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Lecture Essentials of Economics: Chapter 10 - Bradley R. Schiller, Cynthia Hill

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Chapter 10 The business cycle, after reading this chapter, you should be able to: Explain how growth of the economy is measured, tell how unemployment is measured and affects us, discuss why inflation is a problem and how it is measured, define “full employment” and “price stability”, recite the U.S. track record on growth, unemployment, and inflation.

Chapter10 TheBusinessCycle Copyrightâ2014McGrawưHillEducation.Allrightsreserved.NoreproductionordistributionwithoutthepriorwrittenconsentofMcGrawưHillEducation Macroeconomics Macroeconomics is the study of aggregate economic behavior, of the economy as a whole • A basic purpose of macroeconomic theory is to explain the business cycle • Macro policy tries to control the business cycle 10­2 Assessing Macro  Performance • There are three basic measures of macro performance: – Output (GDP) growth – Unemployment – Inflation 10­3 GDP  • GDP is the total value of output (goods and services) produced in an economy during a given time period 10­4 GDP Growth • An economy’s potential output is reflected in its production possibilities curve (PPC): – Production possibilities – the alternative combinations of goods and services that could be produced in a given time period with all available resources and technology • When there is GDP growth, the PPC shifts outward 10­5 The Business Cycle • The business cycle is the alternating periods of economic growth and contraction experienced by the economy • It shows the rise and fall of the economy over time 10­6 Figure 10.1 10­7 Real GDP • Business cycles are measured by changes in real GDP: – Nominal GDP is measured in current prices – Real GDP is the inflation-adjusted value of GDP, the value of output measured in constant prices 10­8 Figure 10.2 10­9 The Great Depression • This was the most prolonged departure from our long-term growth path • Real GDP fell 30 percent from 1929 to 1933 • The economy grew moderately from 1934 to 1936 • Another decline occurred in 1936– 1937 10­10 Recent Recessions • 1981–1982: Lasted 16 months, with an unemployment rate of 10.8 percent, the highest since the 1930s • 1990–1991: A brief 8-month recession • 2001: Another 8-month recession • 2008–2009: Failures in financial and real estate markets led to a significant decline in real GDP and 10 percent unemployment 10­13 U nemployment • Unemployment is the inability of labor force participants to find jobs • When output declines, jobs are eliminated 10­14 The Labor Force • The labor force consists of everyone over the age of 16 who is actually working, plus all those who are not working but are actively seeking employment • This includes about half of the total population 10­15 Figure 10.3 10­16 The U nemployment  Rate • The unemployment rate is the proportion of the labor force that is unemployed: Unemployment rate = Number of unemployed Number in labor force 10­17 Figure 10.4 10­18 The Policy Goal • The goal is to avoid as much cyclical unemployment as possible • To try to achieve full employment • Full employment is the lowest rate of unemployment compatible with price stability: – It is estimated to be between and percent 10­19 Inflation • The biggest fear as an economy reaches full employment is inflation • As an economy reaches its production possibilities, prices will begin to rise as: – Demand for goods outstrip supply – Costs of production rise 10­20 Relative versus  Average Prices • The relative price is the price of one good in comparison with the price of other goods • It is possible for individual prices to rise or fall continuously without changing the average price level 10­21 Relative versus  Average Prices • Relative changes can occur in a period of stable average prices • Changes in relative prices are market signals that help reallocate resources in the economy • In a general inflation – when all prices are rising – prices not help to reallocate resources 10­22 Figure 10.5 10­23 Measuring Inflation • Consumer Price Index (CPI) – a measure of changes in the average price of consumer goods and services • Inflation rate – the annual rate of increase in CPI 10­24 Measuring Inflation • CPI relates current prices to prices that existed in 1982–1984, when CPI was set to 100 • A current CPI of 230 in 2013 means that it takes $230 to buy what $100 could buy in 1983 10­25 Price Stability and  Policy Goal • Price stability is the absence of significant changes in the average price level • The Full Employment and Balanced Growth Act of 1978 establishes a goal for economic policy to hold the rate of inflation at under percent 10­26 The Policy Goal • Congress weighs the tradeoff between inflation and full employment • Zero percent inflation might harm the goal of full employment • Three percent inflation was determined to be a safe target 10­27 ... the inflation-adjusted value of GDP, the value of output measured in constant prices 10 8 Figure 10. 2 10 9 The Great Depression • This was the most prolonged departure from our long-term growth... resources 10 22 Figure 10. 5 10 23 Measuring Inflation • Consumer Price Index (CPI) – a measure of changes in the average price of consumer goods and services • Inflation rate – the annual rate of increase... Figure 10. 3 10 16 The U nemployment  Rate • The unemployment rate is the proportion of the labor force that is unemployed: Unemployment rate = Number of unemployed Number in labor force 10 17

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