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© The McGraw-Hill Companies, Inc., 1998Irwin/McGraw-Hill
Economic Growth, Economic Growth, Business Cycles, Business Cycles, Unemployment, Unemployment,
and Inflationand Inflation Chapter 7
© The McGraw-Hill Companies, Inc., 1998Irwin/McGraw-Hill
Laugher CurveLaugher Curve
An Indian-born economist once explained his personal theory of reincarnation to his graduate economics class.
© The McGraw-Hill Companies, Inc., 1998Irwin/McGraw-Hill
Laugher CurveLaugher Curve
“If you are a good economist, a virtuous economist,” he said, “you are reborn as a physicist.”
© The McGraw-Hill Companies, Inc., 1998Irwin/McGraw-Hill
Laugher CurveLaugher Curve
“If you are a good economist, a virtuous economist,” he said, “you are reborn as a physicist.”
“But if you are an evil, wicked economist, you are reborn as a sociologist.”
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Chapter ObjectivesChapter Objectives
Summarize some relevant statistics about growth, business cycles, unemployment, and inflation.
© The McGraw-Hill Companies, Inc., 1998Irwin/McGraw-Hill
Chapter ObjectivesChapter Objectives
Summarize some relevant statistics about growth, business cycles, unemployment, and inflation.
Name five sources of growth.
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Chapter ObjectivesChapter Objectives
List four phases of the business cycle.
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Chapter ObjectivesChapter Objectives
List four phases of the business cycle. Explain how unemployment is
measured and state some microeconomic categories of unemployment.
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Chapter ObjectivesChapter Objectives
Relate the target rate of unemployment to potential income.
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Chapter ObjectivesChapter Objectives
Relate the target rate of unemployment to potential income.
Define inflation and distinguish a real concept from a nominal concept.
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Chapter ObjectivesChapter Objectives
Differentiate between cost-push and demand-pull inflation and expected and unexpected inflation.
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Chapter ObjectivesChapter Objectives
Differentiate between cost-push and demand-pull inflation and expected and unexpected inflation.
State two important costs of inflation.
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Central Problems of Central Problems of MacroeconomicsMacroeconomics Growth is one of the four central
problems of macroeconomics.
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Central Problems of Central Problems of MacroeconomicsMacroeconomics Growth is one of the four central
problems of macroeconomics. The others are business cycles,
unemployment, and inflation.
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GrowthGrowth
The Benefits and Costs of Growth
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GrowthGrowth
The Benefits and Costs of Growth Generally the U.S. economy is
growing or expanding.
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GrowthGrowth
The Benefits and Costs of Growth Real gross domestic product (GDP) is
the market value of goods and services stated in the prices of a given year.
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GrowthGrowth
The Benefits and Costs of Growth Real gross domestic product (GDP) is
the market value of goods and services stated in the prices of a given year.
The primary measurement of growth is changes in real GDP.
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GrowthGrowth
The Benefits and Costs of Growth Since 1890, the U.S. economic output
has grown at an annual rate of 2.5 to 3.5 per annum.
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GrowthGrowth
The Benefits and Costs of Growth Since 1890, the U.S. economic output
has grown at an annual rate of 2.5 to 3.5 per annum.
This is called the secular growth trend.
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GrowthGrowth
The Benefits and Costs of Growth Per capita economic growth allows
everyone in society, on average to have more.
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GrowthGrowth
The Benefits and Costs of Growth Politically, growth, or predictions of
growth, allows governments to avoid hard questions.
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GrowthGrowth
The Benefits and Costs of Growth Politically, growth, or predictions of
growth, allows governments to avoid hard questions.
A growing economy creates jobs, to the joy of politicians.
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GrowthGrowth
The Benefits and Costs of Growth The costs to material growth include
pollution, resource exhaustion, and destruction to natural habitat.
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GrowthGrowth
The Benefits and Costs of Growth Since many believe the
environmental costs of growth are important, the result is often an environmental-economic growth stalemate.
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GrowthGrowth
The Sources of Growth
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GrowthGrowth
The Sources of Growth Institutions with incentives
compatible with growth Technological development Available resources Investment and accumulated capital Entrepreneurship
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GrowthGrowth
Institutions With Incentives Compatible With Growth
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GrowthGrowth
Institutions With Incentives Compatible With Growth Growth-compatible institutions—those
that foster growth—must have incentives built into them that lead people to work hard and discourage people from activities that inhibit growth.
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GrowthGrowth
Institutions With Incentives Compatible With Growth Private ownership of property plays
an important role in growth.
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GrowthGrowth
Institutions With Incentives Compatible With Growth A corporation is another example of a
growth-promoting economic institution because of limited liability.
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GrowthGrowth
Institutions With Incentives Compatible With Growth Many developing nations have
merchantist policies dictating governmental permission before economic activity can take place.
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GrowthGrowth
Institutions With Incentives Compatible With Growth Many developing nations have
merchantist policies dictating governmental permission before economic activity can take place.
This does not foster growth.
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GrowthGrowth
Technological Development
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GrowthGrowth
Technological Development A much larger aspect of growth
involves changes in technology—changes in the goods we buy and changes in the way we make goods.
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GrowthGrowth
Technological Development Society gets people to work on these
new developments by doing the following:
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GrowthGrowth
Technological Development Society gets people to work on these
new developments by doing the following:
Providing incentives. Working with institutions that foster
creativity and bold thinking. Working through institutions that foster
hard work.
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GrowthGrowth
Technological Development U.S. educational institutions do a
good job of fostering creativity but a poor job of fostering hard work.
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GrowthGrowth
Available Resources
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GrowthGrowth
Available Resources What is a resource depends on the
technology used.
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GrowthGrowth
Available Resources What is a resource depends on the
technology used. A resource in one time period may
not be a resource in another.
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GrowthGrowth
Investment and Accumulated Capital
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GrowthGrowth
Investment and Accumulated Capital Capital accumulation and investment
were once seen as the key elements to growth.
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GrowthGrowth
Investment and Accumulated Capital This is not longer thought to be true
because:
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GrowthGrowth
Investment and Accumulated Capital This is not longer thought to be true
because: The empirical evidence does not support
it. Products and processes change. Capital is far more than machines.
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GrowthGrowth
Investment and Accumulated Capital This is not longer thought to be true
because: Capital also includes human capital—
peoples' knowledge and social capital—the habitual way of doing things that guides people in how they approach production.
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GrowthGrowth
Entrepreneurship
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GrowthGrowth
Entrepreneurship Entrepreneurship involves creativity,
vision, and the ability to translate that vision into reality.
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GrowthGrowth
Turning the Sources of Growth Into Growth
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GrowthGrowth
Turning the Sources of Growth Into Growth Even if the five ingredients to growth
exist, they may not exist in the right proportion.
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GrowthGrowth
Turning the Sources of Growth Into Growth Even if the five ingredients to growth
exist, they may not exist in the right proportion.
It is the combination of investing in machines and technological change that plays a central role in the growth of any economy.
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Business CyclesBusiness Cycles
The business cycle is the upward and downward movement of economic activity that occurs around the growth trend.
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Business CyclesBusiness Cycles
The business cycle is the upward and downward movement of economic activity that occurs around the growth trend. The secular growth trend is an
average 2.5 to 3.5 percent increase in GDP.
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Business CyclesBusiness CyclesP
erc
en
tag
e F
luc
tua
tio
ns
in
Re
al
GD
P
Civil War
Recovery of 1895
World War I
Panic of 1893 Panic
of 1907Great
Depression
20
10
0
–10
–20
Years
World War II
Korean WarVietnam War
1860 65 70 75 80 85 90 95 1900 05 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 2000
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Business CyclesBusiness Cycles
There are a number of theories regarding business cycles.
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Business CyclesBusiness Cycles
There are a number of theories regarding business cycles. The Classicals generally favor laissez-
faire or noninterventionist policies.
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Business CyclesBusiness Cycles
There are a number of theories regarding business cycles. The Keynesians generally favor
activist policies.
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Business CyclesBusiness Cycles
There are a number of theories regarding business cycles. The rational expectationists argue
that expectations about the future based on the best current information is often undermined by the public who anticipate government's actions and do the opposite of what is expected of them.
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Business CyclesBusiness Cycles
Each business cycle is different.
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Business CyclesBusiness Cycles
Each business cycle is different. After World War II, however, down
turns have been less severe.
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Business CyclesBusiness Cycles
Each business cycle is different. If prolonged contractions are a type of
cold the economy catches, the Great Depression of the 1930s was double pneumonia.
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Business CyclesBusiness Cycles
Each business cycle is different. If the severity of business fluctuations
has been reduced, one reason is that changes in institutional structure were made as a result of the Great Depression.
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Business CyclesBusiness Cycles
Each business cycle is different. Since 1945, the average expansion
has lasted about 51 months.
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The Phases of the The Phases of the Business CycleBusiness Cycle The peak is the top of the business
cycle.
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The Phases of the The Phases of the Business CycleBusiness Cycle The peak is the top of the business
cycle. A boom is a very high peak,
representing a big jump in output.
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The Phases of the The Phases of the Business CycleBusiness Cycle The downturn -- the phenomenon of
economic activity starting to fall from a peak.
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The Phases of the The Phases of the Business CycleBusiness Cycle The downturn -- the phenomenon of
economic activity starting to fall from a peak.
A recession is a decline in output that persists for more than two consecutive quarters in a year.
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The Phases of the The Phases of the Business CycleBusiness Cycle A depression is a large recession.
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The Phases of the The Phases of the Business CycleBusiness Cycle A depression is a large recession. The bottom of the recession or
depression is called the trough.
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The Phases of the The Phases of the Business CycleBusiness Cycle As total output starts to expand, the
economy comes out of the trough into an upturn, which may turn into an expansion—an upturn that lasts at least two consecutive quarters of a year.
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The Phases of the The Phases of the Business CycleBusiness Cycle
Tot
al O
utpu
t
Peak
0Jan.– Mar.
Apr.– June
July– Sept.
Oct.– Dec.
Jan.– Mar.
Quarters
Apr.– June
Secular growth trend
July– Sept.
Oct.– Dec.
Jan.– Mar.
Apr.– June
Trough
Expansion ExpansionRecession
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Leading IndicatorsLeading Indicators
Leading indicators are those that tell us what's likely to happen in the economy 12 to 15 months from now.
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Leading IndicatorsLeading Indicators
Leading indicators include the following:
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Leading IndicatorsLeading Indicators
Leading indicators include the following: Average workweek for production
workers in manufacturing Unemployment claims New orders for consumer goods and
materials
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Leading IndicatorsLeading Indicators
Leading indicators include the following: Vendor performance, measured as a
percentage of companies reporting slower deliveries from suppliers
Contracts and orders for plant and equipment
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Leading IndicatorsLeading Indicators
Leading indicators include the following: Number of new building permits
issued for private housing units Change in stock prices
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Leading IndicatorsLeading Indicators
Leading indicators include the following: Change in consumer expectations Changes in the money supply
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Leading IndicatorsLeading Indicators
The drudge work of sifting through statistical series is the backbone of business economists' work
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UnemploymentUnemployment
Business cycles and growth are directly related to unemployment in the U.S. economy.
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UnemploymentUnemployment
Unemployment occurs when people are looking for a job and cannot find one.
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UnemploymentUnemployment
The unemployment rate is the number of people who cannot find a job as a percent of those people in the economy who are willing and able to work.
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Types of Types of UnemploymentUnemployment Frictional unemployment is the
unemployment caused by new entrants into the job market and people quitting a job just long enough to look for and find another one.
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Types of Types of UnemploymentUnemployment Structural unemployment is that caused
by economic restructuring making some skills obsolete.
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Types of Types of UnemploymentUnemployment Structural unemployment is that caused
by economic restructuring making some skills obsolete. It existed in pre-industrial society.
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Types of Types of UnemploymentUnemployment Cyclical unemployment is that which
results from fluctuations in economic activity.
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Types of Types of UnemploymentUnemployment Cyclical unemployment is that which
results from fluctuations in economic activity. It did not exist in pre-industrial
society.
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Types of Types of UnemploymentUnemployment Cyclical unemployment is that which
results from fluctuations in economic activity. The Industrial Revolution changed the
nature of work and introduced unemployment as a problem for society.
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Types of Types of UnemploymentUnemployment Cyclical unemployment is that which
results from fluctuations in economic activity. The Industrial Revolution was
accompanied by a change in how families dealt with unemployment.
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Types of Types of UnemploymentUnemployment Cyclical unemployment is that which
results from fluctuations in economic activity. What had previously been a family
problem, now became a social problem.
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Types of Types of UnemploymentUnemployment Cyclical unemployment is that which
results from fluctuations in economic activity. Hunger was the early solution for
unemployment.
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Types of Types of UnemploymentUnemployment Cyclical unemployment is that which
results from fluctuations in economic activity. Hunger was the early solution for
unemployment. It was not an effective answer to
unemployment.
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Types of Types of UnemploymentUnemployment Cyclical unemployment is that which
results from fluctuations in economic activity. In the Employment Act of 1946,
government took responsibility for full employment—an economic climate in which just about everyone who wants a job can have one.
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The Target Rate of The Target Rate of UnemploymentUnemployment The target rate of unemployment is the
lowest sustainable rate of unemployment that policymakers believe is achievable under existing conditions.
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The Target Rate of The Target Rate of UnemploymentUnemployment Initially government regarded 2 percent
unemployment as a condition of full employment.
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The Target Rate of The Target Rate of UnemploymentUnemployment Initially government regarded 2 percent
unemployment as a condition of full employment. The 2 percent was made up of
frictional unemployment.
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The Target Rate of The Target Rate of UnemploymentUnemployment In the 1980s and 1990s, the target rate
of unemployment was been between 5 and 7 percent.
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The Target Rate of The Target Rate of UnemploymentUnemployment The target rate of unemployment has
changed over time for the following reasons:
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The Target Rate of The Target Rate of UnemploymentUnemployment The target rate of unemployment has
changed over time for the following reasons: In the 1970s and early 1980s, a low
inflation rate seemed to be incompatible with a low unemployment rate.
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The Target Rate of The Target Rate of UnemploymentUnemployment The target rate of unemployment has
changed over time for the following reasons: Demographics have changed.
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The Target Rate of The Target Rate of UnemploymentUnemployment The target rate of unemployment has
changed over time for the following reasons: Demographics have changed. Different age groups have different
rates of unemployment.
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The Target Rate of The Target Rate of UnemploymentUnemployment The target rate of unemployment has
changed over time for the following reasons: Social and institutional structures
have changed.
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The Target Rate of The Target Rate of UnemploymentUnemployment The target rate of unemployment has
changed over time for the following reasons: The economy has undergone major
structural readjustments -- modifications in the types of goods produced and the methods of production.
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The Target Rate of The Target Rate of UnemploymentUnemployment The target rate of unemployment has
changed over time for the following reasons: Governmental institutions also
changed.
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Whose responsibility is Whose responsibility is unemployment?unemployment? The Classicals believe that individuals
are responsible for their own employment.
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Whose responsibility is Whose responsibility is unemployment?unemployment? Keynesian economists tend to say that
society owes a person a job commensurate with the individual's training or past job experience.
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How is unemployment How is unemployment measured?measured? The unemployment rate is published by
the U.S. Department of Labor's Bureau of labor Statistics.
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How is unemployment How is unemployment measured?measured? The unemployment rate is published by
the U.S. Department of Labor's Bureau of labor Statistics. Visit the Bureau of Labor Statistics on
the Internet at : http://stats.Bls.Gov.
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Unemployment Rate Since Unemployment Rate Since 19001900
Pe
rce
nta
ge
of
lab
or
forc
e u
ne
mp
loy
ed 30
20
10
0
Target rate
Years
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
Average unemployment
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Calculating the Calculating the Unemployment RateUnemployment Rate The unemployment rate is calculated by
dividing the number of unemployed individuals by the number of people in the civilian labor force and multiplying by 100.
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Calculating the Calculating the Unemployment RateUnemployment Rate The unemployment rate is calculated by
dividing the number of unemployed individuals by the number of people in the civilian labor force and multiplying by 100.
unemployment rate=number unemployedlabor force
100
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Calculating the Calculating the Unemployment RateUnemployment Rate The unemployment rate is calculated by
dividing the number of unemployed individuals by the number of people in the civilian labor force and multiplying by 100. The labor force is those people in an
economy who are willing and able to work.
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How accurate is the How accurate is the official unemployment official unemployment rate?rate? The unemployment rate does not
include discouraged workers—people who do not look for a job because they feel they do not have a chance of getting one.
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How accurate is the How accurate is the official unemployment official unemployment rate?rate? The unemployment rate counts as
employed those who are underemployed—part-time workers who would prefer full-time work.
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How accurate is the How accurate is the official unemployment official unemployment rate?rate? Both the Classicals and the
Keynesians, for completely different reasons, agree that the unemployment figures are imperfect.
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How accurate is the How accurate is the official unemployment official unemployment rate?rate?
Total civilian population (258 million)
Noninstitutional population (201 million)
Labor force (133.9 million)
Employed (126.7 million)
Not in labor force—(66.6 million)
Unemployed (7.2 million)
Incapable of working—(63 million)
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Unemployment and Unemployment and Potential IncomePotential Income The capacity utilization rate is the rate
at which factories and machines are operating compared to the maximum sustainable rate at which they could be used.
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Unemployment and Unemployment and Potential IncomePotential Income The capacity utilization rate indicates
how much capital is available for economic growth.
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Unemployment and Unemployment and Potential IncomePotential Income Potential output is the output that would
materialize at the target rate of unemployment and the target rate of capacity utilization.
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Unemployment and Unemployment and Potential IncomePotential Income Potential income is defined as the
output that will be achieved at the target rate of unemployment and at the target level of capacity utilization.
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Unemployment and Unemployment and Potential IncomePotential Income There is debate about where the actual
level of potential income is.
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Unemployment and Unemployment and Potential IncomePotential Income To determine the effect changes in the
unemployment rate will have on income, we use Okum's rule of thumb.
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Unemployment and Unemployment and Potential IncomePotential Income To determine the effect changes in the
unemployment rate will have on income, we use Okum's rule of thumb. The rule states that a 1 percentage
point change in unemployment will cause income to change in the opposite direction by 2.5 percent.
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Microeconomic Microeconomic Categories of Categories of UnemploymentUnemployment Macroeconomic measures of
unemployment may be too crude.
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Microeconomic Microeconomic Categories of Categories of UnemploymentUnemployment Macroeconomic measures of
unemployment may be too crude. Different types of unemployment are
susceptible to different types of products.
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Microeconomic Microeconomic Categories of Categories of UnemploymentUnemployment Some microeconomic categories of
unemployment are reason for how people become unemployed, demographic unemployment, duration of unemployment, and unemployment by industry.
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InflationInflation
Inflation is a continual rise in the price level.
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InflationInflation
Since World War II, the U.S. inflation rate has remained positive and relatively stable.
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InflationInflationIn
flatio
n
25 20 15 10
5 0
–5 –10 –15
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
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Measurement of Measurement of InflationInflation In order to estimate inflation one must
first create a price index.
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Measurement of Measurement of InflationInflation A price index is a composite of prices.
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Measurement of Measurement of InflationInflation A price index is a composite of prices.
It is a series of numbers that summarizes what happens to prices of a selection of goods (often called a market basket of goods) over time.
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Measurement of Measurement of InflationInflation The Producer Price Index (PPI)
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Measurement of Measurement of InflationInflation The Producer Price Index (PPI)
An index or ratio of a composite of prices of a number of important raw materials, such as steel, relative to a composite of the prices of those raw materials in a base year.
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Measurement of Measurement of InflationInflation The Producer Price Index (PPI)
It does not accurately measure what most consumers are interested in—final goods.
© The McGraw-Hill Companies, Inc., 1998Irwin/McGraw-Hill
Measurement of Measurement of InflationInflation The Producer Price Index (PPI)
It does not accurately measure what most consumers are interested in—final goods.
It gives an early indication as to where inflation is headed.
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Measurement of Measurement of InflationInflation The GDP Deflator (Gross Domestic
Product Deflator)
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Measurement of Measurement of InflationInflation The GDP Deflator (Gross Domestic
Product Deflator) An index of the price level of
aggregate output or the average price of the components in GDP relative to a base year.
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Measurement of Measurement of InflationInflation The GDP Deflator (Gross Domestic
Product Deflator) This is the measure of inflation most
economists favor since it includes the widest number of goods.
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Measurement of Measurement of InflationInflation The GDP Deflator (Gross Domestic
Product Deflator) Since it is difficult to compute, it is
published only quarterly and with a fairly substantial lag.
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Measurement of Measurement of InflationInflation The Consumer Price Index (CPI)
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Measurement of Measurement of InflationInflation The Consumer Price Index (CPI)
Measures the prices of a fixed "basket" of consumer goods, weighed according to each component's share of an average consumer's expenditures.
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Measurement of Measurement of InflationInflation The Consumer Price Index (CPI)
It is the measure of inflation most often presented in news broadcasts.
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Measurement of Measurement of InflationInflation The Consumer Price Index (CPI)
Many economists believe that the CPI as currently constituted, overstates inflation by one to two percentage points.
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Composition of CPIComposition of CPI
Food and beverage (17.3%)
Housing (41.3%)
Other (7.1%) Entertainment (4.4%)
Medical care (7.4%)
Transportation (17%)
Clothing (5.5%)
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Real and Nominal Real and Nominal ConceptsConcepts Nominal output is the total amount of
goods and services as measured by current prices.
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Real and Nominal Real and Nominal ConceptsConcepts Real output is the total amount of goods
and services produced, adjusted for price level changes.
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Real and Nominal Real and Nominal ConceptsConcepts Real output is the total amount of goods
and services produced, adjusted for price level changes.
100 X index price
output nominal =output real
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Real and Nominal Real and Nominal ConceptsConcepts The “real” amount is the nominal
amount adjusted for inflation.
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Why does inflation Why does inflation occur?occur? The economy has nominal wage- and
price-setting institutions in which people set their relative prices by setting a nominal price.
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Why does inflation Why does inflation occur?occur? Demand-pull inflation is the inflation that
occurs when the economy is at or above full employment.
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Why does inflation Why does inflation occur?occur? Demand-pull inflation is the inflation that
occurs when the economy is at or above full employment. When the majority of industries are
close to capacity and they experience increases in demand, we say there's demand-pull inflation.
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Why does inflation Why does inflation occur?occur? Cost-push inflation involves a rise in the
price level resulting from restrictions on supply due to some sort of legal or social pressure.
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Demand-Pull InflationDemand-Pull Inflation
Pri
ce
P1
P0
Q0 Q1
Quantity
D0
S0
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Demand-Pull InflationDemand-Pull Inflation
Pri
ce
P1
P0
Q0 Q1
Quantity
D1
D0
S0
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Cost-Push InflationCost-Push Inflation
Pri
ce
P1
P0
0(0-A)
Quantity
Qa(A-B)
D0
S0
A B
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Cost-Push InflationCost-Push Inflation
Pri
ce
P1
P0
0(0-A)
Quantity
Qa(A-B)
D0
S0
S1
A B
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Expected and Expected and Unexpected InflationUnexpected Inflation Expectations of inflation play an
important role in exacerbating inflation further.
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Expected and Expected and Unexpected InflationUnexpected Inflation Expected inflation is that which people
anticipate.
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Expected and Expected and Unexpected InflationUnexpected Inflation Expected inflation is that which people
anticipate. Unexpected inflation is that which
surprises people.
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Costs of InflationCosts of Inflation
Inflation does not make a nation poorer.
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Costs of InflationCosts of Inflation
Inflation causes income to be redistributed from those who do not raise their prices to those who do.
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Costs of InflationCosts of Inflation
Inflation causes income to be redistributed from those who do not raise their prices to those who do. For example, from lenders to
borrowers.
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Costs of InflationCosts of Inflation
Inflation can reduce the amount of information that prices are supposed to convey.
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Costs of InflationCosts of Inflation
Despite redisributive costs and a blurring of price information, inflation is usually accepted by governments as long as it stays at a low level.
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Costs of InflationCosts of Inflation
The danger is when inflation becomes hyperinflation—exceptionally high levels of inflation of, say, 100 percent or more a year.
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Costs of InflationCosts of Inflation
The U.S. has never experienced a hyperinflation.
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Economic Growth, Economic Growth, Business Cycles, Business Cycles, Unemployment, Unemployment,
and Inflationand Inflation
End of Chapter 7