Introduction Thinking Like an Economist CHAPTER 6 Economic

Introduction: Thinking Like an Economist CHAPTER 6 Economic Growth, Business Cycles, and Structural Stagnation Remember that there is nothing stable in human affairs; therefore avoid undue elation in prosperity, or undue depression in adversity. — Socrates Mc. Graw-Hill/Irwin Copyright © 2013 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

16 Economic Growth, Business Cycles, and Structural Stagnation Chapter Goals Ø Discuss the history of macro, distinguishing Classical and Keynesian macroeconomists Ø Define growth and discuss its recent history Ø Distinguish a business cycle from structural stagnation Ø Relate unemployment to business cycles and distinguish cyclical unemployment from structural unemployment 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation The Historical Development of Macro Ø Classical economists believe that business cycles are temporary glitches, and generally favor laissez -faire, or nonactivist policies Ø Keynesian economists believe that business cycles reflect underlying problems that can be addressed with activist government policies Ø By the 1980 s, Classical and Keynesian economics merged in a new conventional macroeconomics Ø Following the 2008 crash, the U. S. economy experienced structural stagnation that conventional economists did not anticipate 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Two Frameworks: The Long Run and the Short Run Ø The long-run growth framework focuses on incentives for supply • Sometimes called supply-side economics • Issues of growth are considered in a long-run framework Ø The short-run business cycle focuses on demand • Sometimes called demand-side economics • Business cycles are generally considered in a short-run framework Ø Inflation and unemployment fall within both frameworks 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Two Frameworks: The Long Run and the Short Run Ø The stark division between the short-run and the long-run frameworks is problematic Ø The economy is simultaneously in the long run and short run Ø Both frameworks have to be blended into a composite framework in which both supply and demand influence long-run and short-run forces Ø The long run is just a combination of short runs that cannot be separated 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Growth Ø Economists measure growth with changes in total output over a long period of time Ø Potential output is the highest amount of output an economy can sustainably produce and sell using existing production processes and resources Ø U. S. economic output has grown at an annual 2. 5 to 3. 5 percent rate since World War I that represents the rise in potential output. What it will be in the future is uncertain. Ø Per capita output is output divided by the total population Ø Even if total output is increasing, the population may be growing even faster, so per capita output would be falling 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation The Benefits and Costs of Growth • Per capita economic growth allows everyone in society, on average, to have more: but is this necessarily an increase in well-being? • Growth, or the prediction of growth, allows governments to avoid hard questions • Growth comes with costs: • Pollution • Resource exhaustion • Destruction of natural habitat 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Business Cycles and Structural Stagnation Ø A business cycle is the upward or downward movement of economic activity that occurs around the growth trend • Classical economists argue that the government should just accept that business cycles occur and take a laissez-faire stance • Keynesians economists argue that government can temper these fluctuations with policy actions 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Business Cycle Phases Total Output Boom Secular Growth Trend Up tu n rn ur nt w Do Up tu rn Peak Trough Expansion 1 2 3 Recession 4 1 2 3 Expansion 4 1 2 3 Quarters 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation The Phases of the Business Cycle Ø The four phases of the business cycle are: • The peak • The downturn • The trough • The upturn Ø A recession is a decline in real output that persists for more than two consecutive quarters of a year Ø An expansion is an upturn that lasts at least two consecutive quarters of a year 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Ø Structural stagnation is a cyclical downturn that we do not expect to end any time soon with major changes in the structure of the economy Ø Unemployment is not due to temporary layoffs, but to longer-term changes Ø A depression is a deep and prolonged recession Ø The distinction between a business cycle and structural stagnation goes to the heart of the modern macro policy debates 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Unemployment and Jobs Ø The unemployment rate is the percentage of people in the economy who are willing and able to work but who cannot find jobs Ø Cyclical unemployment is that which results from fluctuations in economic activity Ø Structural unemployment is that caused by the institutional structure of an economy or by economic restructuring making some skills obsolete 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Unemployment Rate since 1900 Percentage of labor force unemployed 30 In the mid-1940 s, the U. S. government started focusing on the unemployment rate as a goal, and initially chose 2%, but it was gradually increased to around 3 to 5% 20 Target rate 10 0 1900 1920 1940 1960 1980 2000 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Unemployment as a Social Problem Ø The Industrial Revolution changed the nature of work and introduced unemployment as a problem for society Ø There was a shift to wage labor and to a division of responsibilities Ø The Industrial Revolution created the possibility of cyclical unemployment and changed how families dealt with unemployment Ø Early capitalism had an unemployment solution: the fear of hunger 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Unemployment as Government’s Problem Ø In the Employment Act of 1946, the U. S. government took responsibility for unemployment Ø Full employment is an economic climate where nearly everyone who wants a job has one Ø Frictional unemployment is unemployment caused by people entering the job market and people quitting a job just long enough to look for and find another job 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Target Rate of Unemployment Ø The target rate of unemployment is the lowest sustainable rate of unemployment that policy makers believe is achievable under existing conditions Ø The appropriate target rate of unemployment was debatable until the downturn of 2008, but, for the US, most economists place it around 3 to 5% Ø The target rate of unemployment changes due to: • Inflation rates • Demographics • Social and institutional structures • Changing government institutions 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation CALCULATION EXAMPLES 1. Calculating Economic Growth Rates: Ø Annual Percentage Change in Real GDP Ø To calculate this growth rate, we use the formula: Growth of real GDP = Real GDP in current year – Real GDP in previous year x 100 Real GDP in previous year For example, if real GDP in the current year is $8. 4 trillion and if real GDP in the previous year was $8. 0 trillion, then the growth rate of real GDP is : Growth of real GDP = $8. 4 trillion – $8. 0 trillion x 100 = 5% 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation CALCULATION EXAMPLES 2. To calculate Real GDP Per Capita (per person), we use the formula: Real GDP Population Ø In current year, when real GDP is $8. 4 trillion, and the population is 202 million, then Real GDP per capita = $41, 584 $8. 4 trillion 202 million Ø In the previous year, when real GDP was $8. 0 trillion, the population was 200 million, real GDP per capita was $8. 0 trillion divided by 200 million, or $40, 000. 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation CALCULATION EXAMPLES 3. To calculate growth in Real GDP Per Capita (per person): - Use the formula from (1), replacing real GDP with real GDP person -Use the two values of real GDP person calcluated in (2): Growth rate of real $41, 584 – $40, 000 x 100 = 4% GDP person = $40, 000 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation CALCULATION EXAMPLES 4. Growth in Real GDP Per can also be estimated by using the formula (accurate enough for rates of 10% or less): Growth of real Growth rate of = – GDP person real GDP Growth rate of population 202 million – 200 million Growth of = x 100 = 1 %. population 200 million Recall, growth rate of real GDP from (1) was 5 %, so: Growth of real GDP = 5 % – 1 % = 4 %. person 6 -

16 Economic Growth, Business Cycles, and Structural Stagnation Links for Overview of Macro Potential output: CBO Budget Outlook GDP report from BEA: BEA-Dept of Commerce GDP Report GDP per capita: World Bank Report on global GDP Unemployment and employment: BLS-Dept of Labor Report 6 -