Business Cycle GDP Unemployment and Inflation Unemployed Inflation

Business Cycle, GDP, Unemployment, and Inflation. “Unemployed” “Inflation” 1

The Business Cycle U. S. has experienced a 3. 0% average economic growth over last 60 years! But, the 3% average has many fluctuations due to The Business Cycle: n Selected Years (rounded to nearest whole %): n 1984: 7% Growth in Goods & Services n 1991: -1% n 1997: 4% n 2001: 0% n 2017: 2. 3% 2

The 4 Phases Of The Business Cycle 1. Peak 2. Recession 3. Trough 4. Recovery (also called expansion) 3

The Business Cycle (Blue Line is 3% Avg. Growth) Peak Rec essio n ion pa ns Rec on nsi h t Grow d ess ion Ex pa Peak Tren Trough Ex Economic Growth Peak Trough Time 4 9 -4

4 Phases of the Business Cycle 1. Peak n Economy is doing at its best n Full employment (4% or lower unemployment) n Maximum output, Household Income is high n Prices likely to rise (inflation) n Demand tends to drive up prices since production is at or near capacity (no more resources to produce and meet the rising demand…thus, producers raise prices) 5

4 Phases of the Business Cycle 2. Recession n n Economy begin to recede or slump due to a decrease in spending. n Declines in n Employment (i. e. , more unemployment) n Output or production falls, Incomes fall n Prices often stable (slow to fall) U. S. averages 1 recession every 6 years > Last recession was the Great Recession of 2007 6

The Business Cycle U. S. Recessions since 1950 Period LO 1 Duration, Months Depth (Decline in Real Output) 1953 -54 10 -2. 6% 1957 -58 8 -3. 7 1960 -61 10 -1. 1 1969 -70 11 -0. 2 1973 -75 16 -3. 2 1980 6 -2. 2 1981 -82 16 -2. 9 1990 -91 8 -1. 4 2001 8 -0. 4 2007 -09 18 -3. 7 Source: National Bureau of Economic Research, www. nber. org, and Minneapolis Federal Reserve Bank, www. minneapolisfed. gov. Output data are in 2000 dollars 7

4 Phases of the Business Cycle 3. Trough (the low point) a. Employment, Output/production, and income are all at their lowest point b. “Bottoming out” of a recession i. “V” shaped (quick bottom and then expand) or “U”shaped (long bottom and then expand) ii. 2001 recession was a “V” (short: 8 mos. ) iii. 2007 recession was a “U” (long: 18 mos. ) 8

4 Phases of the Business Cycle 4. Recovery or Expansion Phase a. Movement out of trough towards Peak phase b. Employment, output/production, and income all rise c. Prices usually start to rise again as nation gets closer to full employment as businesses raise prices due to increasing demand 9

Causes of the Business Cycle Causes of The Business Cycle 1. Changes in total spending: Number 1 Reason 2. “Bubbles” & “Popped Bubbles” 1. Discuss stock market value rises and crashes 2. Discuss housing market value rises and crashes 3. Major inventions increase business activity a. Railroad b. Automobile c. Computer d. Internet 10

Key Economic Goals v Top 3 Economic Goals & Measurements 1. 2. 3. Economic growth (more goods & services, or Gross Domestic Product (GDP)) Full employment (all available resources employed, or low unemployment) Price level stability (little or no price swings, meaning little inflation (rising prices) and no deflation (prices fall). 11

Economics Quiz 1. What are considered the three major economic 2. 3. 4. 5. goals? Falling output and income would be a characteristic of the ______ business cycle phase. Prices usually ______ in the peak phase, ______ in the recessionary phase, and _____ in the expansionary phase. What is the number 1 cause of a recession? What would happen if stock prices decreased by 30%? What industries are affected most and least by a recession? Why? (This answer is not in notes) 12

Opening Comments- GDP Gross Domestic Product (GDP) is perhaps the most well-known macroeconomic measurement! n A measurement that tracks the market value of goods & services produced (measures “economic growth”) n GDP is reported quarterly by the government (Commerce Dept. ) U. S. GDP is approx. $20, 000, 000 per year U. S. has the largest GDP (next 4: China, Japan, Germany, and UK) U. S. GDP has averaged a 3. 0% annual GDP growth rate since 1950 GDP per capita (per head) is a superior measurement of “standard of living”. GDP per capita is $62 K in U. S. versus only $10 K per head in China. 13

GDP Defined: n “The total market value of all final goods and services produced within a country in one year” GDP is a monetary measurement n A measurement expressed in money n Approx. $20 trillion per year in the U. S. 14

GDP: A Closer Look At The Definition GDP is the total market value of all final goods & services produced within a country in one year n “Produced”…. . not “Sold” n “Produced within a country” (whether U. S. or foreign company as long as in-country!) n U. S. GDP includes Toyotas made in Texas n U. S. GDP excludes Cadillacs made in Canada 15

GDP: A Closer Look At The Definition GDP is the total market value of all final goods & services produced within a country in one year n “Final”: purchased for final use by purchaser n Goods that are not final are “intermediate goods”. n Intermediate goods are purchased to be included in another product or to be resold n Tires for a new car, Computer chips for a PC n All business to business transactions are excluded since they are intermediate transactions. n Using only final goods avoids “double counting” which would inflate GDP 16

GDP Includes Services As Well As Goods Services is the primary component of GDP (80%) n All final services: n Haircuts, tax work, consulting, rent, telephone, agent sales (stocks, housing), restaurant sales, etc n Excludes “intermediate” services n Advertising work done for company n Maintenance work done for company n Cleaning the toilets or dragging the infield at a Nationals game 17

GDP: What Else Is Excluded From GDP Besides Intermediate Goods: ALL Non-Production Transactions v Excludes Financial Transactions (non-production) Stock purchases b. Homes that are resold (home is counted once when originally built) c. Govt. transfer payments such as social security, unemployment pay, and welfare. v Excludes “secondhand” sales or used items sold i. Excluded to avoid double counting ii. Resell a 1968 Ford Mustang (not in GDP) a. 18

Economics Quiz 1. Honda produces automobiles in Ohio. Should Honda’s annual production value be included in GDP? 2. Businesses often use advertising agencies to develop their promotions. How are advertising sales reflected in GDP? 3. A car manufactured in 2011 was sold new to a customer in 2012. In 2018, the customer sold the car to a friend. What is the effect on 2011, 2012, and 2018 GDP? 19

Economics Quiz 4. As the stock market or home prices fall, how is this accounted for in GDP? Why? 5. What is an “intermediate transaction”? Explain why intermediate transactions are excluded from GDP. 6. If Smith purchases supplies for his family business, what is the impact on GDP? What if he purchases supplies for his Intro to Business & Marketing class? 20

Nominal Versus Real GDP “Nominal” GDP n GDP Unadjusted. Reported “as is” in current dollars. “Real” GDP n GDP Restated for inflation (or deflation) Key Points: 1. Nominal GDPs can be misleading due to price level changes 2. An increase in GDP could actually mean less output if prices rising faster than output 3. Real GDP makes GDPs comparable between years 21

GDP and Economic Well-Being GDP not intended to be a measure of society’s overall well-being n Shortfalls: 1. Excludes certain non-market home transactions a. Homemaker production (cleaning, carpentry, baby sitting) b. Swap transactions (service for service swap) 2. Excludes underground economy (estimated 8% Of GDP) 3. Excludes value of increased “leisure time” 4. Excludes product quality improvements 5. Says nothing of the “right goods” or the equitable distribution of those goods 22 6. Does not account for impact to the environment

Underground Economy LO 6 23

Unemployment Rate Calculation n Unemployed / Labor Force x 100 n Labor Force = Employed + Unemployed Calculation of Unemployment Rate n Reported by Bureau of Labor Statistics (Govt. ) n Calculated Monthly based on survey of 60, 000 households each month (statistical sample) n To be “unemployed” must be actively seeking work 24

Unemployment Calculation: Approximate Figures Ø 325 M Total U. S. Population Ø (67)M Under 16 and Institutionalized Ø (96)M Not in Labor Force (retirees/homemakers /students) Ø 162 M Labor Force (employed + unemployed) Ø Ø 156 M Employed (full time/part time) 6 M Unemployed (looking) Ø 3. 7%: Unemployment Rate (6 M / 162 M) 25

Calculating Unemployment: An Example Hypothetical Facts: n 1000 Population total n 400 Not in Labor Force (retirees, homemakers, students) n 100 Under 16 and in Institutions n Unemployed 50 What is the unemployment rate? : ____% What is the size of the Labor Force? : _____ 26

Unemployment Criticisms of unemployment rate: n “U. S. unemployment rate is understated” 1. Part-time workers are counted as employed • They may really want full time jobs! 2. “Discouraged workers” are not counted as unemployed a. Discouraged worker: “one who wants a job but has stopped looking” b. Treated as “not in labor force” (treated like a “stay-at-home parent”, even though they want a job) 27

Unemployment The Three Types of Unemployment 1. 2. 3. Frictional Structural Cyclical 28

3 Types Of Unemployment 1. Frictional Unemployment n n n “Temporary and Unavoidable Unemployment” n New college grads looking for jobs n Parents returning to the work force n Quit job to look for a better one n Relocating to a new area n Fired from your job and looking for new one Considered a necessary unemployment and non issue Averages about 2% of the 4% Unemployment rate 29

3 Types Of Unemployment 2. Structural Unemployment n n n Due to changes in the structure or composition of the labor force (a fundamental change) Examples of Structural Unemployment: n Technology (machines) displaces workers n Industry Mergers & Acquisitions n International Trade (workers lose jobs due to trade) n Changing Demand (Tobacco, Coal Mining) Averages about 2% of the 4% Unemployment rate 30

Unemployment 3. Cyclical Unemployment n n Occurs during recessionary phase Highest at the trough phase Not unique to a particular industry Of the 3 unemployment types, this is “bad” unemployment and the unemployment we are trying to avoid. n Right now, this is 0% as our economy is at full employment! 31

Full Employment or The Natural Rate of Unemployment The Full Employment Unemployment Rate or The Natural Rate of Unemployment (NRU) n Does not mean zero unemployment! n Full employment = frictional + structural unemployment n Full employment excludes all cyclical unemployment n Economists estimate the NRU to be about 4%! n If actual unemployment rate > natural rate, then there is cyclical unemployment! n Example: If actual unemployment rate is 5. 5% and the natural rate is 4%, then cyclical unemployment is 1. 5%. 32

Unemployment Rates by Country (October 2018) U. S. : 3. 7% Euro Union: 6. 8% UK: 4. 0% Canada: 5. 9% Mexico: 3. 5% China: 3. 8% Russia: 4. 6% South Africa: 27. 2% Brazil: 12. 1% 33

LO 2 LO 3 34

Economics Quiz 1. How is unemployment calculated? In your own 2. 3. 4. 5. words, describe what the “labor force” is. Why do many say our unemployment rate is understated? How are part-time workers and discouraged workers counted in the unemployment calculation? What are three types of unemployment? Describe an example of each. _____ unemployment occurs during the _____ business cycle phase and is caused by a deficiency of ______. 35

Economics Quiz 5. When workers are replaced by machines, 6. 7. 8. 9. _______ unemployment results. What kind of unemployment is being created by thousands of manufacturing workers losing their jobs? What is full employment and the natural rate of unemployment? If the USA’s natural rate of unemployment is 5. 0%% and the actual rate rises to 9. 0%, what type of unemployment is the 4. 5% difference ? Can the NRU be less than the actual rate? How? 36

Inflation LO 3 LO 2 37

Inflation: Consumer Price Index (CPI) Inflation Defined: “A rising general level of prices” Measured by the Consumer Price Index (CPI) n A “basket” of over 300 tracked goods & services n The % change in the prices of the basket represent the inflation rate. n Weighted index based on consumer spending patterns n Housing inflation has the highest weight since Households spend the most on housing. n Inflation has averaged 3% historically but only 2. 2% over the last 3 years! Low inflation is good! 38

Inflation: What Causes It? Types of Inflation 1. Demand-Pull Inflation a. Total spending in excess of production capacity b. Often described: “too many dollars chasing too few goods” c. Demand curve shifting to the right 39

Inflation Types of Inflation (continued) 2. Cost-Push Inflation (aka: Supply-Side Inflation) q Cost-push Inflation summarized: q Prices rise due to rising production costs (factors of production) called “supply shocks” (oil, wages, other materials) q Supply curve “shifts to the left” 40

Inflation: Nominal vs. Real Income n Nominal Income: actual US dollars received as wages or salaries n Real Income: measures the amount of goods and services that nominal income can buy Nominal vs. Real Income Principles n If nominal income increases at a faster percentage rate than inflation, real income rises (increased “purchasing power”) n If nominal income increases slower than inflation, real income falls (decreased “purchasing power”) 41

Inflation: Nominal vs. Real Income: n Equation: n % change in nominal income – % change in inflation = % change in real income An Example: n If wages increase 4%, but n Inflation increases 7% n Real income has decreased 3%, or said another way: n Purchasing power has decreased 3% 42

Who Does Inflation Help and Hurt? Inflation Hurts: n Savers with low fixed interest rates n Lenders (Creditors): they are paid back with dollars that buy less n Fixed income receivers n Those on pensions (fixed amount retirement pay) n Note: social security indexed to inflation n Landlords with long term lease contracts Inflation Benefits: n Borrowers (Debtors): pay back loans with less valuable dollars 43

Categories or Types of Inflation Creeping Inflation: < 10% per year n Galloping Inflation: 10 -100% per year n Hyperinflation: > 100% per year n Feeds on itself: people spend immediately but producers want to sell tomorrow n Causes economic breakdown: people give up on money system and revert to barter n Germany in the 1920 s n Hungary in 1946 n Zimbabwe in 2008 n 44

Economics Quiz 1. What is inflation and how is it measured? 2. What are the two main causes of inflation? 3. How do the two inflation types link to the supply and demand curves? 4. What is the relationship between spending and inflation? 5. Differentiate between nominal income and real income. What happens to your real income if you get a 10% raise and inflation is increasing by 13%? Are you getting richer or poorer? 6. Who does inflation benefit? Who does it hurt? 45