n on iio ct ct ra ra nt

n on iio ct ct ra ra nt nt Co Co Level of business activity “Too much money” PEAK C on tr ac ti on Ex pa ns ion Inflation Ex pa ns io n PEAK D REN T TH W RO G TROUGH Business Cycle Trough Unemployment Time

An increase in Real GDP, & therefore an increase in income and increase in the standard of living An increase in Real GDP per capita over time [Real GDP/population = Real GDP per capita] capita 1. Main Sources of Economic Growth A. Increase in Resources [land, labor, & capital] B. Increase in Productivity 1. ) better health 2. ) better training 3. ) more education (human capital) 4. ) more motivation

Four Phases of the Business Cycle TROUGH Trough Time D REN T TH W RO G Ex pa ns io n PEAK C on tr ac ti on Ex pa ns ion n on iio ct ct ra ra nt nt Co Co Level of business activity PEAK

Peak R ec es si on Ex pa ns ion Real GDP per year Trough One Cycle Time [Have averaged five years] Peak: real GDP reaches its maximum. Recession: real GDP declines 6 months. Trough: real GDP reaches its minimum. Expansion: an upturn - real GDP rises.

Characteristics of Expansions and Recessions Expansions 1. Less unemployment 2. Increase in real GDP 3. Rapid job growth 4. Increasing interest rate 5. Increasing prices 6. Fewer social problems (alcoholism, domestic violence, divorce, and suicides) Recessions 1. More unemployment 2. Decrease in Real GDP 3. Reduced job growth 4. Lower interest rates 5. Decreasing prices 6. More social problems (alcoholism, domestic violence, divorce and suicide)

Inflation & Business Cycles Inflation – “too many dollars chasing too few goods. ” Deflation – “too few dollars chasing too many goods. ” 12. 5% 10% Three Price Level Movements 1. Inflation – increase in prices[79 -80] 8. 9% 3. 8% 2. Disinflation – decrease in inflation[80 -83] 3. Deflation – decrease in prices[1954]. 1954 -2% 79 80 81 82 1954 was the last deflation year.

Recession – GDP decreases for two quarters (6 months) [Unemployment up to 12%, lasting from 6 months to 3 years] Depression – GDP decreases for most quarters of a 3 -year period. [Unemployment from 12% to 20%, lasting over 3 years] Great Depression – GDP decreases for most quarters of a 6 -yr period. [Unemployment over 20%, lasting over 6 years] Stagflation Durable Goods – last more than a year [autos, furniture] Non-durable – last less than a year [food, gasoline] Inflation & unemployment exist at the same time. [The economy is stagnating and inflating] PL AD 2 AD 1 AS 2 AS Recession-proof Stocks PL “Food, drink, & tobacco” 10% cosmetics, drugs, health 3% 3% care, telephones, utilities, 1% toothpaste, toiletries, and 10%5% detergents. “Disinflationary Recession” AD 10% 5% AS 1

Trough – Pit of a Recession Trough (“base”) – demand, production base and unemployment are at their lowest point. Real GDP begins to increase again. point A trough marks the “pit of a recession”, recession” but – the start of an expansionary phase of the business cycle. The Fed lowers interest rates The trough is “bad news” and “good news. ” It is the bottom of the “valley” of the downturn and the foot of the “hill” of expansion

7. 6/149. 3 x 100 = Unemployment Rate of 5. 1% Not in Labor Force: Kids, military personnel, retired people, stay at home moms and dads, full-time students, your 35 year old uncle who sleeps on the couch all day, and most of the homeless. Under 16 and/or Institutionalized (70. 5 Million) Not in Labor Force (76. 8 Million) Total Population (297 Million) Employed (141. 7 Million) Unemployed 7. 6 mil. Labor Force (149. 3 Million)

Frictional – “temporary”, “transitional”, “short-term. ” (“between jobs” or “search” unemployment) Examples: 1. People who get “fired” or “quit” to look for a better one. [30 mil. a yr] mil yr [6 million U. S. workers get laid off each year] 2. “Graduates” from high school or college who are looking for a job. 3. “Seasonal” or weather-dependent jobs such as “agricultural”, “construction”, “retail”, or “tourism”. “agricultural” “construction” “retail” “tourism” [lifeguards, resort workers, Santa’s, & migrant workers. ] Frictional unemployment signals that “new jobs” are available and reflects “freedom of choice”. These are qualified workers with “transferable” skills.

2. Structural Unemployment Structural – “technological” or “long term”. There are basic changes in the “structure” of the labor force which make certain “skills obsolete”. [also caused by “international competition”] Automation may result in job losses. Consumer taste may make a good “obsolete”. The auto reduced the need for carriage makers. Farm machinery reduced the need for farm laborers “Creative destruction” means as jobs are created, other jobs are lost. Jobs of the future destroy jobs of today. Frictional and Structural make up the “natural rate of unemployment”. “These jobs do not come back. ” “Non-transferable skills” – choice is prolonged unemployment or retraining.

3. Cyclical Unemployment Cyclical – “economic downturns” in the business cycle. “Cyclical fluctuations” caused by “deficient AD” “Durable goods jobs” are impacted the most. These can be postponed because they can be repaired “Cyclical unemployment” is “real unemployment. ” “These jobs do come back. ”

Cyclical Unemployment “These jobs do come back. ” If Arnold S. gets laid off producing autos, he says,

Defining “Full Employment” An economy is fully employed when frictional and structural but no cyclical unemployment exists. This is when the …. Natural Rate of Unemployment Exists. This is also referred to as the Full Employment Rate of Unemployment. When labor markets are in balance, ie. the # of job seekers = the number of job vacancies.

Wish I had not dropped out of school. Will Work For Food Discouraged workers – those who have given up. Unemployed workers - those who are actively looking. Part-time workers – half employed, half unemployed, but counted as fully employed. Employed workers – those who work for even one hour per week for wages or 15 hours a week if not getting paid. We have full employment when cyclical unemployment is “ 0”. In Europe, full employment is 8 -10%. Europe 8 -10%

The unemployment rate in January of 2008 was 4. 9%. The next month, 63, 000 jobs were lost. “Did the unemployment rate go up in February, 2008? ” No, because 450, 000 became discouraged and quit looking, the February unemployment rate actually improved to 4. 8%. But, the economy was worse off.

Crime rates move with the business cycle…rising during periods of high unemployment and falling during periods of low unemployment. The crime unemployment statistics released in the fall of 1997 bear this out. With unemployment at a 25 -year low at 4. 9% the rate of violent crime was down for a fifth consecutive year, and the murder rate fell to its lowest level since 1969. FBI crime statistics show that both property crime and violent crime increased sharply between 1985 and 1991 and fell dramatically from 1991 to 1997 in step with unemployment

UNEMPLOYMENT Economic Costs of Unemployment GDP Gap and Okun’s Law The amount by which actual GDP falls short of potential GDP For every 1% unemployment exceeds the natural rate. . . Approximately a 2% GDP Gap occurs

Unemployment Rate over 6% x 2 Okun’s Law GDP Gap = Unemployment Rate over 6% x 2 7. 5% unemployment, so 1. 5 x 2% = 3%. [$3 bil. GDP Gap($100 Bil. nominal GDPx 3%; or $100 B x. 03 =$3 B. ) 1. Unemployment is 7%; Nominal GDP is $200 billion. 1 2 4 Real unemp. is __%. The % gap is __%. Y being forgone is $__ B. 2. Unemployment is 8%; Nominal GDP is $500 billion. 2 4 20 Real unemp. is __%. The % gap is __%. Y being forgone is $__ B. 3. Unemployment is 10%; Nominal GDP is $100 billion. 8 8 4 Real unemp. is __%. The % gap is __%. Y being forgone is $__ B. NS 43 & 44 43. Unemployment is 17%. Nominal GDP is $200 billion. 44 What % is the GDP gap? 22 __% What output is forgone? $___ 44. Unemployment is 16%. Nominal GDP is $300 billion. 60 What % is the GDP gap? 20 __% What output is forgone? $___

INFLATION Defined and Measurement • A rising general level of prices • Rate of inflation calculated using index numbers Consumer Price Index CPI = Price of most recent market basket in the particular year Price of the same market basket in 1982 -1984 x 100

1. PPI – wholesale prices [what retailers are buying] 2. CPI – retail prices [what consumers are buying] 3. GDP Deflator – production prices [what consumers, businesses, government, and foreigners are buying that we produced. ]

16% Food and beverages 17% Transportation Education and communication 6% 41% Housing 6% 6% 4% 4% Medical care Recreation Apparel Other goods and services

Consumer Price Index (CPI) Food & energy make up 23% of the CPI. Core inflation makes sense only for people who “don’t eat or drive. ” [CPI measures cost of living relative to a base year[100] The CPI is a market basket of 364 items at 21, 000 establishments in 91 cities that the typical householder buys. It does not include exports because we do not buy exports but does include imports. About 55% of the CPI is services. imports services

1. 2. 3. 4. If orange goes from $1. 00 to $2. 00 Substitutes not counted & Quality not considered (airbags) Tomato juice goes from $1 No discount stores (“outlet bias”) to. 80 New items not counted a. 1 st VCR, the Phillips 1500, the world’s 1 st VCR for home use sold for $1, 295 but $50 today. They fell in price 70% before entering the CPI. 1969 Sharp QT-8 D Calculator for $475 [4 functions] [First battery-powered electronic calculator] b. First solar powered calculators appeared in 1972 for $120 but didn’t make the CPI until 1978. c. In 2000, a 20 -inch LCD TV cost $5, 000, today under $400. d. Cell phones[The “Brick”]were introduced in 1984 at $3, 995. Brick” e. The camcorder cost $1, 500 in 1987, now under $400. f. HDTV cost $8, 000 in 1998. g. 42 inch Plasma TV in 1999 cost $11, 000, now $900.

GDP Deflator includes prices for all goods that we produce: 1. What householders are buying [PCE] 2. What businesses are buying 3. What the government is buying 4. What foreigners are buying [does not include imports because we don’t produce imports]

Demand-Pull Inflation – increase in AD. [“Too many dollars chasing too few goods”] Originates from “buyers side of the market”. D 1 D 2 S P 2 P 1 “Demand-pull” PL 2 PL 1 D S 2 S 1 Cost-Push Inflation – 3 things may cause “cost-push” inflation. “Cost-push” 1. Wage-push – strong labor unions 2. Profit-push – companies increase prices when their costs increase. 3. Supply-side cost shocks – unanticipated “Wage-price” Spiral increase in raw materials such as oil.

Above about too much. Up in 2005 Tomatoes 50% Fuel Oil 40% Butter 28% Gasoline 26% Home gas 16% Chicken 8% Col. Tuition 9% Sausage 7% Sports tickets 7% 2. 0 -2. 5% inflation is considered [2. 3% in 2007 & 4. 1% in 2008] Take some money out of circulation to make it more valuable. Down in 2004 Eggs -20% PCs -14% Photos -14% TVs -12% Lettuce -8% Toys -6% Cars -4% Girls cloth -1% Inflation – overall increase in prices Deflation – decrease in prices (1954) Disinflation – decrease in inflation(1980 -83)

Disinflationary Recessions [“Good News”–lower prices; “Bad News”–job losses] AD 2 AS AD 1 PL 2 “Good news” -lower prices YR “Bad news” - job losses Y*

Adverse Supply Shocks [“bad news” – job losses; “bad news” – inflation] AS 2 AD PL 2[10%] PL 1 $2. 25 AS 1 This economy is Inflating stagnating but inflating. Stagflation Stagnating YR Y* 10%

[“good news”–job gains; “good news”–disinflation] AD AS 1 AS 2 99 cents PL 1 PL 2 Y* Y 2

• Who is Hurt by Inflation? – Fixed-Income Receivers – Savers – Creditors • Who is Unaffected by Inflation? – Flexible-Income Receivers • Cost-of-Living Adjustments (COLAs) – Debtors

[Nominal income – inflation rate = Real Income] 16% Nominal Income 6% Inflation Premium = 10% Real Income

“Real Income” measures the amount of goods/services nominal income will buy. [% change in real income = % change in nominal income - % change in PL. ] PL 5% 10% 5% Nominal income rose by 10%, PL increased by 4% - then real income rose by ___%. 6 15 Nominal income rose by 20%, PL increased by 5% - then real income rose by ___%. “You will get a 10% raise”

70 _____________ “Rule of 70” = % annual rate of increase (3%) = 23 years [Inflation (prices to double)] 70 70 70 [Investments to double] 8 years 6 years 9 = _____ [GDP (standard of living) to double] 7 years 10 = ______ 12 = _____ 70

Real GDP = Nominal GDP/Index X 100 “Nominal” “Real” $9, 299. 2[1999]/104. 77[1996] x 100 = $8, 875. 8 [So, +$1, 062. 6] “Real GDP deflates nominal GDP to actual value” [takes the air out of the nominal balloon] $5, 250. 8 $3, 774. 7 $5, 671. 8 4, 848 4, 839 3, 492 108. 5 x 100=$_____ 108. 1 x 100=$_____ 117. 0 x 100=$_____ NS 12 and 13 12. Using the above formula, what is the real GDP for 1994 if nominal GDP was $6, 947 trillion and the GDP deflator was 126. 1? ($6, 611/$5, 610/$5, 509) trillion. [$6, 947/126. 1 x 100 = $5, 509 trillion 13. For 1996, what would real GDP be if nominal GDP were $7, 636 trillion and the GDP deflator were 110. 2? ($6, 929/$9, 628/$6, 928). [$7, 636 trillion/110. 2 x 100 = $6, 929 trillion]

Unemployment 5, 655, 000 Unemployment Rate = Labor Force x 100; 4. 0% = 140, 863, 000 x 100 [Employed + unemployed] [135, 208, 000+5, 655, 000] 6 In Forney, 42 are unemployed & 658 are employed. The unemployment rate is __%. 5 One mil. are unemployed & 19 mil. are employed. The unemploy. rate is __%. NS 41 41. If the total population is 280 million, and the civilian labor force includes 129, 558, 000 with jobs and 6, 739, 000 unemployed but looking for jobs, then the unemployment rate would be 4. 9 ____%. [6, 739, 000/136, 297, 000 x 100 = 4. 9%]

[Change/Original X 100 = inflation] So, 3. 3% increase in Social Security benefits for 2007 (2006 -later year) (2005 -earlier year) Current year’s index – last year’s index 199. 1 – 192. 7 [6. 7] C. P. I. = Last year’s index(2006 -earlier year) x 100; 192. 7 x 100 = 3. 3% 130. 7 -124. 0(6. 7) 116 -120(-4) 124. 0 x 100 = ____ -3. 3% 5. 4% 120 x 100 = ____ 333 -300(33) 11% 300 x 100 = ____ NS 50, 51, & 52 50. The CPI was 166. 6 in 1999 and 172. 2 in 2000 Therefore, the rate of inflation for 2000 was (2. 7/3. 4/4. 2)% [5. 6/166. 6 x 100 = 3. 4%] 51. If the CPI falls from 160 to 149 in a particular year, the economy has experienced (inflation/deflation) of (5/-4. 9/-6. 9)%. [-11/160 x 100 = -6. 9%] 52. If CPI rises from 160. 5 to 163. 0 in a particular year, the rate of inflation for that year is (1. 6/2. 0/4. 0)%.

(42%) 18. Suppose that a typical consumer buys the following quantities of these three commodities in 2000 and 2001 Commodity Quantity Food Clothing Shelter 5 units 2 units 3 units 2000 per Unit Price $6. 00 $7. 00 $12. 00 2001 per Unit Price $5. 00 $9. 00 $19. 00 Which of the following can be concluded about the CPI for this individual from 2000 to 2001? 2001 a. It remained unchanged. c. it decreased by 20% b. It decreased by 25%. d. It increased by 20% e. It increased by 25%. (Answer) Year 1 [2000]: [5 food x $6 = $30; 2 clothing x $7 = $14; 3 shelters x $12 = $36, for dollar value of $80. CPI = 100 ($80/$80 x 100 = 100 for 2000) Year 2 [2001]: [5 food x $5 = $25; 2 clothing x $9 = $18; 3 shelters x $19 = $57, for dollar value of $100. CPI =125 (125/100 x 100 = 125 for 2001) Change Original = $100 -$80 [$20] $80 x 100 = 25%; so the CPI for this individual is 25%.

1. Leading Indicators 2. Coincident Indicators 3. Lagging Indicators

[“The leading indicators have predicted 11 of the last 15 recessions”] “Barometer Of The Future” “Like taking the blood pressure of the economy” [3 -6 months] “Where we are heading” Leading Indicators Average workweek Vender performance New orders-capital goods New orders-consumer goods Interest Rate spread Housing permits Stock prices Money supply Vender performance Housing permits Had a recession in 2001 A drop for three straight months usually indicates a recession is coming.

“Where we have been” Lagging Indicators Labor cost, unemployment rate & duration, prime rates, CPI for services, commercial loans, etc.

Inflation Rate + Unemployment Rate = Misery Index Arthur Okun developed the economic “discomfort index” to summarize the “health of the economy. ” Jimmy Carter used it against Gerald Ford and won. Ronald Reagan used it against Carter(20%) and won. Inflation Rate Unemployment Rate Arthur Okun

NS 31 -49 31. (Frictional/Structural/Cyclical) is “temporary”, “short-term” unemployment. 32. (Frictional/Structural/Cyclical) is technological, “long-term” unemployment. 33. (Frictional/Structural/Cyclical) is unemployment resulting from recessions F. FRICTIONAL S. STRUCTURAL C. CYCLICAL ___ 34. Michael lost his job due to the recession [business cycle downturn]. C ___ 35. College graduate is searching for his first job. F ___ 36. Amanda is quitting Wendy’s to work at Mc. Donald’s. F ___ 37. There are job losses at Ford due to a decrease in AD. AD C ___ 38. Lifeguards in the winter and Santa’s during the spring. F ___ 39. The auto replaces carriage makers S ___ 40. ATM machines replace bank tellers S 45. The cost of unemployment can be measured by the amount by which (potential/actual) GDP exceeds (potential/actual) GDP. 46. If the unemployment rate is 8%, we can infer that the (potential/actual) GDP is in excess of (potential/actual) GDP. 47. (Inflation/Disinflation/Deflation) is a general increase in prices 48. (Inflation/Disinflation/Deflation) is a decline in prices 49. (Inflation/Disinflation/Deflation) is a decrease in the rate of inflation

NS 54 -60 54. (Demand-pull/Cost-push) inflation results from an increase in aggregate demand [AD]. 55. (Demand-pull/Cost-push) inflation results from an increase in production costs [wages or input cost]. 56. The only group that benefits from inflation are (creditors/debtors/fixed income pensioners). unemployment rate [4. 7%] 59. The misery index is equal to the ____________ inflation rate [2. 3%] plus the __________. 7% 60. The current misery index is ____. [changes every month]

Review For NIA, Economic Growth, Unemployment, Recessions, Inflation, & Business Cycles 1. If Maytag produces a washer and sells it, it counts as (Consumption/investment/disinvestment). If they don’t sell it, it counts as (“C”/investment/disinvestment). If they don’t sell it until the next year, it counts as (“C”/invest. /disinvestment). 2. If depreciation exceeds gross investment, then investment In is (positive/negative). In = $40 Depreciation $60 Depreciation $700 -$200 In Ig $500 bil. 3. If Ig were $100 bil. , & In was Ig $40 bil. , then in that year the $100 country’s capital stock [national factory] (increased/decreased) by ($40/$60) billion.

4. GDP is all goods/services produced (by a nation’s citizens all over the world/within the U. S. ). 5. Depreciation can be determined by: (subtracting In from Ig/ subtract In from GDP). 6. National Income Accounting [just the first 2 – GDP & NDP] GDP = C+Ig+G+X-M NDP = GDP – depreciation NI = NDP +NFFI – Statistical Discrepancy PI = NI U(-undis. Corp profits), Can(-corp. inc. taxes, Can See(-soc. Secur. ), Those [Taxes on production & See imports + Thunderducks (transfer payments) DI = PI – individual income taxes 7. Nominal GDP Price Index x 100 = Real GDP 8. Workers most likely to get hurt during a depression are (durable/non-durable) ones because these goods are postponable & they have monopoly [few sellers] power

9. Inflation later year’s index(120 -earlier year’s index(115) earlier year’s index (115) (chg. ) [5] (org. ) [115] x 100 = 4. 3% If CPI falls from one year to the next, (inflation/deflation) results. 110 -115 _-5_ 115 = 115 x 100 = -4. 3% 100 10. In the base year, the price index is always? ______ year $10 trillion x 100 = 100 2002 11. Income earned by U. S. resource suppliers [here & abroad] is (NDP/NI/PI). 12. Another name for FE GDP is (zero unemployment/potential GDP).

Recession 13. During a recession, (actual/potential) GDP exceeds recession (actual/potential) GDP, but the (actual/potential) unemployment rate exceeds the (actual/potential) unemployment rate. 14. If there are 5 million part time workers and 2 million get full time jobs, the unemployment rate jobs (increases/decreases/stays the same). 15. If there are 6 million unemployed and 3 million get discouraged and quit looking, unemployment (increases/decreases/stays the same). 16. The presence of discouraged workers and counting part-time workers as fully employed (understates/overstates) the official rate. 17. If the unemployment rate is 10% & nominal GDP is $400 billion, then 10 billion 8 cyclical (real) unemployment is ___%, the % gap is ___%, and output real 4 32 billion (GDP) being forgone is $_____. (NRU is 6%) 18. If we move from a recession to FE, we move from a FE (point inside the PPC to the PPC/shift the PPC out). 19. If unemployment is 15% & nominal GDP is $100 bil. , then cyclical (real) bil 18 bil 9 unemployment is ___%, the % gap is 18 ___%, & Y being forgone is $______. .