE = 1,000-600 = 40% > 25% 1,000 29

  30. Costs of Unemployment • Personal costs • Social costs • Economic costs Why is 0% unemployment undesirable? 30

  31. SOCIAL COSTS OF UNEMPLOYMENT • UNEMPLOYMENT IS A SOCIAL CATASTROPHE • DEPRESSION MEANS IDLENESS • IDLENESS MEANS LOSS OF SKILLS, SELF RESPECT, MORALE, FAMILY DISINTEGRATION AND SOCIOPOLITICAL UNREST 31

  32. ECONOMIC COSTS OF UNEMPLOYMENT • GNP GAP • UNEQUAL BURDENS 32

  33. GNP GAP • WHEN THE ECONOMY FAILS TO GENERATE ENOUGH JOBS FOR ALL WHO ARE WILLING AND ABLE TO WORK, POTENTIAL PRODUCTION OF GOODS AND SERVICES IS LOST • OKUN’S LAW: FOR EVERY 1% ABOVE NORMAL UNEMPLOYMENT RATE, THERE SHALL BE A 2.5% GNP GAP 33

  34. EXAMPLE • ASSUME THE FOLLOWING: • FULL-EMPLOYMENT UNEMPLOYMENT RATE = 9% • UNEMPLOYMENT RATE = 18% • POTENTIAL OUTPUT = $5,000,000 • ABOVE NORMAL UNEMPLOYMENT RATE = 18% - 9% = 9% • GNP GAP = 9% x 2.5% = 22.5% • GNP = 5,000,000 ( 1 - 0.225 ) = $3,875,000 34

  35. 45º LINE EXPENDITURES AD E GNP GAP GNP ($MILLION) 0 3.875 5 35

  36. EXAM-TYPE PROBLEM a. If full employment output is $4 million, and equilibrium national output is $3 million, what shall be the GNP gap? GNP gap = 4 - 3 = $1 million b. What is the rate of GNP gap? Rate of GNP gap = 1/4 = 25% 36

  37. If the natural rate of unemployment is 9%, what is • the actual unemployment rate in the economy? Above normal unemployment rate = 25 ÷ 2.5 = 10 Unemployment rate = 10 + 9 = 19% • If the actual unemployment rate falls by 4% in • the coming year, what shall be the rate of GNP gap? New unemployment rate = 19 - 4 = 15% Above normal unemployment rate = 15 - 9 = 6% Rate of GNP gap = 6 x 2.5 = 15% 37

  38. UNEQUAL BURDENS • IF AS UNEMPLOYMENT RISES, WORKING HOURS OF ALL LABOR FALLS  EQUAL BURDEN • BUT AS UNEMPLOYMENT RISES, GROUPS OF PEOPLE ARE ENTIRELY UNEMPLOYED  UNEQUAL BURDEN 38

  39. EXAMPLE • LABOR FORCE = 1,000 WORKERS • DAILY WORKING TIME = 8 HOURS • UNEMPLOYMENT RATE = 25% • SHARING THE BURDEN OF UNEMPLOYMENT WOULD MEAN ALL 1,000 WORKERS HAD TO BE EMPLOYED 6 HOURS EACH • BUT THE REAL LIFE PRACTICE IS NOT SO, RATHER 250 WORKERS WOULD BE 100% UNEMPLOYED, AND 750 WORKERS WOULD BE 100% EMPLOYED 39

  40. Macroeconomic Problems Inflation 40

  41. How Do We Measure the Price Level? • GDP deflator: a measure of the prices of all goods produced • CPI: Consumer Price Index: a measure of the price of a market basket of goods 41

  42. The Price Level in Cicely • In Cicely, three goods are produced: • meat • Coffee • shoes • A market basket is 2 meats, 5 Coffees, and 1 pair of shoes. 42

  43. Production in Cicely • 1991 • PriceQuantity • $3 10 • $5 15 • $7 20 • 1992 • Price Quantity • $4 20 • $4 10 • $20 15 Meat Coffee Shoes What is the price level in Cicely? 43

  44. CPI • Multiply the price of the good by the quantity in the market basket and add over all goods. • In 1991: $3(2) + $5(5) + $7(1) = $38 • In 1992: $4(2) + $4(5) + $20(1) = $48 • Rate of Inflation (48_-_38) = 26%. 38 44

  45. GDP Deflator • Nominal GDP: GDP measured in current year prices • Real GDP: GDP measured in constant prices (prices derived from a base year) 45

  46. EXAM TYPE QUESTION T F GNP in constant dollars refers to the value of all goods and services produced in an economy per year deflated for price changes. The statement is TRUE. 46

  47. GDP in Cicely • 1991 • $245 • 1992 Nominal GDP Real GDP GDP deflator $245 = $3(10) + $5(15) + $7(20) 47

  48. GDP in Cicely • 1991 • $245 • 1992 • $420 Nominal GDP Real GDP GDP deflator $420 = $4(20) + $4(10) + $20(15) 48

  49. GDP in Cicely • 1991 • $245 • $245 • 1992 • $420 Nominal GDP Real GDP GDP deflator $245 = $3(10) + $5(15) + $7(20) 49

  50. GDP in Cicely • 1991 • $245 • $245 • 1992 • $420 • $215 Nominal GDP Real GDP GDP deflator • $215 = $3(20) + $5(10) + $7(15) • Note that we have used 1991 prices. 50

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