Chapter 17 keele prosperity growth - employment - indexing
Economics Combined Version Edwin G. Dolan Best Value Textbooks 4th edition Chapter 17 In Search ofProsperity and Stability
Economic Growth• The growth rate of real Gross Domestic Product (GDP) per capita is the most common measurement of increasing prosperity – Nominal GDP is stated in terms of prices at which goods are actually bought and sold – Real GDP is adjusted to remove the effects of inflation• US growth rate of real GDP is about average for the world – About 2-3% per year
Real and Nominal GDP • The term "real" means adjusted for inflation. • Nominal GDP is a measure of national output based on the current prices of goods and services. It is also called “money GDP”. • Real GDP is a measure of the quantity of final goods and services produced, obtained by eliminating the influence of price changes from nominal GDP. • Adjusting for Inflation requires a price index of some sort.3
Calculating a Price Index: the old fashioned, simple way• Select a basket of goods• Price of that basket of goods in Y1 divided by the price of that same basket in Y25
Calculating an Index price index = current cost of basket base period cost of basketNotes:• This formula yields a decimal. To translate it into the published form of the index (like CPI) multiply it by 100 (as if you were turning it to a percentage).• When using the index to calculate “real” values, use it in its decimal form6
Calculating “Real” Values Real GDP, Real Wage, Real Price, Real Income, etc.Real Value of Xt = Xt . Price index at time t• Note: when using this formula, be sure you use the price index in it’s decimal form, not in its expanded percentage form.7
Three Key Price Indexes Consumer Price Index (CPI) – measures the impact of price changes on the cost of the typical bundle of goods and services purchased by households. Producer Price Index (PPI) – A measure of the average prices received by producers for raw materials, intermediate, and final goods. The PPI used to be called the Wholesale Price Index (WPI). GDP Deflator (GDP Price Index or GDPPI) – Is a broader price index than the CPI. It is designed to measure the change in the average price of all the goods and services included in GDP.8
Price Indexes• The value of a price index in any particular year indicates how prices have changed relative to a base year. (1982-84)• The base year is the year against which all other years are compared.• The index is 100 ± the percent change in prices from the base year.• This type of index suffers from substitution bias as some buyers will change the mix of goods that they buy in response to price changes.• Chain-type indexes of real GDP were created to correct for this bias. Such an index uses the mean of the growth rates using beginning and ending year prices.9
Sources of Growth• Growth of population and increased labor force participation• Growth of productivity (output per worker) – Increase in capital per worker – Increase in total factor productivity
Productivity Growth in the United StatesProductivity growth varies from year to year. In the 1970s U.S.productivity growth slowed down. It revived again during the hi-techboom of the 1990s, but has recently slowed again.
Growth and the environment: Trade-off?• In early stages of economic development, increasing production of material goods often leads to reduced environmental quality (A to B)• In later stages, properly managed growth can increase both production of material goods and environmental quality
Actual and Natural/Potential GDP GrowthBecause of increasing population and productivity, the nation’s natural orpotential GDP increases steadily over time. As it does so, actual real output issometimes above and sometimes below the natural level.The difference is called the output gap
Business Cycles• Business Cycle: the pattern of real GDP rising and falling.• Recession (Contraction): two or more successive quarters of falling real GDP.• Depression: a severe, prolonged economic contraction. Usually involves unemployment rising to greater than 10% for years.
Economic Indicators• Leading Indicators • Variables that fairly consistently changes before real GDP changes• Coincident Indicators • Variables that fairly consistently changes at the same time as real GDP changes• Lagging Indicators • Variables that fairly consistently changes after real GDP changes
Indicators of Business CycleLeading Indicators Money Supply Manufacturers’ New Building Permits New Orders New plant and Average Work Week equipment orders Interest Rate Spread Unemployment ClaimsConsumer Expectations Stock Prices
Indicators of Business CycleCo-incident Indicators Personal income Payroll employment Industrial production Manufacturing and trade sales
Indicators of Business CycleLagging Indicators Inventories to Labor cost per sales ratio unit of output Unemployment duration Prime interest rate
Great DepressionYear U.S. Unemployment Rate1929 3.2%1930 8.7%1931 15.9%1932 23.6%1933 24.9% ↓ ↓1939 17.2%
UnemploymentThe unemployment rate is the percentage of the laborforce that is not working. Rate of number unemployed Unemploymen = number in the Labor Force tThe U.S. Labor Department defines the labor force asbeing equal to: • All U.S. residents • Over the age of 16 • Who are not institutionalized • Who are working or looking for work
Interpreting the Unemployment Rate• Discouraged Workers are workers who have looked for work in the past year, but who have stopped looking because they believe no one will offer them a job.• Underemployment is the employment of workers in jobs that do not utilize their productive skills.
Types of UnemploymentSeasonal Unemployment:A product of regular, recurring changes in thehiring needs of certain industries on a monthlyor seasonal basis.For example, retail sales are higher during theholiday season therefore unemployment inthis industry goes down during the months ofNovember and December.
Types of UnemploymentFrictional UnemploymentUsually short term, occurs because workers andemployers have to find one another.Example: College graduates seeking employmentare a good example of frictional unemployment.
Types of UnemploymentStructural UnemploymentReflects an imperfect match-up of employee skillsand the skill requirements of the available jobs ora permanent reduction in demand for anindustry’s output.Example: Advancements in technology haveresulted in consistent declines in employment inthe agriculture, forestry and fishing industries.
Types of UnemploymentCyclical UnemploymentA product of business cycle fluctuations.As a recession occurs, cyclical unemploymentincreases, and as growth occurs, cyclicalunemployment decreases.As the housing boom of the early 21st centuryslows, unemployment in related industries likebuilders and real estate agents increases.
Unemployment and Its Costs• Natural Rate of Unemployment The level of unemployment that results when the rate of unemployment is normal, considering both frictional and structural factors. Also called the NAIRU (Nonaccelerating Inflation Rate of Unemployment)• Potential Real GDP The level of output produced when nonlabor resources are fully utilized and unemployment is at its natural rate.• GDP gap = potential real GDP – actual GDP
Unemployment in the United StatesThe unemployment rate rises during contractions and falls duringexpansions. Because some people are always entering the laborforce or changing jobs, it never falls to zero.
Unemployment: US vs EuropeThe natural rate of unemployment varies from country to country,depending on cultural factors and labor laws. The natural rate hasfallen over time in the United States while it has risen in Europe
Unemployment by durationDuring a recession, morepeople are unemployed, andthe average duration ofunemployment also increases.Even during a recession, manyof the unemployed are out ofwork for 14 weeks or less.Social costs of unemploymentfall most heavily on the long-term unemployed, whosenumbers increase greatlyduring a recession.
Inflation in the United States• Inflation means a sustained rise in the price level• Deflation means a sustained fall in the price level• During 2009, the United States experienced several months of deflation, but prices began to rise again late in the year.
World inflation averages• Inflation was much higher in the 1970s and 1980s than it is now• During the 1990s, inflation fell, first in advanced countries and then in developing countries
Calculating an Inflation Rate Inflation or deflation = change in index X 100 initial value of the indexNotes:• Inflation is stated as a percentage, hence, the “X 100” which is just shifting a decimal to a percentage.• Price increases are referred to as Inflation, price decreases are Deflation• Once you’ve calculated the total inflation, you can divide it by the number of years to get an annualized inflation Rate33
Inflation and interest rates• Inflation affects interest Let rates as well as prices • R = nominal rate of interest• The nominal rate of • r = real rate of interest interest is expressed in the • π = rate of inflation ordinary way, in current dollars Then• The real rate of interest is r=R-π the nominal rate adjusted by subtracting the rate of inflation
Inflation and GrowthInflation of more than a few percent per year tends to undermineeconomic growth. On average, countries with more than 100percent annual inflation have negative economic growth.
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