Lecture Four Macroeconomic Concerns: Unemployment, Inflation, and Growth.

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Lecture FourLecture Four

Macroeconomic Concerns:Macroeconomic Concerns:

Unemployment, Inflation, Unemployment, Inflation, and Growthand Growth

Macroeconomic ConcernsMacroeconomic Concerns

Aggregate Price Level Aggregate Output Total Employment Rest of the World

Inflation and PricesInflation and Prices

Price levelPrice level: a measure of the behavior of all prices in the economyPrice level is a yardstick -- a tool for comparison of prices over time.InflationInflation: the rate of change in the price level

Percentage change in GDP deflator, 1959 - 1994

1959 1963 1967 1971 1975 1979 1983 1987 1991

Inflation Rate

Measuring the Price Level:Measuring the Price Level:Price IndexesPrice Indexes

CPICPI: Consumer Price Index: a measure of the price of a market basket of goods purchased monthly by the typical urban consumer.GDP deflatorGDP deflator: a measure of the prices of all goods produced in GDP basket. PPIPPI: Producer Price Index: a measure of prices that producers receive for products at all stages in the production process.

Production in MuletownProduction in Muletown

In Muletown, three goods are produced:

–Mule hides;

–Espresso;

–Sandals.A market basket is 2 Mule hides, 5 Espressos, and 1 pair of sandals.

Production in MuletownProduction in Muletown

1997Price Quantity $3 10 $5 15 $7 20

Mule hidesEspressoSandals

1998Price Quantity $4 20 $4 10 $20 15

What is the price level in Muletown?

Calculating the CPICalculating the CPIMultiply the price of the good by the quantity in the market basket and add over all goods.In 1997: $3(2) + $5(5) + $7(1) = $38In 1998: $4(2) + $4(5) + $20(1) = $48Rate of Inflation:

–($48 - $38)/$38 = 26%.

GDP DeflatorGDP Deflator

Nominal GDP: GDP measured in current year pricesReal GDP: GDP measured in constant prices (prices derived from a base year)

GDP in MuletownGDP in Muletown

Nominal GDPReal GDPGDP deflator

1997$245

$245 = $3(10) + $5(15) + $7(20)

1997$245

1998$420

$420 = $4(20) + $4(10) + $20(15)

1997$245$245

1998$420

$245 = $3(10) + $5(15) + $7(20)

1991$245$245

1992$420$215

$215 = $3(20) + $5(10) + $7(15)

Note that we have used 1991 prices.

1991$245$245

1992$420$215

100 = 100 * $245/$245

1991$245$245

1992$420$215

195 = 100*$420/$215

1991$245$245

1992$420$215

Rate of Inflation = (195 - 100)/100 = 95%

The Real/Nominal RelationshipThe Real/Nominal Relationship

Real Quantity = Nominal Quantity Price Level/100

Costs of InflationCosts of Inflation

Changing distribution of income

– indexed income: income rises with the rate of inflation

Lending distortionsAdministrative costs and inefficiencies

Aggregate Output (GDP)Aggregate Output (GDP)

Gross Domestic ProductGross Domestic Product (GDP) is the dollar value of all finalfinal goods and services produced.

Final goodFinal good: a product which is ready to be used by consumers

Business CycleBusiness Cycle

Periodic movements in output, prices, and employmentBusiness cycles are not created equal.

–Duration–Severity

Business CycleBusiness Cycle

GDP rises and falls over short spans of timeAt any point in time, it may be above or below its long run trendThese fluctuations define the business cyclebusiness cycle

Parts of the Business CycleParts of the Business Cycle

Trough

Recession

Expansion

AggregateOutput

Recession-1Recession-1

A recession recession is a period in which real GDP declines for at least two consecutive quarters. Most recessions are marked by falling output and rising unemployment.

Recession-2Recession-2

Growth rate of GDP falls Firms decrease production Unemployment rises

GDP Unemploy-ment

The Recession of 1980-1982The Recession of 1980-1982

Unemployment

GDP Growth

DepressionDepression

DepressionDepression: a prolonged and deep recession

Great Depression: 1929-1933The Great DepressionGreat Depression was a period of severe

economic contraction and high unemployment that began in 1929 and

continued throughout the 1930’s.

Great DepressionGreat Depression

1929 1930 1931 1932 1933

Unemployment

GDP Growth

ExpansionExpansion

GDP growth rate rises Firms increase production Unemployment falls

GDPUnemploy-

Real GDP in the U.S., 1959 - 1994

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

4,000.0

4,500.0

5,000.0

5,500.0

1959 1963 1967 1971 1975 1979 1983 1987 1991

Real GDP in the U.S., 1959 - 1994

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

4,000.0

4,500.0

5,000.0

5,500.0

1959 1963 1967 1971 1975 1979 1983 1987 1991

Trend Line

UnemploymentUnemployment

The unemployment rateunemployment rate refers to the percentage of people in the labor force who can’t find a job.

Labor ForceLabor Force: peoplewho are actively seekingor are currently holding

Unemployment Rate, 1959 - 1994

1959 1963 1967 1971 1975 1979 1983 1987 1991

Unemployment Rate

Unemployment Rate in Selected Unemployment Rate in Selected CountriesCountries

U.S. Sweden Canada

1929 1933

Defining Unemployment - 1Defining Unemployment - 1

EmployedEmployed: Any person 16 years old or older,

(1) who works for pay, either for someone else or in their own business, for one or more hours a week,

(2) who works without pay for 15 hours a week in a family business, or

(3) who has a job but has been temporarily absent, with or without pay.

UnemployedUnemployed: A person 16 years or older who is not working, is available for work, and has made specific efforts to find work during the previous four weeks.

Labor forceLabor force: The number of people employed plus the number of unemployed.

Labor ForceLabor Force = Employed + Unemployed PopulationPopulation = Labor Force + Not in Labor Force Unemployment RateUnemployment Rate =

Labor Force Participation RateLabor Force Participation Rate =

UnemployedLabor Force

Labor Force

Population

UnemploymentPoolEntrants

5% Unemployment

Job FindersDiscouraged

WorkersLabor Force

Leavers

New Entrants: 11% Re-entrants: 26%Job Leavers: 12%Job Losers: 63%

Types of UnemploymentTypes of Unemployment

CyclicalCyclical

–due to business cycle movements in GDPFrictionalFrictional

–due to job search activitiesStructuralStructural

–due to changes in economic institutions

–geographic displacement, technological change, discrimination

Natural Rate of UnemploymentNatural Rate of Unemployment

The natural rate of unemploymentnatural rate of unemployment refers to the unemployment that occurs as a normal part of the functioning of the economy. Sometimes taken as the sum of frictional unemployment and structural unemployment. (The rate of unemployment that occurs at full full employmentemployment).

Costs of UnemploymentCosts of Unemployment

Personal costsSocietal costsEconomic costs

Government Policies for Government Policies for Influencing the MacroeconomyInfluencing the Macroeconomy

Fiscal PolicyFiscal Policy: Government policies regarding taxes and expendituresMonetary PolicyMonetary Policy: The tools used by the Federal Reserve to control the money supplySupply-side PoliciesSupply-side Policies: policies that focus on aggregate supply and increasing production

Aggregate DemandAggregate Demand

Aggregate demandAggregate demand represents the total demand for goods and services in an economy.

Aggregate Demand CurveAggregate Demand Curve

PriceLevel

Aggregate Output

Aggregate SupplyAggregate Supply

Aggregate supplyAggregate supply represents the total supply of goods and services in an economy.

Aggregate Supply CurveAggregate Supply Curve

PriceLevel

Aggregate Output

EquilibriumEquilibrium

Aggregate equilibriumequilibrium is a level of prices and GDP such that the quantity of goods and services purchased equals the overall quantity of goods and services produced

EquilibriumEquilibrium

PriceLevel

Aggregate Output

Equilibrium

Lecture Four Macroeconomic Concerns: Unemployment, Inflation, and Growth.

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