Economic Growth,

Business Cycles,
Unemployment, and
Inflation
Chapter 7
By: Mehwish Bhatti

© 2003 McGraw-Hill Ryerson Limited.

 6-2

Central Problems of
Macroeconomics
 Macroeconomics is the study of the
aggregate moods of the economy.
 The four central issues of
macroeconomics are growth, business
cycles, unemployment, and inflation.

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Two Timeframes: The Long

Run and the Short Run
 Issues of growth are considered in a
long-run framework.
 Long-run growth focuses on supply (also
called supply-side economics).
 Supply is so important in the long run,
policies that affect production - such as
incentives that promote work, capital, and
technological change - are key.

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Two Timeframes: The Long

Run and the Short Run
 Business cycles are generally
considered in a short-run framework.
 The short-run fluctuation framework
focuses on demand.
 Much of the policy discussion of short-run
fluctuations focuses on ways to increase or
decrease components of aggregate
expenditures.

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Growth
 Generally the Canadian economy is
growing or expanding.
 The primary measurement of growth is
change in real gross domestic product
(GDP).

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Growth
 Real gross domestic product (real
GDP) – the market value of final goods
and services stated in the prices of a
given period.

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Growth
 Another measure of growth is change in
per capita real output.
 Per capita real output is real output
divided by the total population.

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Global Experience with

Growth
 Global experiences with growth vary
across time and among nations.
 Today's growth rates are high by
historical standards.
 The range of growth rates among
nations is wide.

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The Benefits and Costs of

Growth
 Per capita economic growth allows
everyone in society, on average to have
more.
 Growth, or predictions of growth, allows
governments to avoid hard questions.
 A growing economy creates jobs.

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The Benefits and Costs of

Growth
 The costs of growth include pollution,
resource exhaustion, and destruction of
natural habitat.
 Since many believe the environmental
costs of growth are important, the result
is often an environmental-economic
growth stalemate.

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Business Cycles
 There are numerous fluctuations around
the secular growth trend,called the
business cycle.
 The business cycle is the upward and
downward movement of economic
activity that occurs around the growth
trend.

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Business Cycles
 There are a number of theories
regarding the nature and causes of
business cycles.
 Classicals are a group of economists
who generally favour laissez-faire or
noninterventionist policies.
 Keynesians generally favour activist
policies.
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Business Cycles
 Classical economists argue that
business cycles are to be expected in a
market economy.
 Keynesian economists believe that
fluctuations can and should be
controlled.

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The Phases of the Business

Cycle
 The peak is the top of the business
cycle.
 A boom is a very high peak,
representing a big jump in output.
 The downturn is the phenomenon of
economic activity starting to fall from a
peak.

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The Phases of the Business

Cycle
 A recession is a decline in real output
that persists for more than two
consecutive quarters in a year.
 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 Business

Cycle
 As total output starts to expand, the
economy comes out of the trough into
an upturn, which may turn into an
expansion.
 An expansion is an upturn that lasts at
least two consecutive quarters of a year.

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Business Cycle Phases, Fig. 6-2, p 140

Expansion Recession Expansion

Peak
Total Output

Secular
growth
trend
Trough

0
Jan.- Apr.- July- Oct.- Jan.- Apr.- July- Oct.- Jan.- Apr.-
Mar June Sept. Dec. Mar June Sept. Dec. Mar June

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Why Do Business Cycles

Occur
 Recessions and expansions are caused
primarily by demand-side shocks.
 A debate exists about whether these
fluctuations can and should be reduced.

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Why Do Business Cycles

Occur
 Most economists believe that potential
depressions should be offset by
economic policy.
 This general view was built into
economics in the Great Depression of
the 1930s.

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Why Do Business Cycles

Occur
 During this period there were changes
in the economy's structure, with
government playing a much more active
role.

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Leading Indicators
 Leading indicators are a set of signs
that indicate what is likely to happen 12
to 15 months from now.

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Leading Indicators
 Variables that make up the leading
indicator include:
 Average workweek for production
workers in manufacturing.
 An index of housing starts.
 The U.S. composite leading index.

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Leading Indicators
 Variables that make up the leading
indicator include :
 The money supply M1 divided by the price
index.
 New orders for durable goods.
 Retail trade in furniture and appliances.
 Durable goods sales excluding furniture
and appliances.

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Leading Indicators
 Variables that make up the leading
indicator include:
 The ratio of shipments to inventories or
finished products.
 The TSE 300 stock price index.
 Employment in business and personal
service sector.

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Leading Indicators
 Economists use indicators in making
forecasts about the economy. They are
indicators, not predictors.

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Unemployment
 Business cycles and growth are directly
related to unemployment in the
economy.
 Unemployment occurs when people are
looking for a job and cannot find one.

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Unemployment
 The unemployment rate is the
percentage of people in the economy
who are willing and able to work but
who are not working.

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Unemployment
 Cyclical unemployment results from
fluctuations in economic activity.

 It did not exist in pre-industrial society.

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Unemployment
 Structural unemployment is caused
by economic restructuring, making
some skills obsolete.
 It existed in pre-industrial society.

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Unemployment as a Social
Problem
 The Industrial Revolution was
accompanied by a change in how
families dealt with unemployment.
 What had previously been a family
problem, now became a social problem.

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Unemployment as
Government’s Problem
 The Federal Unemployment Insurance
Act of 1940 assigned government the
responsibility for providing assistance to
the unemployed.
 Full employment – an economic
climate in which just about everyone
who wants a job can have one.

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Unemployment as
Government’s Problem
 Initially government regarded 3 percent
unemployment as a condition of full
employment.
 The 3 percent was made up of frictional
unemployment.

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Unemployment as
Government’s Problem
 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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Unemployment as
Government’s Problem
 The target rate of unemployment
(sometimes called the natural rate of
unemployment) is the lowest
sustainable rate of unemployment that
policymakers believe is achievable
under existing conditions.

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Why the Target Rate of

Unemployment Changed
 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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Why the Target Rate of

Unemployment Changed
 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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Why the Target Rate of

Unemployment Changed
 The target rate of unemployment has
changed over time for the following
reasons:
 Social
and institutional structures have
changed.
 Governmental institutions also changed.

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Whose Responsibility Is
Unemployment?
 Classical economists believe that
individuals are responsible for their own
employment.
 They argue that every person can find
some job at some wage, so all
unemployment is frictional.

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Whose Responsibility Is
Unemployment?
 Keynesian economists tend to say that
society owes a person a job
commensurate with the individual's
training or past job experience.
 They argue that jobs should be closer to
home, so people do not have to move.
According to this view, unemployment is
mainly cyclical and structural.

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How Is Unemployment
Measured?
 The unemployment rate is published by
Statistics Canada.

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Calculating the
Unemployment Rate
 The unemployment rate is calculated
by dividing the number of unemployed
individuals by the number of people in
the labour force and multiplying by 100.
number unemployed
unemployme nt rate = ×100
labour force

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Calculating the
Unemployment Rate
 The labour force is those people in an
economy who are willing and able to
work.
 The labour force excludes those
incapable of working and those not
looking for work.

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Microeconomic Categories of
Unemployment
 Macroeconomic measures of
unemployment may be too crude.
 Different types of unemployment are
susceptible to different types of policies.

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Microeconomic Categories of
Unemployment
 Some microeconomic categories of
unemployment are reasons for
unemployment, demographic
unemployment, duration of
unemployment, unemployment by
industry,and unemployment by age
group.

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Inflation
 Inflation is a continual rise in the price
level.
 Since World War II, the Canadian
inflation rate has remained positive and
relatively stable.

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Measurement of Inflation
 Inflation is measured with changes in
price indexes.
 A price index is a composite of prices.

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Measurement of Inflation
 A price index is a series of numbers
that summarizes what happens to a
weighted composite of prices of a
selection of goods (often called a
market basket of goods) over time.

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Real-World Price Indexes

 Real-world price indexes include the
raw materials price index, the CPI, and
the GDP deflator.

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The Raw Materials Price

Index
 The raw materials price index
measures the prices of a number of
important raw materials, such as steel.

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The Raw Materials Price

Index
 This index does not accurately measure
what most consumers are interested
in—final goods.
 It gives an early indication of which way
inflation is headed.

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The GDP Deflator

 The GDP deflator (gross domestic
product deflator) is an index of the
price level of aggregate output, or the
average price of the components in total
output (GDP) relative to a base year.

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The Consumer Price Index

(CPI)
 The consumer price index (CPI)
measures the prices of a fixed basket of
consumer goods, weighted according to
each component's share of an average
consumer's expenditures.

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Real and Nominal Concepts

 Nominal output is the total amount of
goods and services measured at current
prices.

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Real and Nominal Concepts

 Real output is the total amount of
goods and services produced, adjusted
for price level changes.

nominal output
real output = X 100
price index

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Real and Nominal Concepts

 The “real” amount is the nominal
amount adjusted for inflation.

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Expected and Unexpected

Inflation
 Expected and unexpected inflation
affect behavior differently.
 Expected inflation is that which people
anticipate.
 Unexpected inflation is that which
surprises people.

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Costs of Inflation
 There are two main costs of inflation:
redistribution costs and blurring of price
information.

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Costs of Inflation
 Inflation causes income to be
redistributed from those who do not
raise their prices to those who do.
 Inflation can reduce the amount of
information that prices are supposed to
convey.

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Costs of Inflation
 The danger is when inflation becomes
hyperinflation.
 Hyperinflation – exceptionally high
levels of inflation of, say, 100 percent or
more a year.
 Canada has not experienced
hyperinflation.

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 Economic Growth,
Business Cycles,
Unemployment, and
Inflation

End of Chapter 6

© 2003 McGraw-Hill Ryerson Limited.