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Copyright © 2002 by Thomson Learning, Inc.
to accompanyto accompany
Exploring EconomicsExploring Economics
33rdrd
EditionE...
Copyright © 2002 by Thomson Learning, Inc.
Macroeconomic GoalsMacroeconomic Goals
Chapter 17Chapter 17
Copyright © 2002 by Thomson Learning, Inc.
17.1 Macroeconomic Goals17.1 Macroeconomic Goals
 Three major macroeconomic go...
Copyright © 2002 by Thomson Learning, Inc.
 We use the termWe use the term real grossreal gross
domestic product (RGDP)do...
Copyright © 2002 by Thomson Learning, Inc.
 Technically,Technically, gross domesticgross domestic
product (GDP)product (G...
Copyright © 2002 by Thomson Learning, Inc.
What Other Goals Are Important?What Other Goals Are Important?
 Concern has be...
Copyright © 2002 by Thomson Learning, Inc.
How Do Value JudgmentsHow Do Value Judgments
Affect Economic Goals?Affect Econo...
Copyright © 2002 by Thomson Learning, Inc.
Acknowledging Our Goals:Acknowledging Our Goals:
The Employment Act of 1946The ...
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 The concern over both unemploymentThe concern over both unemployment
and pric...
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17.2 Employment and17.2 Employment and
UnemploymentUnemployment
 Nearly everyo...
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The Consequences Of HighThe Consequences Of High
UnemploymentUnemployment
 Soc...
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 Hence, other things equal, relativelyHence, other things equal, relatively
hi...
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What Is The UnemploymentWhat Is The Unemployment
Rate?Rate?
 The unemployment ...
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 Official unemployment measuresOfficial unemployment measures
those over the a...
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 The civilian labor force figure excludes:The civilian labor force figure excl...
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Copyright © 2002 by Thomson Learning, Inc.
The Worst Case Of U.S.The Worst Case Of U.S.
UnemploymentUnemployment
 By far ...
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 The debilitating impact of havingThe debilitating impact of having
millions o...
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 Some economists would argue thatSome economists would argue that
modern macro...
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Variations In The UnemploymentVariations In The Unemployment
RateRate
 Unemplo...
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Are Unemployment Statistics AccurateAre Unemployment Statistics Accurate
Reflec...
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 Also, people looking for full-time workAlso, people looking for full-time wor...
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 However, at least partially balancingHowever, at least partially balancing
th...
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 In addition, there may be manyIn addition, there may be many
people who claim...
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Who Are The Unemployed?Who Are The Unemployed?
 Unemployment usually varies gr...
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 Unemployment tends to be greaterUnemployment tends to be greater
amongamong
...
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 Considering the great variations inConsidering the great variations in
unempl...
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Copyright © 2002 by Thomson Learning, Inc.
Categories For UnemployedCategories For Unemployed
WorkersWorkers
 There are f...
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 Job losers typically account for 50Job losers typically account for 50
to 60 ...
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Copyright © 2002 by Thomson Learning, Inc.
How Much Unemployment?How Much Unemployment?
 While unemployment is painful, r...
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The Average Duration OfThe Average Duration Of
UnemploymentUnemployment
 The d...
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 The duration of unemployment tends toThe duration of unemployment tends to
 ...
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Labor Force Participation RateLabor Force Participation Rate
 The percentage o...
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17.3 Types of Unemployment17.3 Types of Unemployment
 Frictional unemploymentF...
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Should We Worry AboutShould We Worry About
Frictional Unemployment?Frictional U...
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 Hence, frictional unemployment,Hence, frictional unemployment,
while not good...
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 It is unusual for it to be much lessIt is unusual for it to be much less
than...
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Structural UnemploymentStructural Unemployment
 Structural un employment makes...
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 Many persons advocate government-Many persons advocate government-
subsidized...
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 To a considerable extent, one canTo a considerable extent, one can
view both ...
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 If individuals seeking jobs andIf individuals seeking jobs and
employers seek...
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Cyclical UnemploymentCyclical Unemployment
 In years of relatively high unempl...
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 Given its volatility and dimensions,Given its volatility and dimensions,
gove...
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The Natural Rate Of UnemploymentThe Natural Rate Of Unemployment
 The median, ...
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 The 5 percentThe 5 percent natural rate ofnatural rate of
unemploymentunemplo...
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 Today, economists, for the most part,Today, economists, for the most part,
ha...
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 When all of the economy’s laborWhen all of the economy’s labor
resources, and...
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 When the economy is experiencingWhen the economy is experiencing
cyclical une...
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17.4 Reasons for17.4 Reasons for
UnemploymentUnemployment
 Obstacles in labor ...
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Copyright © 2002 by Thomson Learning, Inc.
Why Does UnemploymentWhy Does Unemployment
Exist?Exist?
 Economists have cited...
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Minimum Wages AndMinimum Wages And
UnemploymentUnemployment
 AA minimum wage r...
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The Impact Of Unions OnThe Impact Of Unions On
The Unemployment RateThe Unemplo...
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 This has led to theThis has led to the insider-outsiderinsider-outsider
hypot...
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Efficiency WageEfficiency Wage
 In theIn the efficiency wage modelefficiency w...
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 But because the wage is above theBut because the wage is above the
equilibriu...
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Job SearchJob Search
 Because of frictional unemployment,Because of frictional...
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 In a dynamic economy, jobs areIn a dynamic economy, jobs are
constantly being...
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Unemployment InsuranceUnemployment Insurance
 It partially offsets the hardshi...
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 It has been estimated that this mayIt has been estimated that this may
raise ...
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Does New Technology LeadDoes New Technology Lead
To Greater Unemployment?To Gre...
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 If new equipment is a substitute forIf new equipment is a substitute for
labo...
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 New inventionsNew inventions
 Generally produce cost savingGenerally produce...
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17.5 Inflation17.5 Inflation
 Overall stableOverall stable price levelprice le...
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Stable Price Level As AStable Price Level As A
Desirable GoalDesirable Goal
 I...
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The Price Level Over The YearsThe Price Level Over The Years
 TheThe Consumer ...
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Copyright © 2002 by Thomson Learning, Inc.
Who Loses With Inflation?Who Loses With Inflation?
 Erodes the purchasing powe...
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 Inflation brings about changes in realInflation brings about changes in real
...
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 Inflation can raise one nation's priceInflation can raise one nation's price
...
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 In its extreme form, inflation can leadIn its extreme form, inflation can lea...
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Unanticipated InflationUnanticipated Inflation
Distorts Price SignalsDistorts P...
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Menu And Show-Leather CostsMenu And Show-Leather Costs
 Another cost of inflat...
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Inflation And Interest RatesInflation And Interest Rates
 Nominal interestNomi...
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 If people correctly anticipate inflation,If people correctly anticipate infla...
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 Failure to understand the differenceFailure to understand the difference
betw...
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 In the last exhibit, we saw that when theIn the last exhibit, we saw that whe...
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 An interest rate is, in effect, the priceAn interest rate is, in effect, the ...
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 The lower the interest rate, the greater theThe lower the interest rate, the ...
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 When people start expecting futureWhen people start expecting future
inflatio...
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 Likewise, demanders of fundsLikewise, demanders of funds
(borrowers) are more...
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 Both the decrease in supply and theBoth the decrease in supply and the
increa...
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Do Creditors Always LoseDo Creditors Always Lose
During Inflation?During Inflat...
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 Nominal interest rates and realNominal interest rates and real
interest rates...
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Protecting Ourselves FromProtecting Ourselves From
InflationInflation
 Increas...
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 Some have argued that we should goSome have argued that we should go
one step...
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 Approaches to try to stop inflationApproaches to try to stop inflation
includ...
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17.6 Economic Fluctuations17.6 Economic Fluctuations
 Business cyclesBusiness ...
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The Phases Of A Business CycleThe Phases Of A Business Cycle
 ExpansionExpansi...
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 ExpansionExpansion
 Usually is longer than the contraction.Usually is longer...
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 PeakPeak
 when the expansion comes to an endwhen the expansion comes to an e...
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 Contraction phase can also be calledContraction phase can also be called
aa r...
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 TroughTrough
 the point in time when output stopsthe point in time when outp...
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How Long Does A BusinessHow Long Does A Business
Cycle Last?Cycle Last?
 Often...
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 The contraction phase is one ofThe contraction phase is one of
recession, a d...
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Seasonal Fluctuations AffectSeasonal Fluctuations Affect
Economic ActivityEcono...
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 Often, key economic statistics, likeOften, key economic statistics, like
unem...
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 Thus, seasonally adjustedThus, seasonally adjusted
unemployment rates in summ...
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Political Business CyclesPolitical Business Cycles
 Studies have shown a stron...
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 Of course, the negative side to all ofOf course, the negative side to all of
...
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Forecasting Cyclical ChangesForecasting Cyclical Changes
 Businesses, governme...
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 Economists gather statistics onEconomists gather statistics on
economic activ...
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 Because human behavior changes,Because human behavior changes,
 we cannot co...
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 One less sophisticated but veryOne less sophisticated but very
useful forecas...
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 There are about a dozen such leadingThere are about a dozen such leading
indi...
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 Since the development of the indexSince the development of the index
of leadi...
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 While the economic indicators doWhile the economic indicators do
provide a wa...
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Macroeconomic goals

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Macroeconomic goals

  1. 1. Copyright © 2002 by Thomson Learning, Inc. to accompanyto accompany Exploring EconomicsExploring Economics 33rdrd EditionEdition by Robert L. Sextonby Robert L. Sexton Copyright © 2005 Thomson Learning, Inc.Copyright © 2005 Thomson Learning, Inc. Thomson Learning™ is a trademark used herein under license.Thomson Learning™ is a trademark used herein under license. ALL RIGHTS RESERVED. Instructors of classes adopting EXPLORING ECONOMICS, 3ALL RIGHTS RESERVED. Instructors of classes adopting EXPLORING ECONOMICS, 3rdrd Edition byEdition by Robert L. Sexton as an assigned textbook may reproduce material from this publication forRobert L. Sexton as an assigned textbook may reproduce material from this publication for classroom use or in a secure electronic network environment that prevents downloading orclassroom use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part of this work covered by the copyrightreproducing the copyrighted material. Otherwise, no part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, orhereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including, but not limited to, photocopying, recording, taping, Web distribution,mechanical, including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage and retrieval systems—without the writteninformation networks, or information storage and retrieval systems—without the written permission of the publisher.permission of the publisher. Printed in the United States of AmericaPrinted in the United States of America ISBN 0-324-26086-5ISBN 0-324-26086-5 A Lecture PresentationA Lecture Presentation
  2. 2. Copyright © 2002 by Thomson Learning, Inc. Macroeconomic GoalsMacroeconomic Goals Chapter 17Chapter 17
  3. 3. Copyright © 2002 by Thomson Learning, Inc. 17.1 Macroeconomic Goals17.1 Macroeconomic Goals  Three major macroeconomic goalsThree major macroeconomic goals  maintain employment of humanmaintain employment of human resources at relatively high levelsresources at relatively high levels  meaning that jobs are relatively plentiful andmeaning that jobs are relatively plentiful and  financial suffering from lack of work isfinancial suffering from lack of work is relatively uncommonrelatively uncommon  maintain relatively stable price levelmaintain relatively stable price level  so that consumers and producers can makeso that consumers and producers can make better decisionsbetter decisions  achieve a high rate of economic growthachieve a high rate of economic growth  with growth in real, per-capita total outputwith growth in real, per-capita total output over timeover time
  4. 4. Copyright © 2002 by Thomson Learning, Inc.  We use the termWe use the term real grossreal gross domestic product (RGDP)domestic product (RGDP) toto measure output or production.measure output or production.  The termThe term realreal is used to indicate thatis used to indicate that the output is adjusted for the generalthe output is adjusted for the general increase in prices over time.increase in prices over time.
  5. 5. Copyright © 2002 by Thomson Learning, Inc.  Technically,Technically, gross domesticgross domestic product (GDP)product (GDP) is defined as theis defined as the total value of all final goods andtotal value of all final goods and services produced in a given period,services produced in a given period, such as a year or a quarter.such as a year or a quarter.
  6. 6. Copyright © 2002 by Thomson Learning, Inc. What Other Goals Are Important?What Other Goals Are Important?  Concern has been expressed atConcern has been expressed at various times and places about othervarious times and places about other economic issues:economic issues:  the "quality of life"the "quality of life"  reducing “bads” such as pollutionreducing “bads” such as pollution  fairness in the distribution of income orfairness in the distribution of income or wealthwealth  becoming self sufficient in the production‑becoming self sufficient in the production‑ of certain goods or servicesof certain goods or services
  7. 7. Copyright © 2002 by Thomson Learning, Inc. How Do Value JudgmentsHow Do Value Judgments Affect Economic Goals?Affect Economic Goals?  Individuals differ considerably in evaluatingIndividuals differ considerably in evaluating the issues, or whether certain "problems"the issues, or whether certain "problems" are really problems.are really problems.  Economic growth is viewed positively by mostEconomic growth is viewed positively by most people but negatively by some.people but negatively by some.  Some think the income distribution is aboutSome think the income distribution is about right; others think the poorer members ofright; others think the poorer members of society have insufficient incomes.society have insufficient incomes.  Others think confiscation of the income of theOthers think confiscation of the income of the relatively rich reduces incentives to income-relatively rich reduces incentives to income- producing activities.producing activities.
  8. 8. Copyright © 2002 by Thomson Learning, Inc. Acknowledging Our Goals:Acknowledging Our Goals: The Employment Act of 1946The Employment Act of 1946  Many economic problems are pressingMany economic problems are pressing concerns for the U.S. government,concerns for the U.S. government, particularlyparticularly  unemploymentunemployment  price instabilityprice instability  economic stagnationeconomic stagnation
  9. 9. Copyright © 2002 by Thomson Learning, Inc.  The concern over both unemploymentThe concern over both unemployment and price instability led to the passageand price instability led to the passage of theof the Employment Act of 1946Employment Act of 1946, in, in which the United States committedwhich the United States committed itself to policies designed to reduceitself to policies designed to reduce unemployment in a manner consistentunemployment in a manner consistent with price stability. The governmentwith price stability. The government was holding itself responsible for short-was holding itself responsible for short- run economic fluctuations.run economic fluctuations.
  10. 10. Copyright © 2002 by Thomson Learning, Inc. 17.2 Employment and17.2 Employment and UnemploymentUnemployment  Nearly everyone agrees that it isNearly everyone agrees that it is unfortunate when a person whounfortunate when a person who wants a job cannot find one.wants a job cannot find one.  A loss of a job can mean financialA loss of a job can mean financial insecurity and a great deal of anxiety.insecurity and a great deal of anxiety.  High rates of unemployment in aHigh rates of unemployment in a society can lead to increased tensionssociety can lead to increased tensions and despair.and despair.
  11. 11. Copyright © 2002 by Thomson Learning, Inc. The Consequences Of HighThe Consequences Of High UnemploymentUnemployment  Society loses some potential output ofSociety loses some potential output of goods when some of its productivegoods when some of its productive resources—human or non human—‑resources—human or non human—‑ remain idle, and potentialremain idle, and potential consumption is also reduced.consumption is also reduced.  Clearly, there is a loss in efficiencyClearly, there is a loss in efficiency when people are willing to work butwhen people are willing to work but productive equipment remains idle.productive equipment remains idle.
  12. 12. Copyright © 2002 by Thomson Learning, Inc.  Hence, other things equal, relativelyHence, other things equal, relatively high rates of unemployment arehigh rates of unemployment are almost universally viewed asalmost universally viewed as undesirable.undesirable.
  13. 13. Copyright © 2002 by Thomson Learning, Inc. What Is The UnemploymentWhat Is The Unemployment Rate?Rate?  The unemployment rate is oneThe unemployment rate is one measure of labor market conditions.measure of labor market conditions.  TheThe unemployment rateunemployment rate is theis the number of people officiallynumber of people officially unemployed divided by the laborunemployed divided by the labor force.force.
  14. 14. Copyright © 2002 by Thomson Learning, Inc.  Official unemployment measuresOfficial unemployment measures those over the age of 16 who arethose over the age of 16 who are able for employment, but are unableable for employment, but are unable to obtain a job.to obtain a job.  TheThe labor forcelabor force is the number ofis the number of people over the age of 16 who arepeople over the age of 16 who are either employed or unemployed.either employed or unemployed.
  15. 15. Copyright © 2002 by Thomson Learning, Inc.  The civilian labor force figure excludes:The civilian labor force figure excludes:  those in the armed servicesthose in the armed services  prisonprison  mental hospitalsmental hospitals  as well homemakersas well homemakers  retireesretirees  full-time studentsfull-time students because they are not considered currentlybecause they are not considered currently available for employment.available for employment.
  16. 16. Copyright © 2002 by Thomson Learning, Inc.
  17. 17. Copyright © 2002 by Thomson Learning, Inc. The Worst Case Of U.S.The Worst Case Of U.S. UnemploymentUnemployment  By far the worst employmentBy far the worst employment downturn in U.S. history was thedownturn in U.S. history was the Great Depression, which began in lateGreat Depression, which began in late 1929 and continued until 1941.1929 and continued until 1941.  Unemployment fell from only 3.2 percentUnemployment fell from only 3.2 percent of the labor force in 1929 to more thanof the labor force in 1929 to more than 20 percent in the early 1930s, and20 percent in the early 1930s, and  double-digit unemployment persisteddouble-digit unemployment persisted through 1941.through 1941.
  18. 18. Copyright © 2002 by Thomson Learning, Inc.  The debilitating impact of havingThe debilitating impact of having millions of productive persons outmillions of productive persons out of work led Americans (and peopleof work led Americans (and people in other countries too) to sayin other countries too) to say "Never again.""Never again."
  19. 19. Copyright © 2002 by Thomson Learning, Inc.  Some economists would argue thatSome economists would argue that modern macroeconomics, with itsmodern macroeconomics, with its emphasis on the determinants ofemphasis on the determinants of unemployment and its elimination,unemployment and its elimination, truly began in the 1930s.truly began in the 1930s.
  20. 20. Copyright © 2002 by Thomson Learning, Inc. Variations In The UnemploymentVariations In The Unemployment RateRate  Unemployment since 1960 hasUnemployment since 1960 has ranged from a low of 3.5 percent inranged from a low of 3.5 percent in 1969 to a high of 9.7 percent in 1982.1969 to a high of 9.7 percent in 1982.  Unemployment in the worst years isUnemployment in the worst years is twice or more what it is in goodtwice or more what it is in good years.years.  Before 1960, variations tended to beBefore 1960, variations tended to be even more pronounced.even more pronounced.
  21. 21. Copyright © 2002 by Thomson Learning, Inc.
  22. 22. Copyright © 2002 by Thomson Learning, Inc. Are Unemployment Statistics AccurateAre Unemployment Statistics Accurate Reflections Of The Labor Market?Reflections Of The Labor Market?  In periods of prolonged recession,In periods of prolonged recession, some individuals feel that thesome individuals feel that the chances of landing a job are sochances of landing a job are so bleak that they quit looking.bleak that they quit looking.  These "These "discouraged workersdiscouraged workers,"," who have not actively sought workwho have not actively sought work for four weeks, are not counted asfor four weeks, are not counted as unemployed; instead they fall outunemployed; instead they fall out of the labor force.of the labor force.
  23. 23. Copyright © 2002 by Thomson Learning, Inc.  Also, people looking for full-time workAlso, people looking for full-time work who grudgingly settle for a part-timewho grudgingly settle for a part-time job are counted as “fully” employed,job are counted as “fully” employed, yet they are only “partly” employed.yet they are only “partly” employed.
  24. 24. Copyright © 2002 by Thomson Learning, Inc.  However, at least partially balancingHowever, at least partially balancing thesethese biases in governmentbiases in government employment statistics is the numberemployment statistics is the number of people who are overemployed—of people who are overemployed— that is, working overtime or extrathat is, working overtime or extra jobs.jobs.  Also, there are a number of jobs inAlso, there are a number of jobs in the underground economy that arethe underground economy that are not reported at all.not reported at all.
  25. 25. Copyright © 2002 by Thomson Learning, Inc.  In addition, there may be manyIn addition, there may be many people who claim they are actuallypeople who claim they are actually seeking work when, in fact, theyseeking work when, in fact, they may just be going through themay just be going through the motions so that they can continuemotions so that they can continue to collect unemploymentto collect unemployment compensation or receive othercompensation or receive other government benefits.government benefits.
  26. 26. Copyright © 2002 by Thomson Learning, Inc. Who Are The Unemployed?Who Are The Unemployed?  Unemployment usually varies greatlyUnemployment usually varies greatly between different segments of thebetween different segments of the population and over time.population and over time.  unemployment rate is significantly lowerunemployment rate is significantly lower for college graduates thanfor college graduates than  those without a high-school diploma acrossthose without a high-school diploma across sex and race, orsex and race, or  for those with some college education, butfor those with some college education, but who have not completed a bachelor’s degree.who have not completed a bachelor’s degree.
  27. 27. Copyright © 2002 by Thomson Learning, Inc.  Unemployment tends to be greaterUnemployment tends to be greater amongamong  the very young,the very young,  blacks and other minorities,blacks and other minorities,  less-skilled workers.less-skilled workers.  Adult female unemployment tendsAdult female unemployment tends to be higher than adult maleto be higher than adult male unemployment.unemployment.
  28. 28. Copyright © 2002 by Thomson Learning, Inc.  Considering the great variations inConsidering the great variations in unemployment for different groupsunemployment for different groups in the population, we calculatein the population, we calculate separate unemployment rates forseparate unemployment rates for groups classified by sex, age, race,groups classified by sex, age, race, family status, and type of occupation.family status, and type of occupation.
  29. 29. Copyright © 2002 by Thomson Learning, Inc.
  30. 30. Copyright © 2002 by Thomson Learning, Inc. Categories For UnemployedCategories For Unemployed WorkersWorkers  There are four main categories ofThere are four main categories of unemployed workersunemployed workers  job losersjob losers (temporarily laid off or fired)(temporarily laid off or fired)  job leaversjob leavers (quit)(quit)  reentrantsreentrants (worked before and now(worked before and now reentering labor force)reentering labor force)  new entrantsnew entrants (entering the labor force(entering the labor force for first time—primarily teenagers).for first time—primarily teenagers).
  31. 31. Copyright © 2002 by Thomson Learning, Inc.  Job losers typically account for 50Job losers typically account for 50 to 60 percent of the unemployed,to 60 percent of the unemployed, but sizeable fractions are also duebut sizeable fractions are also due to job leavers, new entrants, and re-to job leavers, new entrants, and re- entrants.entrants.
  32. 32. Copyright © 2002 by Thomson Learning, Inc.
  33. 33. Copyright © 2002 by Thomson Learning, Inc. How Much Unemployment?How Much Unemployment?  While unemployment is painful, reducingWhile unemployment is painful, reducing unemployment is not costless.unemployment is not costless.  In the short run, reducing unemployment mayIn the short run, reducing unemployment may generate a higher inflation rate, especially ifgenerate a higher inflation rate, especially if resources are fully employed.resources are fully employed.  Matching employees with jobs quickly mayMatching employees with jobs quickly may lead to mismatches between the worker’slead to mismatches between the worker’s skill level and that required for a job.skill level and that required for a job.  The skills of the employee may be higher than thatThe skills of the employee may be higher than that necessary for the job, resulting innecessary for the job, resulting in underemploymentunderemployment..
  34. 34. Copyright © 2002 by Thomson Learning, Inc. The Average Duration OfThe Average Duration Of UnemploymentUnemployment  The duration of unemployment isThe duration of unemployment is equally as important as the amountequally as important as the amount of unemployment in determining itsof unemployment in determining its financial consequences.financial consequences.  Therefore, it is useful to look at theTherefore, it is useful to look at the average duration of unemployment.average duration of unemployment.
  35. 35. Copyright © 2002 by Thomson Learning, Inc.  The duration of unemployment tends toThe duration of unemployment tends to  be greater when the amount of unemploymentbe greater when the amount of unemployment is high, andis high, and  be smaller when the amount of unemploymentbe smaller when the amount of unemployment is low.is low.  Unemployment of any duration, of course,Unemployment of any duration, of course, means a potential loss of output that ismeans a potential loss of output that is permanent; it is not made up whenpermanent; it is not made up when unemployment starts falling again.unemployment starts falling again.
  36. 36. Copyright © 2002 by Thomson Learning, Inc.
  37. 37. Copyright © 2002 by Thomson Learning, Inc. Labor Force Participation RateLabor Force Participation Rate  The percentage of the population thatThe percentage of the population that is in the labor force is called theis in the labor force is called the labor force participation ratelabor force participation rate..  Since 1950 it has increased from 59.2%Since 1950 it has increased from 59.2% to 67.1%, mostly between 1970 & 1990.to 67.1%, mostly between 1970 & 1990.  The increase can be attributed in largeThe increase can be attributed in large part to the entry of the baby boom intopart to the entry of the baby boom into the labor force and a 14.2 percentagethe labor force and a 14.2 percentage point increase in women’s labor forcepoint increase in women’s labor force participation rate.participation rate.
  38. 38. Copyright © 2002 by Thomson Learning, Inc.
  39. 39. Copyright © 2002 by Thomson Learning, Inc. 17.3 Types of Unemployment17.3 Types of Unemployment  Frictional unemploymentFrictional unemployment  people are temporarily between jobspeople are temporarily between jobs  is short term and results from the normalis short term and results from the normal turnover in the labor marketturnover in the labor market  Structural unemploymentStructural unemployment  people lack the necessary skills for availablepeople lack the necessary skills for available jobsjobs  Cyclical unemploymentCyclical unemployment  results from short-term cyclical fluctuationsresults from short-term cyclical fluctuations in the economyin the economy
  40. 40. Copyright © 2002 by Thomson Learning, Inc. Should We Worry AboutShould We Worry About Frictional Unemployment?Frictional Unemployment?  With frictional unemployment,With frictional unemployment, geographic and occupational mobilitygeographic and occupational mobility are considered good for the economy,are considered good for the economy, generally leading human resourcesgenerally leading human resources from activities of relatively lowfrom activities of relatively low productivity or value to areas ofproductivity or value to areas of higher productivity, increasing outputhigher productivity, increasing output in society as well as the wage incomein society as well as the wage income of the mover.of the mover.
  41. 41. Copyright © 2002 by Thomson Learning, Inc.  Hence, frictional unemployment,Hence, frictional unemployment, while not good in itself, is awhile not good in itself, is a byproduct of a healthy phenomenon,byproduct of a healthy phenomenon, and because it is short-lived, it isand because it is short-lived, it is therefore not generally viewed astherefore not generally viewed as a serious problem.a serious problem.
  42. 42. Copyright © 2002 by Thomson Learning, Inc.  It is unusual for it to be much lessIt is unusual for it to be much less than 2 percent of the labor force.than 2 percent of the labor force.  It tends to be somewhat greater inIt tends to be somewhat greater in periods of low unemployment, whenperiods of low unemployment, when job opportunities are plentiful.job opportunities are plentiful.
  43. 43. Copyright © 2002 by Thomson Learning, Inc. Structural UnemploymentStructural Unemployment  Structural un employment makes it wiseStructural un employment makes it wise to look at both unemployment and jobto look at both unemployment and job vacancy statistics in assessing laborvacancy statistics in assessing labor market conditions.market conditions.  Like frictional unemployment, it reflectsLike frictional unemployment, it reflects the dynamic dimension of a changingthe dynamic dimension of a changing economy.economy.  Over time, new jobs open up that requireOver time, new jobs open up that require new skills, while old jobs that requirednew skills, while old jobs that required different skills disappear.different skills disappear.
  44. 44. Copyright © 2002 by Thomson Learning, Inc.  Many persons advocate government-Many persons advocate government- subsidized retraining programs as asubsidized retraining programs as a means of reducing structuralmeans of reducing structural unemployment.unemployment.  The dimensions of structural unemploy-The dimensions of structural unemploy- ment are debatable, in part because ofment are debatable, in part because of the difficulty in precisely defining thethe difficulty in precisely defining the term in an operational sense. Structuralterm in an operational sense. Structural unemployment varies considerably.unemployment varies considerably.
  45. 45. Copyright © 2002 by Thomson Learning, Inc.  To a considerable extent, one canTo a considerable extent, one can view both frictional and structuralview both frictional and structural unemployment as phenomenaunemployment as phenomena resulting from imperfections in theresulting from imperfections in the labor market.labor market. Labor Market ImperfectionsLabor Market Imperfections And UnemploymentAnd Unemployment
  46. 46. Copyright © 2002 by Thomson Learning, Inc.  If individuals seeking jobs andIf individuals seeking jobs and employers seeking workers had betteremployers seeking workers had better information about each other, theinformation about each other, the amount of frictional unemploymentamount of frictional unemployment would be considerably lower.would be considerably lower.  But because information and job searchBut because information and job search are costly, the bringing of demandersare costly, the bringing of demanders and suppliers of labor services togetherand suppliers of labor services together does not occur instantaneously.does not occur instantaneously.
  47. 47. Copyright © 2002 by Thomson Learning, Inc. Cyclical UnemploymentCyclical Unemployment  In years of relatively high unemploy-In years of relatively high unemploy- ment, cyclical unemployment mayment, cyclical unemployment may result from the short-term cyclicalresult from the short-term cyclical fluctuations in the economy.fluctuations in the economy.  During a recession, or whenever theDuring a recession, or whenever the unemployment rate is greater thanunemployment rate is greater than the natural rate, there is cyclicalthe natural rate, there is cyclical unemployment.unemployment.
  48. 48. Copyright © 2002 by Thomson Learning, Inc.  Given its volatility and dimensions,Given its volatility and dimensions, governments have viewed unemploy-governments have viewed unemploy- ment resulting from inadequate demandment resulting from inadequate demand to be especially correctable throughto be especially correctable through government policies.government policies.  Most attempts to solve theMost attempts to solve the unemployment problem have placedunemployment problem have placed an emphasis on increasing aggregatean emphasis on increasing aggregate demand.demand.
  49. 49. Copyright © 2002 by Thomson Learning, Inc. The Natural Rate Of UnemploymentThe Natural Rate Of Unemployment  The median, or typical annualThe median, or typical annual unemployment rate has been at orunemployment rate has been at or slightly above 5 percent.slightly above 5 percent.  Some economists call this the naturalSome economists call this the natural rate of unemployment.rate of unemployment.  When unemployment rises well aboveWhen unemployment rises well above 5 percent, we have abnormally high5 percent, we have abnormally high unemployment; when it falls belowunemployment; when it falls below 5 percent, we have abnormally low5 percent, we have abnormally low unemployment.unemployment.
  50. 50. Copyright © 2002 by Thomson Learning, Inc.  The 5 percentThe 5 percent natural rate ofnatural rate of unemploymentunemployment roughly equals theroughly equals the sum of frictional and structuralsum of frictional and structural unemployment at a maximum.unemployment at a maximum.  Unemployment rates below the naturalUnemployment rates below the natural rate reflect a below-average level ofrate reflect a below-average level of frictional and structural unemployment.frictional and structural unemployment.  Unemployment above the natural rate,Unemployment above the natural rate, however, reflects cyclical unemployment.however, reflects cyclical unemployment.
  51. 51. Copyright © 2002 by Thomson Learning, Inc.  Today, economists, for the most part,Today, economists, for the most part, have come to accept a current rangehave come to accept a current range somewhere between 5 and 5.5 percentsomewhere between 5 and 5.5 percent for the natural rate of unemployment.for the natural rate of unemployment.  The natural rate of unemployment mayThe natural rate of unemployment may change over time as technological,change over time as technological, demographic, institutional, and otherdemographic, institutional, and other conditions vary.conditions vary.
  52. 52. Copyright © 2002 by Thomson Learning, Inc.  When all of the economy’s laborWhen all of the economy’s labor resources, and other resources likeresources, and other resources like capital are fully employed, thecapital are fully employed, the economy is said to be producing ateconomy is said to be producing at its potential level of output.its potential level of output.  That is, at the natural rate ofThat is, at the natural rate of unemployment, all resources are fullyunemployment, all resources are fully employed and the economy isemployed and the economy is producing itsproducing its potential outputpotential output..
  53. 53. Copyright © 2002 by Thomson Learning, Inc.  When the economy is experiencingWhen the economy is experiencing cyclical unemployment,cyclical unemployment,  unemployment rate > the natural rate.unemployment rate > the natural rate.  The economy can also temporarilyThe economy can also temporarily exceed potential output as workersexceed potential output as workers take on overtime or moonlight bytake on overtime or moonlight by taking on extra employment.taking on extra employment.
  54. 54. Copyright © 2002 by Thomson Learning, Inc. 17.4 Reasons for17.4 Reasons for UnemploymentUnemployment  Obstacles in labor markets preventObstacles in labor markets prevent wages from adjusting to bring intowages from adjusting to bring into balance the quantity of labor suppliedbalance the quantity of labor supplied and the quantity of labor demanded.and the quantity of labor demanded.  When wages are higher than theWhen wages are higher than the market equilibrium wage, themarket equilibrium wage, the quantity of labor supplied is greaterquantity of labor supplied is greater than the quantity of labor demanded,than the quantity of labor demanded, leading to unemployment.leading to unemployment.
  55. 55. Copyright © 2002 by Thomson Learning, Inc.
  56. 56. Copyright © 2002 by Thomson Learning, Inc. Why Does UnemploymentWhy Does Unemployment Exist?Exist?  Economists have cited three reasonsEconomists have cited three reasons for the failure of wages to balancefor the failure of wages to balance labor demand and labor supplylabor demand and labor supply  minimum wagesminimum wages  unionsunions  the efficiency wage theorythe efficiency wage theory  Each results in wage rates aboveEach results in wage rates above their equilibrium level.their equilibrium level.
  57. 57. Copyright © 2002 by Thomson Learning, Inc. Minimum Wages AndMinimum Wages And UnemploymentUnemployment  AA minimum wage rateminimum wage rate can set thecan set the wage for unskilled workers above itswage for unskilled workers above its equilibrium level, leading to a surplusequilibrium level, leading to a surplus of unskilled workers and higherof unskilled workers and higher unemployment.unemployment.
  58. 58. Copyright © 2002 by Thomson Learning, Inc. The Impact Of Unions OnThe Impact Of Unions On The Unemployment RateThe Unemployment Rate  Unions negotiate wages and benefitsUnions negotiate wages and benefits through collective bargaining.through collective bargaining.  If the union wage exceeds the equilibrium level,If the union wage exceeds the equilibrium level, union labor supplied will exceed union laborunion labor supplied will exceed union labor demanded, leading to higher unemployment.demanded, leading to higher unemployment.  Union workers who keep their jobs are betterUnion workers who keep their jobs are better off; the unemployed either seek nonunion workoff; the unemployed either seek nonunion work or wait to be recalled.or wait to be recalled.  Many economists believe union jobs have a wageMany economists believe union jobs have a wage premium over comparable nonunion jobs.premium over comparable nonunion jobs.
  59. 59. Copyright © 2002 by Thomson Learning, Inc.  This has led to theThis has led to the insider-outsiderinsider-outsider hypothesishypothesis::  Those who keep the union wage aboveThose who keep the union wage above the equilibrium level—the insiders—havethe equilibrium level—the insiders—have little or no concern for outsiders—little or no concern for outsiders— nonmembers or previous members.nonmembers or previous members.
  60. 60. Copyright © 2002 by Thomson Learning, Inc. Efficiency WageEfficiency Wage  In theIn the efficiency wage modelefficiency wage model, employers, employers pay their employees more than thepay their employees more than the equilibrium wage to be more efficientequilibrium wage to be more efficient because they believe that higher wages willbecause they believe that higher wages will  lead to greater productivitylead to greater productivity  attract the most productive workersattract the most productive workers  reduce job turnoverreduce job turnover  increase worker moraleincrease worker morale  lower hiring and training costslower hiring and training costs  reduce absenteeismreduce absenteeism  reduce shirkingreduce shirking
  61. 61. Copyright © 2002 by Thomson Learning, Inc.  But because the wage is above theBut because the wage is above the equilibrium level, the quantity ofequilibrium level, the quantity of labor supplied exceeds the quantitylabor supplied exceeds the quantity of labor demanded, and greaterof labor demanded, and greater amounts of unemployment result.amounts of unemployment result.
  62. 62. Copyright © 2002 by Thomson Learning, Inc. Job SearchJob Search  Because of frictional unemployment,Because of frictional unemployment, we would have some unemploymentwe would have some unemployment even if there were a balance betweeneven if there were a balance between labor supply and labor demand, aslabor supply and labor demand, as workers and employers engage inworkers and employers engage in search for costly information aboutsearch for costly information about abilities, opportunities, compensationabilities, opportunities, compensation packages, tastes, and preferences.packages, tastes, and preferences.
  63. 63. Copyright © 2002 by Thomson Learning, Inc.  In a dynamic economy, jobs areIn a dynamic economy, jobs are constantly being destroyed andconstantly being destroyed and created.created.  This leads to lots of temporaryThis leads to lots of temporary unemployment as workers searchunemployment as workers search for the best job for their skills.for the best job for their skills.
  64. 64. Copyright © 2002 by Thomson Learning, Inc. Unemployment InsuranceUnemployment Insurance  It partially offsets the hardships ofIt partially offsets the hardships of unemployment.unemployment.  Those who have worked a certain periodThose who have worked a certain period of time and lost their job because theof time and lost their job because the employer no longer needed their skill getemployer no longer needed their skill get compensation that is typically half salarycompensation that is typically half salary for up to 26 weeks.for up to 26 weeks.  However, it also leads to prolonged periodsHowever, it also leads to prolonged periods of job search because it lowers theof job search because it lowers the opportunity cost of being unemployed.opportunity cost of being unemployed.
  65. 65. Copyright © 2002 by Thomson Learning, Inc.  It has been estimated that this mayIt has been estimated that this may raise unemployment rates by asraise unemployment rates by as much as 1 percentage point.much as 1 percentage point.  A longer search might mean a betterA longer search might mean a better match, but it comes at the expensematch, but it comes at the expense of lost production and greaterof lost production and greater amounts of tax dollars.amounts of tax dollars.
  66. 66. Copyright © 2002 by Thomson Learning, Inc. Does New Technology LeadDoes New Technology Lead To Greater Unemployment?To Greater Unemployment?  Although many believe technologicalAlthough many believe technological advances displace workers, this isadvances displace workers, this is not necessarily the case.not necessarily the case.
  67. 67. Copyright © 2002 by Thomson Learning, Inc.  If new equipment is a substitute forIf new equipment is a substitute for labor, then it might displace workers.labor, then it might displace workers.  e.g., self-service beverage barse.g., self-service beverage bars  However, new capital equipmentHowever, new capital equipment means that new workers will bemeans that new workers will be needed to manufacture and repair it,needed to manufacture and repair it, and it may generate a whole newand it may generate a whole new growth industry that creates jobs.growth industry that creates jobs.
  68. 68. Copyright © 2002 by Thomson Learning, Inc.  New inventionsNew inventions  Generally produce cost savingGenerally produce cost saving  Cost savings generate higher incomes forCost savings generate higher incomes for producers and lower prices and better productsproducers and lower prices and better products for consumersfor consumers  Ultimately result in the growth of otherUltimately result in the growth of other industriesindustries  But it is easy to just see the initial effectBut it is easy to just see the initial effect (displaced workers) without recognizing the(displaced workers) without recognizing the implications of that invention throughout theimplications of that invention throughout the whole economy over time.whole economy over time.
  69. 69. Copyright © 2002 by Thomson Learning, Inc. 17.5 Inflation17.5 Inflation  Overall stableOverall stable price levelprice level increasesincreases security.security.  InflationInflation is a continuing rise in the overall priceis a continuing rise in the overall price level.level.  DeflationDeflation is a falling overall price level.is a falling overall price level.  In both cases, a country’s currency unit changesIn both cases, a country’s currency unit changes in purchasing power.in purchasing power.  Without price stability, consumers andWithout price stability, consumers and producers will experience more difficulty inproducers will experience more difficulty in coordinating their plans and decisions.coordinating their plans and decisions.
  70. 70. Copyright © 2002 by Thomson Learning, Inc. Stable Price Level As AStable Price Level As A Desirable GoalDesirable Goal  In general, the only thing that canIn general, the only thing that can cause a sustained increase in the ratecause a sustained increase in the rate of inflation is a high rate of growth inof inflation is a high rate of growth in money.money.  Unanticipated and sharp priceUnanticipated and sharp price changes are almost universallychanges are almost universally considered to be a "bad" thing thatconsidered to be a "bad" thing that needs to be remedied by some policy.needs to be remedied by some policy.
  71. 71. Copyright © 2002 by Thomson Learning, Inc. The Price Level Over The YearsThe Price Level Over The Years  TheThe Consumer Price IndexConsumer Price Index is theis the standard measure of inflation.standard measure of inflation.  The CPI from 1914 to 2003 isThe CPI from 1914 to 2003 is presented in the next slide.presented in the next slide.
  72. 72. Copyright © 2002 by Thomson Learning, Inc.
  73. 73. Copyright © 2002 by Thomson Learning, Inc. Who Loses With Inflation?Who Loses With Inflation?  Erodes the purchasing power of retirees onErodes the purchasing power of retirees on fixed pensions, creditors, and those whosefixed pensions, creditors, and those whose incomes are tied to long-term contracts.incomes are tied to long-term contracts.  Debtors and those who can quickly raiseDebtors and those who can quickly raise the prices on their goods can gain fromthe prices on their goods can gain from inflation.inflation.  Wage earners can lose if wages rise moreWage earners can lose if wages rise more slowly than the price level.slowly than the price level.  Inflation’s uncertainties discouragesInflation’s uncertainties discourages investment and economic growth.investment and economic growth.
  74. 74. Copyright © 2002 by Thomson Learning, Inc.  Inflation brings about changes in realInflation brings about changes in real incomes of persons, and theseincomes of persons, and these changes may be either desirable orchanges may be either desirable or undesirable.undesirable.  The redistributional impact of inflationThe redistributional impact of inflation is not the result of conscious publicis not the result of conscious public policy; it just happens.policy; it just happens.
  75. 75. Copyright © 2002 by Thomson Learning, Inc.  Inflation can raise one nation's priceInflation can raise one nation's price level relative to price levels in otherlevel relative to price levels in other countries, which can lead tocountries, which can lead to  difficulties in financing the purchase ofdifficulties in financing the purchase of foreign goods orforeign goods or  to a decline in the value of the nationalto a decline in the value of the national currency relative to that of othercurrency relative to that of other countries.countries.
  76. 76. Copyright © 2002 by Thomson Learning, Inc.  In its extreme form, inflation can leadIn its extreme form, inflation can lead to a complete erosion in faith in theto a complete erosion in faith in the value of money.value of money.  as in Germany after both world wars,as in Germany after both world wars,  or hyperinflation,or hyperinflation,  as in Argentina in the 1980s andas in Argentina in the 1980s and  Brazil in the 1990s.Brazil in the 1990s.
  77. 77. Copyright © 2002 by Thomson Learning, Inc. Unanticipated InflationUnanticipated Inflation Distorts Price SignalsDistorts Price Signals  In periods of high and variableIn periods of high and variable inflation, households and firms haveinflation, households and firms have a difficult time distinguishing changesa difficult time distinguishing changes in thein the relative pricerelative price from changesfrom changes in the general price level, distortingin the general price level, distorting the information that flows from pricethe information that flows from price signals.signals.  This undermines good decision-This undermines good decision- making.making.
  78. 78. Copyright © 2002 by Thomson Learning, Inc. Menu And Show-Leather CostsMenu And Show-Leather Costs  Another cost of inflation is the cost thatAnother cost of inflation is the cost that firms incur as a result of being forced tofirms incur as a result of being forced to change their prices more often.change their prices more often.  MenuMenu costscosts—the costs of changing posted—the costs of changing posted pricesprices  Shoe-leatherShoe-leather costscosts—the costs of checking on—the costs of checking on your assets.your assets.  These costs are modest with low inflationThese costs are modest with low inflation rates, but can be quite large where inflationrates, but can be quite large where inflation is substantial.is substantial.
  79. 79. Copyright © 2002 by Thomson Learning, Inc. Inflation And Interest RatesInflation And Interest Rates  Nominal interestNominal interest raterate—not adjusted—not adjusted for inflationfor inflation  Real interest rates-Real interest rates- nominal interestnominal interest rate – inflation raterate – inflation rate  For example, if the nominal interest rateFor example, if the nominal interest rate was 5 percent and the inflation rate waswas 5 percent and the inflation rate was 3 percent, the real interest rate would be3 percent, the real interest rate would be 2 percent.2 percent.
  80. 80. Copyright © 2002 by Thomson Learning, Inc.  If people correctly anticipate inflation,If people correctly anticipate inflation, they will behave in a manner that willthey will behave in a manner that will largely protect them against loss.largely protect them against loss.  To protect themselves, creditors willTo protect themselves, creditors will demand a rate of interest that is largedemand a rate of interest that is large enough to compensate for theenough to compensate for the deteriorating value of the dollar.deteriorating value of the dollar.
  81. 81. Copyright © 2002 by Thomson Learning, Inc.  Failure to understand the differenceFailure to understand the difference between real and nominal interest rates isbetween real and nominal interest rates is critical.critical.  In most economic decisions, it is the realIn most economic decisions, it is the real rate of interest that matters because it israte of interest that matters because it is this rate that shows how much borrowersthis rate that shows how much borrowers pay and lenders receive in terms ofpay and lenders receive in terms of purchasing power—goods and servicespurchasing power—goods and services money can buy.money can buy.  When the real interest rate is negative theWhen the real interest rate is negative the lender pays the borrower rather than thelender pays the borrower rather than the borrower paying the lender!borrower paying the lender!
  82. 82. Copyright © 2002 by Thomson Learning, Inc.
  83. 83. Copyright © 2002 by Thomson Learning, Inc.
  84. 84. Copyright © 2002 by Thomson Learning, Inc.
  85. 85. Copyright © 2002 by Thomson Learning, Inc.  In the last exhibit, we saw that when theIn the last exhibit, we saw that when the when the nominal interest rate is high thewhen the nominal interest rate is high the inflation rate is high and when the nominalinflation rate is high and when the nominal interest rate is low the inflation rate is low.interest rate is low the inflation rate is low. Why?Why?  When inflation is high, borrowers offer andWhen inflation is high, borrowers offer and lenders demand higher nominal interestlenders demand higher nominal interest rates to compensate for the falling value ofrates to compensate for the falling value of money in the future.money in the future.
  86. 86. Copyright © 2002 by Thomson Learning, Inc.  An interest rate is, in effect, the priceAn interest rate is, in effect, the price that one pays for the use of funds.that one pays for the use of funds. Like other prices, interest rates areLike other prices, interest rates are determined by the interaction ofdetermined by the interaction of demand and supply forces.demand and supply forces.  The lower the interest rate (price),The lower the interest rate (price), the greater the quantity of loanablethe greater the quantity of loanable funds demanded,funds demanded, ceteris paribus.ceteris paribus. Anticipated Inflation And TheAnticipated Inflation And The Nominal Interest RateNominal Interest Rate
  87. 87. Copyright © 2002 by Thomson Learning, Inc.
  88. 88. Copyright © 2002 by Thomson Learning, Inc.  The lower the interest rate, the greater theThe lower the interest rate, the greater the quantity of loanable funds demanded. Thequantity of loanable funds demanded. The higher the interest rate, the greater thehigher the interest rate, the greater the quantity of loanable funds supplied byquantity of loanable funds supplied by individuals and institutions like banks,individuals and institutions like banks, ceteris paribusceteris paribus..  The equilibrium interest rate will be whereThe equilibrium interest rate will be where the quantity demanded equals the quantitythe quantity demanded equals the quantity supplied.supplied.
  89. 89. Copyright © 2002 by Thomson Learning, Inc.  When people start expecting futureWhen people start expecting future inflation, creditors become less willinginflation, creditors become less willing to lend funds at any given interest rateto lend funds at any given interest rate because they fear they will be repaidbecause they fear they will be repaid in dollars of lesser value than thosein dollars of lesser value than those they loaned.they loaned.  This is depicted by a leftward shift inThis is depicted by a leftward shift in the supply curve of loanable funds (athe supply curve of loanable funds (a decrease in supply).decrease in supply).
  90. 90. Copyright © 2002 by Thomson Learning, Inc.  Likewise, demanders of fundsLikewise, demanders of funds (borrowers) are more anxious to(borrowers) are more anxious to borrow because they think they willborrow because they think they will pay their loans back in dollars ofpay their loans back in dollars of lesser purchasing power than thelesser purchasing power than the dollars they borrowed. Thus, thedollars they borrowed. Thus, the demand for funds increases.demand for funds increases.
  91. 91. Copyright © 2002 by Thomson Learning, Inc.  Both the decrease in supply and theBoth the decrease in supply and the increase in demand push up theincrease in demand push up the interest rate to a new, higherinterest rate to a new, higher equilibrium level.equilibrium level.  Whether the equilibrium quantityWhether the equilibrium quantity of loanable funds will increase orof loanable funds will increase or decrease depends on the relativedecrease depends on the relative sizes of the shifts in the respectivesizes of the shifts in the respective curves.curves.
  92. 92. Copyright © 2002 by Thomson Learning, Inc. Do Creditors Always LoseDo Creditors Always Lose During Inflation?During Inflation?  Often, lenders are able to anticipateOften, lenders are able to anticipate inflation with reasonable accuracy.inflation with reasonable accuracy.  If the inflation rate is accuratelyIf the inflation rate is accurately anticipated, new creditors do not lose,anticipated, new creditors do not lose, nor do debtors gain, from inflation.nor do debtors gain, from inflation.
  93. 93. Copyright © 2002 by Thomson Learning, Inc.  Nominal interest rates and realNominal interest rates and real interest rates do not always moveinterest rates do not always move together.together.  In periods of high unexpectedIn periods of high unexpected inflation, the nominal interest ratesinflation, the nominal interest rates can be very high while the realcan be very high while the real interest rates are low or eveninterest rates are low or even negative.negative.
  94. 94. Copyright © 2002 by Thomson Learning, Inc. Protecting Ourselves FromProtecting Ourselves From InflationInflation  Increasingly, laborers, pensioners,Increasingly, laborers, pensioners, etc. try to protect themselves frometc. try to protect themselves from inflation by using cost-of-livinginflation by using cost-of-living clauses in contracts.clauses in contracts.  Personal income taxes are also nowPersonal income taxes are also now indexed for inflation.indexed for inflation.
  95. 95. Copyright © 2002 by Thomson Learning, Inc.  Some have argued that we should goSome have argued that we should go one step further and indexone step further and index everything.everything.  All contractual arrangements would beAll contractual arrangements would be adjusted frequently to take account ofadjusted frequently to take account of changing prices.changing prices.  Such an arrangement might reduce theSuch an arrangement might reduce the impact of inflation, but it would alsoimpact of inflation, but it would also entail additional contracting costs (andentail additional contracting costs (and not every good—notably currency—cannot every good—notably currency—can be indexed).be indexed).
  96. 96. Copyright © 2002 by Thomson Learning, Inc.  Approaches to try to stop inflationApproaches to try to stop inflation includeinclude  various policies relating to the amountvarious policies relating to the amount of government spending, tax rates, orof government spending, tax rates, or the amount of money created,the amount of money created,  as well asas well as wage and price controlswage and price controls—— legislation limiting wage and pricelegislation limiting wage and price increases.increases.
  97. 97. Copyright © 2002 by Thomson Learning, Inc. 17.6 Economic Fluctuations17.6 Economic Fluctuations  Business cyclesBusiness cycles refer to therefer to the short term fluctuations in economic‑short term fluctuations in economic‑ activity, not to the long term trend‑activity, not to the long term trend‑ in output, which in modern timesin output, which in modern times has usually been upward.has usually been upward.
  98. 98. Copyright © 2002 by Thomson Learning, Inc.
  99. 99. Copyright © 2002 by Thomson Learning, Inc. The Phases Of A Business CycleThe Phases Of A Business Cycle  ExpansionExpansion  PeakPeak  ContractionContraction  TroughTrough
  100. 100. Copyright © 2002 by Thomson Learning, Inc.
  101. 101. Copyright © 2002 by Thomson Learning, Inc.  ExpansionExpansion  Usually is longer than the contraction.Usually is longer than the contraction.  In a growing economy, output (real GDP) willIn a growing economy, output (real GDP) will rise from one business cycle peak to the next.rise from one business cycle peak to the next.  When output is rising significantly,When output is rising significantly, unemployment is falling and both consumerunemployment is falling and both consumer and business confidence is high.and business confidence is high.  Investment is rising, as well as expenditures forInvestment is rising, as well as expenditures for expensive durable consumer goods, such asexpensive durable consumer goods, such as automobiles and household appliances.automobiles and household appliances.
  102. 102. Copyright © 2002 by Thomson Learning, Inc.  PeakPeak  when the expansion comes to an endwhen the expansion comes to an end  when output is at the highest point in thewhen output is at the highest point in the cycle.cycle.  ContractionContraction  a period of falling real outputa period of falling real output  rising unemployment and decliningrising unemployment and declining business and consumer confidencebusiness and consumer confidence  investment spending and consumerinvestment spending and consumer durable expenditures fall sharplydurable expenditures fall sharply
  103. 103. Copyright © 2002 by Thomson Learning, Inc.  Contraction phase can also be calledContraction phase can also be called aa recessionrecession..  Usually a recession is said to occurUsually a recession is said to occur if there are two quarters of decliningif there are two quarters of declining real GDP.real GDP.
  104. 104. Copyright © 2002 by Thomson Learning, Inc.  TroughTrough  the point in time when output stopsthe point in time when output stops decliningdeclining  the moment when business activity isthe moment when business activity is at its lowest point in the cycleat its lowest point in the cycle  Unemployment is relatively high at theUnemployment is relatively high at the trough, although the actual maximumtrough, although the actual maximum amount of unemployment may not occuramount of unemployment may not occur exactly at the trough.exactly at the trough.
  105. 105. Copyright © 2002 by Thomson Learning, Inc. How Long Does A BusinessHow Long Does A Business Cycle Last?Cycle Last?  Often, unemployment remains fairlyOften, unemployment remains fairly high well into the expansion phase.high well into the expansion phase.  There is no uniformity to a businessThere is no uniformity to a business cycle's length. In both the 1980s andcycle's length. In both the 1980s and 1990s, the expansions were quite1990s, the expansions were quite long by historical standards.long by historical standards.
  106. 106. Copyright © 2002 by Thomson Learning, Inc.  The contraction phase is one ofThe contraction phase is one of recession, a decline in businessrecession, a decline in business activity.activity.  Severe recessions are calledSevere recessions are called depressions. Likewise, a prolongeddepressions. Likewise, a prolonged expansion in economic activity isexpansion in economic activity is sometimes called asometimes called a boomboom..  Contractions seem to be gettingContractions seem to be getting shorter over time.shorter over time.
  107. 107. Copyright © 2002 by Thomson Learning, Inc.
  108. 108. Copyright © 2002 by Thomson Learning, Inc. Seasonal Fluctuations AffectSeasonal Fluctuations Affect Economic ActivityEconomic Activity  Some fluctuation in economic activitySome fluctuation in economic activity also reflects seasonal patterns.also reflects seasonal patterns.  Business activity tends to be high in theBusiness activity tends to be high in the two months before the winter holidays,two months before the winter holidays, and somewhat lower in summertime,and somewhat lower in summertime, when many families are on vacation.when many families are on vacation.  Within individual industries, of course,Within individual industries, of course, seasonal fluctuations in output often areseasonal fluctuations in output often are extremely pronounced, agriculture beingextremely pronounced, agriculture being the best example.the best example.
  109. 109. Copyright © 2002 by Thomson Learning, Inc.  Often, key economic statistics, likeOften, key economic statistics, like unemployment rates, are seasonallyunemployment rates, are seasonally adjusted, meaning the numbers areadjusted, meaning the numbers are modified to take account of normalmodified to take account of normal seasonal fluctuations.seasonal fluctuations.
  110. 110. Copyright © 2002 by Thomson Learning, Inc.  Thus, seasonally adjustedThus, seasonally adjusted unemployment rates in summerunemployment rates in summer months are below actualmonths are below actual unemployment rates becauseunemployment rates because unemployment is normally high inunemployment is normally high in summertime as a result of the inflowsummertime as a result of the inflow of school-age workers into the laborof school-age workers into the labor force.force.
  111. 111. Copyright © 2002 by Thomson Learning, Inc. Political Business CyclesPolitical Business Cycles  Studies have shown a strong correlationStudies have shown a strong correlation between economic performance and anbetween economic performance and an incumbent’s bid for re-election.incumbent’s bid for re-election.  The incumbent might do everything in his powerThe incumbent might do everything in his power to stimulate the economy in the period leadingto stimulate the economy in the period leading up to the election.up to the election.  pressure the Federal Reserve System to lower thepressure the Federal Reserve System to lower the interest rateinterest rate  press Congress to cut taxes or increase governmentpress Congress to cut taxes or increase government spendingspending  anything that might generate more spending and thusanything that might generate more spending and thus greater employmentgreater employment
  112. 112. Copyright © 2002 by Thomson Learning, Inc.  Of course, the negative side to all ofOf course, the negative side to all of this is that although the incumbentthis is that although the incumbent may get re-elected, the economy maymay get re-elected, the economy may have been overstimulated, causinghave been overstimulated, causing inflationary problems.inflationary problems.
  113. 113. Copyright © 2002 by Thomson Learning, Inc. Forecasting Cyclical ChangesForecasting Cyclical Changes  Businesses, government agencies,Businesses, government agencies, and to a lesser extent, consumers,and to a lesser extent, consumers, rely on economic forecasts to learnrely on economic forecasts to learn of forthcoming developments in theof forthcoming developments in the business cycles.business cycles.
  114. 114. Copyright © 2002 by Thomson Learning, Inc.  Economists gather statistics onEconomists gather statistics on economic activity in the immediate past,economic activity in the immediate past, and use past historical relationshipsand use past historical relationships between these factors and the overallbetween these factors and the overall level of economic activity (which formlevel of economic activity (which form the basis of the economic theories used)the basis of the economic theories used) to formulate econometric models.to formulate econometric models.  Statistics from the immediate past areStatistics from the immediate past are plugged into the models and forecastsplugged into the models and forecasts are made.are made.
  115. 115. Copyright © 2002 by Thomson Learning, Inc.  Because human behavior changes,Because human behavior changes,  we cannot correctly make assumptionswe cannot correctly make assumptions about certain future developments,about certain future developments,  economists’ numbers are imperfect andeconomists’ numbers are imperfect and  econometric forecasts are not alwayseconometric forecasts are not always accurate.accurate.  But while they are not perfect, theyBut while they are not perfect, they are helpful.are helpful.
  116. 116. Copyright © 2002 by Thomson Learning, Inc.  One less sophisticated but veryOne less sophisticated but very useful forecasting tool is watchinguseful forecasting tool is watching trends intrends in leading economicleading economic indicatorsindicators, which tend to change, which tend to change before the economy as a wholebefore the economy as a whole changes.changes.
  117. 117. Copyright © 2002 by Thomson Learning, Inc.  There are about a dozen such leadingThere are about a dozen such leading indicators, which are compiled into anindicators, which are compiled into an index of leading indicators.index of leading indicators.  If the index rises sharply for two orIf the index rises sharply for two or three months, it is likely (but notthree months, it is likely (but not certain) that increases in the overallcertain) that increases in the overall level of activity will follow.level of activity will follow.
  118. 118. Copyright © 2002 by Thomson Learning, Inc.  Since the development of the indexSince the development of the index of leading economic indicators, it hasof leading economic indicators, it has never failed to give some warning ofnever failed to give some warning of an economic downturn.an economic downturn.  Unfortunately, the lead time hasUnfortunately, the lead time has varied widely, which makes it lessvaried widely, which makes it less accurate and can cause timing andaccurate and can cause timing and expectation problems with policy.expectation problems with policy.
  119. 119. Copyright © 2002 by Thomson Learning, Inc.  While the economic indicators doWhile the economic indicators do provide a warning of a likelyprovide a warning of a likely downturn, they do not providedownturn, they do not provide accurate information on the depthaccurate information on the depth or duration of the downturn.or duration of the downturn.

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