Chapter 9 - Summary Macroeconomics PDF

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Chapter 9 - Business Cycles, Unemployment, and Inflation The Business Cycle ● Business cycle - growth trend ● Alternating rises and declines in the level of economic activity ● Phases ○ Peak ■ Temporary maximum ■ Economy near or at full employment ■ Level of real output is at or very close to the economy’s capacity ■ Price level is likely to rise ○ Recession ■ Period of decline in total output, income, and employment ■ Lasts 6 or more months ■ Significant increases in unemployment ○ Trough ■ Recession or depression ■ At the lowest levels ■ Phase might be short-lived or quite long ○ Expansion ■ Real GDP, income, and employment rise ■ Economy approaches full employment ● Possible general sources of shocks that can cause business cycles ○ Irregular innovation ■ Significant new products or production methods that increases investment, consumption, output, and employment ■ After economy absorbs the new innovation, the economy may for a time slow down or possibly decline ■ Such innovation occurs irregularly and unexpectedly, they may contribute to the variability of economic activity ○ Productivity changes ■ When unexpectedly increases, the economy booms and vise versa ○ Monetary factors ■ When a nation’s central bank shocks the economy by creating more money than people were expecting, an inflationary boom in output occurs ■ Printing less money than people were expecting triggers an output decline - leads to a price-level fall ○ Political events ■ Unexpected political events, such as peace treaties, new wars, or terrorist attack - those can create economic opportunities or strains ○ Financial instability ■ Unexpected financial bubbles or bursts can spill over to the general economy by expanding or contracting lending, and boosting or eroding the confidence of consumers and businesses

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Consumer durables ○ Automobiles, personal computer, refrigerators … ○ Most affected by the business cycle Nondurable consumer goods ○ It’s harder to cut back on needed medical and legal services

Unemployment ● 3 groups ○ People under 16 years old and people who are institutionalized ■ Not considered potential members of the labor force ○ “Not in labor force” ■ Adults who are potential workers but are not employed and are not seeking work ■ Stay-at-home parents ■ Full-time students ■ Retirees ○ Labor force ■ Consists of people who are able and willing to work ■ Both those employed ad those who are unemployed but actively seeking work ● Unemployment rate ○ Percentage of the labor force ○ ●

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Unemployment rate =

unemployed X 100 labor force

Frictional unemployment ○ Search unemployment and wait unemployment - for workers who are either searching for jobs or waiting to take jobs in the near future Structural unemployment ○ Changes over time in consumer demand and in technology alter the “structure” of the total demand for labor, both occupationally and geographically ○ Occupationally - demain for certain skills may decline ■ Demand for others intensify ■ Unemployment results as the labor force does not respond immediately or completely to the new structure of job opportunities ○ Geographically - demand for labor also changes ■ Migration of industry ■ Movement of jobs from inner-city factors to suburban industrial parks ■ As job opportunities shift from one place to another, some workers become structurally unemployed Cyclical unemployment ○ Unemployment caused by a decline in total spending ○ Typically begins in the recession phase of the business cycle ○ Demand for goods and services decreases, employment falls and unemployment rises

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○ Cyclical unemployment results from insufficient demand for goods and services Full-employment rate of unemployment/natural rate of unemployment ○ Employment rate that is consistent with full employment GDP gap ○ Difference between actual and potential GDP ○ Can either be negative or positive Okun’s law ○ For every 1% point by which the actual unemployment rate exceeds the natural rate, a negative GDP of about 2% occurs Generalizations ○ Occupation ■ Workers in lower-skilled occupations have higher unemployment rates ■ More and longer spells of structural unemployment than higher skilled workers ■ Less likely to be self employed ○ Age ■ Teenagers have higher unemployment rates than adults ■ Lower skill levels and quit jobs more frequently ○ Race and ethnicity ■ Unemployment rates for African Americans and Hispanics are higher than that for whites ■ Lower rates of educational attainment, greater concentration in lowerskilled occupations ○ Gender ■ Unemployment rates for men and women normally very similar ○ Education ■ Less educated workers have higher unemployment rates than workers with more education ○ Duration ■ Number of persons unemployed for longer periods is much lower than the overall unemployment rates

Inflation ● Inflation ○ Rise in the general level of prices ○ Each dollar of income will buy fewer goods and services than before ● Consumer Price Index (CPI) ○ Main measure of inflation ○ Government uses this index to report inflation rate each month and each year ○ Uses CPI to adjust SS benefits and income tax brackets for inflation ● Deflation ○ Price level declines ● Demand-pull inflation

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Increases in the price level are caused by an excess of total spending beyond the economy’s capacity to produce ○ Excess demand bids up the prices of the limited output Cost-push inflation ○ Rising prices in terms of factors that raise per-unit production costs at each level of spending ○ Per-unit production costs is the average cost of a particular level of output ○

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Per-unit production cost =

total input cost units of output

Core inflation ○ Underlying increases in the CPI after volatile food and energy prices are removed ○ Low and stable

Redistribution Effects of Inflation ● Nominal income ○ Number of dollars received as wages, rent, interest, or profit ● Real income ○ Measure of the amount of goods and services nominal income can buy ○ Purchasing power of nominal income ○ ●

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Real income =

nominalincome price index(¿ hundredths)

Unanticipated inflation ○ Hurts fixed-income recipients, savers, and creditors ○ Redistributes real income away from them and towards others ○ Fixed-income receivers ■ People whose incomes are fixed feel their real incomes fall when inflation occurs ■ Elderly couple living on a private pension ○ Savers ■ As prices rise, the real value, or purchasing power, of an accumulation of savings deteriorates ○ Creditors ■ Each of those dollars will buy only half as much as it did when the loan was negotiated ■ As prices go up, the purchasing power of the dollar goes down Flexible-income receivers ○ People who have flexible incomes may escape inflation’s harm or even benefit from it ○ Individuals who derive their incomes solely from SS are largely unaffected by inflation because SS payments are indexed to CPI Debtors ○ Benefits debtors ○ Inflation reduces the real burden of the public debt to the federal government

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Anticipated inflation ○ Effects are less severe or are eliminated if people anticipate inflation and can adjust their nominal incomes to reflect the expected price-level rises Real interest rate ○ Percentage increase in purchasing power that the borrower pays the lender Nominal interest rate ○ Percentage increase in money that borrowers pay the lender Nominal interest rate = real interest rate + inflation premium Other redistribution issues ○ Deflation ■ Effects of unanticipated deflation - declines in the price level - are the reverse of those of inflation ■ People with fixed nominal incomes will find their real incomes enhanced ■ Creditors will benefit at the expense of debtors ○ Mixed effects ■ If the person owns fixed-value monetary assets, inflation will lessen their real value ■ Same inflation may produce an increase in the person’s nominal wage ○ Arbitrariness ■ Effects of inflation occur regardless of society’s goals and values ■ Inflation lacks a social conscience and takes from some and gives to others

Does Inflation Affect Output? ● Low levels of inflation reduce real output because inflation diverts time and effort toward activities designed to hedge against inflation ● Hyperinflation ○ Extraordinarily rapid inflation, can have a devastating impact on real output and employment...