Chapter 4 Notes PDF

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Chapter 4- the importance of the study of macroeconomics ...

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Chapter 4 OBJECTIVES: 4.1Explain why the study of macroeconomics is important. 4.2 Describe economic growth and business fluctuations and explain their effects. 4.3 Calculate the rate of unemployment and discuss the three kinds of unemployment. 4.4 Explain how inflation is measured and describe the effects of inflation and deflation.

4.1Explain why the study of macroeconomics is important. Microeconomics looked at a single firm and their costs of production. Macroeconomics looks at the big picture, or in other words it looks at variables that impact all of the economy, such as inflation and unemployment. As a business student, you need to be able to read the newspaper and look at the economic indicators so you can make better business decisions. We will look at three major variables, GDP, unemployment and inflation.

4.2 Describe economic growth and business fluctuations and explain their effects. Gross Domestic Product (GDP) – The value of all goods and services produced in a country in a year.

This is an important indicator of how the economy is doing. Most often over the years we have experienced growth, which helps determine our standard of living. One problem that we encounter is that we can not just compare the GDP of 1880 with the GDP of 2006, because of price changes. So, we will learn how to calculate what is called, Real GDP, which simple means that we will adjust GDP for inflation. Of course over the long term, growth will go through different cycles. Expansion is an increase in overall economic activity. Contraction is a decrease in overall economic activity. Recession is when economic activity declines for two consecutive quarters or more. Depression is an extremely deep and presistant recession.

BUSI NESSCYCLE ACTI VI TY

RECESSI ON

PEAK RECOVERY TROUGH

TI ME 1. PEAK - economy is at full employment and output is close to capacity, price level is rising 2. RECESSION - output and employment decline, price sticky likely to fall only in a depression 3. TROUGH - output and employment "bottom out" at lowest levels

4. RECOVERY - output and employment expand toward full employment price level rises PRIOR to increase in output & employment REASONS FOR THE CYCLES: - Major innovations - electricity, cars - Random events - war - Aggregate (TOTAL) expenditures i.e. C + G + Ig +Xn - Seasonal - Xmas - winter - Durables - postpone or make do

4.3 Calculate the rate of unemployment and discuss the three kinds of unemployment. Working age population – the number of people 15 years of age or older. Labour Force – Individuals aged 15 years or older who either have jobs or are looking and available for jobs; the number of employed plus the unemployed. Therefore labour force = employed + unemployed PARTICIPATION RATE - is the labour force expressed as a % of the labour force. Participation rate = labour force --------------------------labour force population

x 100

UNEMPLOYMENT RATE - is percentage of the labour force that is unemployed. Unemployment rate = unemployed / labour force EMPLOYED - any person who did any work at all or had a job but did not work because of illness, vacation, labour disputes, personal or family responsibilities or bad weather

EXAMPLE: 02 LABOUR FORCE POPULATION

20,000

03 19,200

LABOUR FORCE

17,315

EMPLOYED

15,260

UNEMPLOYED

2,055

2,089

EMPLOYMENT RATE UNEMPLOYMENT RATE PARTICIPATION RATE

88% 12%

87.8% 12.2% .895 17198/19200= .895

.865

17,198 15,109

TYPES OF UNEMPLOYMENT Unemployment – total number of adults aged 15 and older who are willing and able to work, and who are actively looking for work but have not found a job. Statistics Canada considers someone unemployed if they are available for work and fit into any of these 3 categories: a. Not working, but looking within the previous 4 weeks b. Laid off within the previous 26 weeks and waiting for recall c. Waiting to begin a new job within the next 4 weeks Discouraged workers – Individuals who have stopped looking – no way to measure so not included. 1. FRICTIONAL - given freedom of job choice - some people will be between jobs - changing jobs - finding new jobs - first jobs - maternity leave - seasonal layoffs - inevitable & in part desirable (move to better jobs) 2. SEASONAL/STRUCTURAL – Unemployment resulting from the seasonal pattern of work in specific industries. -

agriculture construction tourist

- technological changes make some skills obsolete and other skills in demand - unemployment results because labour force is slow to respond and retraining is usually necessary - also geographic distribution of jobs changes 3. CYCLICAL - unemployment as the result of recession phase of cycle, if business down - employment down & visa versa Full employment rate of unemployment: - reached when cyclical unemployment is zero - natural rate of unemployment is achieved when - # of job seekers = # of job vacancies - natural rate has increased from 3% to 6%, and is now estimated at 7.4 to 9.5% 1. White collar workers enjoy lower unemployment rates and are less vulnerable to unemployment during recessions than are blue collar workers 2. Teenagers incur much higher unemployment rates than do adults 3. Male and female rate are quite comparable 4. The number of people unemployed for long periods ( 14+ weeks) is often much less than the unemployment rate (rises during recession) - a large portion of unemployment is of relatively short duration.

4.4 Explain how inflation is measured and describe the effects of inflation and deflation. 1. MEANING OF INFLATION INFLATION IS A GENERAL RISING OF THE PRICE LEVEL (not all

prices need to be rising) 2. MEASURING INFLATION INFLATION IS MEASURED BY PRICE INDEX NUMBERS - GENERAL LEVEL OF PRICES WITH REFERENCE TO A BASE YEAR. PRICE INDEX = Cost of Goods in Current Year ----------------------------------------Cost of Goods in Base Year

X 100

Consumer Price Index in 2002 = 100 – base year Commodity Quantity 2002 Cost of basket 2017 Price Cost of basket Price per in 2002 per Unit in 2017 Unit Cars 4000 $22,000 88,000,000 $26,000 104,000,000 Hot dogs

1,300,000

$2.00

2,600,000 $2.50

Totals

90,600,000

107,250,000

Consumer Price Index for 2017 = 107,250,000/90,600,000 X 100 = 118.38

RATE OF INFLATION = LATER INDEX – EARLIER INDEX ----------------------------------EARLIER INDEX EXAMPLE: YEAR 1

PRICE INDEX 100

RATE OF INFLATION -

3,250,000

x 100

2 3 4

125 141.5 166.2

125 - 100 / 100 = 25% 141.5 - 125 / 125 = 13.2% 166.2 - 141.5 / 141.5 = 17.5%

RULE OF 70 - APPROXIMATE NUMBER OF YEARS = 70 REQUIRED TO DOUBLE -----------------Annual % Inflation Rate EXAMPLE: YEAR 2 3 4

70/25 = 2.8 YEARS 70/13.2 = 5.3 YEARS 70/17.5 = 4 YEARS

CPI – already explained PPI – Producer Price Index – weighted average of prices of commodities that firms purchase from other firms GDP deflator – Nominal GDP / Real GDP x 100 - price index measuring the changes in prices of all new goods and services produced in the economy Anticipated Inflation – the inflation rate we believe will occur Unanticipated inflation – comes as a surprise Nominal Rate of interest – the market rate of interest expressed in today’s dollars – unadjusted for inflation Real Rate of Inflation – nominal rate – anticipated rate of inflation - Keeping real output and real income constant - MONEY OR NOMINAL INCOME is - number of dollars received as wages, rent, interest or profits. - REAL INCOME - measures the amounts of goods and services one's money income can buy. - purchasing power REAL INCOME = NOMINAL INCOME -------------------------PRICE INDEX (IN HUNDREDTHS)

- the purchasing power of the dollar declines with inflation. Real income declines only if nominal income does not keep pace with inflation. - If inflation is expected, steps might be taken to avoid the adverse effects. Unanticipated inflation – creditors lose and debtor wins – borrowers are not charged a nominal rate of interest that fully covers the rate of inflation. COLA’s – cost of living adjustments – wages increase as inflation increases Repricing or menu cost of inflation – costs associated with recalculating prices and printing new price lists. FIXED-MONEY INCOME RECEIVERS - inflation penalizes people who receive relatively fixed nominal pensions (now indexed to keep up with inflation) SAVERS - as price increases the real value of liquid savings will deteriorate. - rate of inflation > rate of nterest

incomes. i.e....