Long-run and Short-run Concerns

© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

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Prepared by: Fernando Prepared by: Fernando Quijano and Yvonn QuijanoQuijano and Yvonn Quijano

Long-Run and Short-Run Long-Run and Short-Run Concerns: Growth, Concerns: Growth,

Productivity, Unemployment, Productivity, Unemployment, and Inflationand Inflation


Long-Run Output andLong-Run Output andProductivity GrowthProductivity Growth

• An ideal economy is one in An ideal economy is one in which there is:which there is:

• rapid growth of output per worker,rapid growth of output per worker,

• low unemployment, andlow unemployment, and

• low inflation.low inflation.



• The average growth rate of output in The average growth rate of output in the economy since 1900 has been the economy since 1900 has been about 3.4 percent per year.about 3.4 percent per year.

• An area of economics called “An area of economics called “growth growth theorytheory” is concerned with the ” is concerned with the question of what determines this question of what determines this rate.rate.



• There are a number of ways to There are a number of ways to increase output. An economy can:increase output. An economy can:

• Add more workersAdd more workers

• Add more machinesAdd more machines

• Increase the length of the workweekIncrease the length of the workweek

• Increase the quality of the workersIncrease the quality of the workers

• Increase the quality of the machinesIncrease the quality of the machines



• A harder question to answer is why A harder question to answer is why has the quality of labor and capital has the quality of labor and capital grown more slowly since the early grown more slowly since the early 1970s.1970s.

• The growth of the Internet, which The growth of the Internet, which brings about an increase in the brings about an increase in the quality of capital, should lead to a quality of capital, should lead to a “new age” of productivity growth.“new age” of productivity growth.


Recessions, Depressions,Recessions, Depressions,and Unemploymentand Unemployment

• A recessionA recession is roughly a period in is roughly a period in which real GDP declines for at least which real GDP declines for at least two consecutive quarters. It is two consecutive quarters. It is marked by falling output and rising marked by falling output and rising unemployment.unemployment.

• The The business cyclebusiness cycle describes the describes the periodic ups and downs in the periodic ups and downs in the economy, or deviations of output economy, or deviations of output and employment away from the long-and employment away from the long-run trend.run trend.


Recessions, Depressions,Recessions, Depressions,and Unemploymentand Unemployment

• Capacity utilization rates,Capacity utilization rates, which which show the percentage of factory show the percentage of factory capacity being used in production, capacity being used in production, are one indicator of recession.are one indicator of recession.

• A A depressiondepression is a prolonged and is a prolonged and deep recession. The precise deep recession. The precise definitions of prolonged and deep definitions of prolonged and deep are debatable.are debatable.


Defining and Measuring UnemploymentDefining and Measuring Unemployment

• The most frequently discussed symptom The most frequently discussed symptom of a recession is unemployment.of a recession is unemployment.

• An An employedemployed person is any person 16 person is any person 16 years old or older years old or older

1.1. who works for pay, either for someone else or who works for pay, either for someone else or in his or her own business for 1 or more hours in his or her own business for 1 or more hours per week,per week,

2.2. who works without pay for 15 or more hours who works without pay for 15 or more hours per week in a family enterprise, orper week in a family enterprise, or

3.3. who has a job but has been temporarily who has a job but has been temporarily absent, with our without pay.absent, with our without pay.



• An An unemployedunemployed person is a person 16 person is a person 16 years old or older who:years old or older who:

1.1. is not working, is not working,

2.2. is available for work, andis available for work, and

3.3. has made specific efforts to find work during has made specific efforts to find work during the previous 4 weeks.the previous 4 weeks.

• A person who is not looking for work, A person who is not looking for work, either because he or she does not want a either because he or she does not want a job or has given up looking, is job or has given up looking, is not in the not in the labor forcelabor force..



u n em p lo y m en t ra te = u n em p lo y ed

em p lo y ed + u n em p lo y ed

lab o r fo rce = em p lo y ed + u n em p lo y e d

p o p u la tio n = lab o r fo rce + n o t in lab o r fo rce

lab o r fo rce p artic ip a tio n ra te = lab o r fo rce

p o p u la tio n


Discouraged-Worker EffectsDiscouraged-Worker Effects

• The The discouraged-worker effectdiscouraged-worker effect lowers lowers the unemployment rate. Discouraged the unemployment rate. Discouraged workers are people who want to work but workers are people who want to work but cannot find jobs, grow discouraged, and cannot find jobs, grow discouraged, and stop looking for work, thus dropping out stop looking for work, thus dropping out of the ranks of the unemployed and the of the ranks of the unemployed and the labor force.labor force.


Types of UnemploymentTypes of Unemployment

• Frictional unemploymentFrictional unemployment is the is the portion of unemployment that is due portion of unemployment that is due to the normal working of the labor to the normal working of the labor market; used to denote short-run market; used to denote short-run job/skill matching problems.job/skill matching problems.

• Structural unemploymentStructural unemployment is the is the portion of unemployment that is due portion of unemployment that is due to changes in the structure of the to changes in the structure of the economy that result in a significant economy that result in a significant loss of jobs in certain industries.loss of jobs in certain industries.


Types of UnemploymentTypes of Unemployment

• Cyclical unemploymentCyclical unemployment is the is the increase in unemployment that increase in unemployment that occurs during recessions and occurs during recessions and depressions.depressions.

• The The natural rate of unemploymentnatural rate of unemployment is the unemployment that occurs as is the unemployment that occurs as a normal part of the functioning of a normal part of the functioning of the economy. Sometimes taken as the economy. Sometimes taken as the sum of frictional unemployment the sum of frictional unemployment and structural unemployment.and structural unemployment.


The Benefits of RecessionsThe Benefits of Recessions

• Recessions may help to reduce inflation.Recessions may help to reduce inflation.

• Some argue that recessions may increase Some argue that recessions may increase efficiency by driving the least efficient firms efficiency by driving the least efficient firms in the economy out of business and forcing in the economy out of business and forcing surviving firms to trim waste and manage surviving firms to trim waste and manage their resources better.their resources better.

• Also, a recession leads to a decrease in Also, a recession leads to a decrease in the demand for imports, which improves a the demand for imports, which improves a nation’s balance of payments.nation’s balance of payments.


InflationInflation

• InflationInflation is an increase in the overall is an increase in the overall price level.price level.

• DeflationDeflation is a decrease in the overall is a decrease in the overall price level.price level.

• Sustained inflationSustained inflation is an increase in is an increase in the overall price level that continues the overall price level that continues over a significant period.over a significant period.


Price IndexesPrice Indexes

• Price indexesPrice indexes are used to measure are used to measure overall price levels. The price index that overall price levels. The price index that pertains to all goods and services in the pertains to all goods and services in the economy is the economy is the GDP price indexGDP price index..

• The The consumer price index (CPI)consumer price index (CPI) is a is a price index computed each month by the price index computed each month by the Bureau of Labor Statistics using a bundle Bureau of Labor Statistics using a bundle that is meant to represent the “market that is meant to represent the “market basket” purchased monthly by the typical basket” purchased monthly by the typical urban consumer.urban consumer.


Price IndexesPrice Indexes

• The The consumer price index (CPI)consumer price index (CPI) is the is the most popular fixed-weight price index.most popular fixed-weight price index.

• Other popular price indexes are Other popular price indexes are producer producer price indexesprice indexes ( (PPIsPPIs). These are indexes ). These are indexes of prices that producers receive for of prices that producers receive for products at all stages in the production products at all stages in the production process. The three main categories are process. The three main categories are finished goodsfinished goods, , intermediate materialsintermediate materials, , and and crude materialscrude materials..


The Costs of InflationThe Costs of Inflation

• People’s income increases during People’s income increases during inflations, when most prices, inflations, when most prices, including input prices, tend to rise including input prices, tend to rise together.together.

• Inflation changes the distribution of Inflation changes the distribution of income. People living on fixed income. People living on fixed incomes are particularly hurt by incomes are particularly hurt by inflation.inflation.



• The benefits of many retired The benefits of many retired workers, including social security, workers, including social security, are fully are fully indexedindexed to inflation. When to inflation. When prices rise, benefits rise.prices rise, benefits rise.

• The poor have not fared so well. The poor have not fared so well. Welfare benefits are not indexed and Welfare benefits are not indexed and have not kept pace with inflation.have not kept pace with inflation.



• Unanticipated inflationUnanticipated inflation—an inflation that —an inflation that takes people by surprise—can hurt takes people by surprise—can hurt creditors.creditors.

• Inflation that is higher than expected Inflation that is higher than expected benefits debtors; inflation that is lower than benefits debtors; inflation that is lower than expected benefits creditors.expected benefits creditors.

• The The real interest ratereal interest rate is the difference is the difference between the interest rate on a loan and the between the interest rate on a loan and the inflation rate.inflation rate.



• Inflation creates administrative costs and Inflation creates administrative costs and inefficiencies. Without inflation, time could inefficiencies. Without inflation, time could be used more efficiently.be used more efficiently.

• The opportunity cost of holding cash is The opportunity cost of holding cash is high during inflations. People therefore high during inflations. People therefore hold less cash and need to stop at the hold less cash and need to stop at the bank more often.bank more often.

• People are not fully informed about price People are not fully informed about price changes and may make mistakes that lead changes and may make mistakes that lead to a misallocation of resources.to a misallocation of resources.

Education

Long-run and Short-run Concerns