13.1

Economic Instability

Business CyclesEconomic growth is something that is

beneficial to almost everyoneWe cannot take it for grantedBusiness Cycles – regular ups and downs of

real GDP – interrupt economic growthBusiness Fluctuations – the rise and fall of

real GDP over time in an irregular manner – interrupt growth at other times.

GDPGDP - is the market value of all final goods

and services produced within a country in a given period of time.

GDP by Comparisonhttp://www.google.com/publicdata?ds=wb-

wdi&met=ny_gdp_mktp_cd&idim=country:USA&dl=en&hl=en&q=gdp#met=ny_gdp_mktp_cd&idim=country:USA:CHN:JPN:DEU:FRA:GBR:CAN:MEX

Slower Economic Growth• Slower economic growth always a matter of

concern• Businesses lose sales• Voters become unhappy• Investors get nervous• Stock market shows its disapproval • Because of this economists have developed

elaborate forecasting models and statistical tools

The Phases of a Business Cycle• 2 Phases of a business cycle• First Phase = Recession – a period during

which real GDP – declines for at least two quarters in a row, or six consecutive months

• The recession begins when the economy reaches a peak

• The point where real GDP stops going up • It ends when the economy reaches a

trough – the turnaround point where real GDP stops going down.

Phases of a Business Cycle

Second PhaseAs soon as the declining real GDP bottoms

out Expansion – a period of recovery from a

recession Expansion continues until the economy

reaches a new peak.When it does the current business cycle

ends and a new one begins

Trend LineTrend Line – The economy departs from,

and then returns to, its trend line as it passes from through phases or recession and expansion

Or Growth path the economy would follow if it were not interrupted by alternating periods of recession and recovery

DepressionIf a recession is very severe – it may turn

into a depression – a state of economy with large numbers of people out of work, acute shortages, and excess capacity in manufacturing plans

Causes of Business CyclesChanges in Investment SpendingInnovation and Imitation Monetary Policy DecisionsExternal Shocks

The Great Depression of the 1930s• 1929 – 1933 GDP declined 50 %• $103 Billion - $55 Billion• Unemployment rose 800%• 1.6 million to 12.8 million• 25 % of the workforce• Wages fell from $.55 to $.05 per hour• Banks across the country failed• FDIC did not exist• Bank Holidays• Depression Script

Causes 1. Enormous gap between Rich and Poor2.Easy Credit – buying on margin 3. Global Economic Conditions4. High Tariffs

Causes of the Great DepressionDisparity in the distribution of income

– the Great Gatsby effect. America did not really have a middle class. It was split up into the very poor and the very rich.The poor could not stimulate the economy

with consumer spending, because they had very little or no money to spend.

The rich had the money, but didn’t use it in ways to spark economic growth. They either saved it in banks or used it to speculate on the stock market.

Causes of the Great DepressionEasy and Plentiful credit

Many people borrowed heavily in the 1920s – more than they could afford to pay back. High interests rates and business fluctuations also impacted this.

Causes of the Great DepressionGlobal Economic Conditions:

Europe was still recovering from a massive war (WWI). A good deal of farmable land had been decimated by trench warfare.

During the 1920s, banks, businesses and public institutions made tons of loans to foreign companies, interests and nations to help support business and international trade.

When the Depression began, these companies called in their debts. This left these foreign interests broke. As a result, they didn’t have any money to buy American goods. This led to American job losses.

High American tariffs made foreign good too expensive for Americans to buy.

Recovery and LegislationSocial Security Act of 1935Minimum WageUnemployment Benefits/ProgramsSEC – Securities and Exchange Commission(Companies required to give full disclosure

of financial statements) FDIC

Great Recession of the 2000sWhy? How were we able to avoid another Great

Depression?Huge Government Bail Outs -

CPI and the Cost of Living

The Consumer Price IndexConsumer price index (CPI)

Measure of the overall cost of goods & services bought by a typical consumer

How the consumer price index is calculated1.Fix the basket2.Find the prices3.Compute the basket’s cost

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The Consumer Price IndexHow the consumer price index is calculated

4. Chose a base year and compute the CPIPrice of basket of goods & services in current year Divided

by price of basket in base year Times 100

5. Compute the inflation ratePercentage change in the price index from the preceding

period

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1001 year in CPI

1 year in CPI-2 year in CPI2 year in rate Inflation

The typical basket of goods and services

1

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This figure shows how the typical consumer divides spending among various categories of goods and services. The Bureau of Labor Statistics calls each percentage the “relative importance” of the category.

The Consumer Price IndexProducer price index (PPI)

Measure of the cost of a basket of goods and services bought by firms

Problems in measuring the cost of livingSubstitution biasIntroduction of new goodsUnmeasured quality change

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The Consumer Price IndexThe GDP deflator vs. consumer price indexGDP deflator

Ratio of nominal GDP to real GDPReflects prices of all goods & services produced

domesticallyCPI

Reflects prices of goods & services bought by consumers

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The Consumer Price IndexThe GDP deflator vs. consumer price indexGDP deflator

Compares the price of currently produced goods and services to the price of the same goods and services in the base year

CPICompares price of a fixed basket of goods and

services to the price of the basket in the base year

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“The Warning”http://www.pbs.org/wgbh/pages/frontline/w

arning/view/?utm_campaign=viewpage&utm_medium=grid&utm_source=grid

Chapter 13Section 2

Inlfation

Hyperinflation was so severe in the 1920s that it completely wiped out the savings of many middle-class Germans. By the end of 1923, $1 was worth four trillion German marks.

InflationThe inflation rate is determined by

comparing the price level at the beginning and end of a period.

Sometimes Deflation can occur when there is a decrease in the general price level.

Creeping inflation is inflation in a range of 1 to 3 percent annually.

Galloping inflation is when inflation can go as high as 100 to 300 percent annually.

Inflation of more than 500% a year is known as hyperinflation.

What Happens when there is inflation?Money loses its value.People have difficult comparing prices.Bartering takes place.

Causes of InflationDemand-pull inflation

occurs when all sectors of the economy try to buy more goods and services than the economy can produce.

Shortages occur and prices go up. Prices are “pulled up” by excessive demand.

sometimes caused by the federal government’s deficit spending.

Causes of InflationCost-push inflation

occurs when input costs – especially labor – drive production costs up. This is usually only possible when the unemployment rate is exceptionally low.

The wage-price spiral occurs when higher prices force workers to demand higher wages. This forces producers to raise their prices even more.Why do you think this is called a “spiral?”

Causes of InflationExcessive monetary growth can cause

inflation. Most popular explanation. In other words, there is more money than there

should be. Supply outpaces GDP growth.

Consequences of InflationWhen inflation occurs, the dollar buys less.

(see chart on page 366)This hurts people on fixed incomes (why?)Inflation causes people to change their

spending habits, which disrupts the economy.See example on Page 293 about the housing

market, second column, second paragraph.Inflation tempts people to speculate heavily

to take advantage of the higher price level.It alters the distribution of income

13.3

Unemployment

What is the unemployment rate of the United States? Michigan?

US & Michigan FactsUSA: 7.6%Michigan: 8.5%

Detroit-Livonia-Warren: 18%Troy-Farmington Hills: 7.4%

Natural Rate of Unemployment: 5-6%

How do we compare to the rest of the world?

World FactsGreece: 26.8%Brazil: 5.7%European Union: 10.7%U.K: 7.8%Saudi Arabia: 10.7% (25% for men)Senegal: 10.2%Crow Reservation: 46.5%Liberia: 5.1%

True UnemploymentHow do we figure it out?

Census Bureau surveys about 50,000 Americans per month, in 200 counties, across all 50 states to gain a sample number they hope reflects the entire nation.

They are looking for the people who are officially unemployed per the definition of the US government.

What is that?

Unemployment“People available for work who made a specific

effort to find a job during the past month”

Plus!In addition, they have to have worked for less

than one hour for par or profit a week.

You have to have worked at a family business without pay for less than 15 hours a week.

o Also, you have to be over the age of 15 and not a dependent.

All this data is turned over to the BLS and published once per month

Unemployment RateTo figure this out, we take the total number

of people unemployed and divide it by the total workforce.

Look at figure 13.6 on page 371. You’ll see that there is a usually a direct relationship between unemployment and an economic recession. What is it?

Group Work!

Get into groups of three and write down what you think are the limitations of this system. What does this rate miss?

Understatement3 major reasons that this reported number is too low.

1.Frustrated or discouraged workers

2.Underemployment3.People who do not want/care about traditional employment

Overstatement?

What might not be taken into account, that would lower the unemployment rate?

Types of UnemploymentMuch like Econ teachers, not all types of

unemployment are created equal.

What causes lead to unemployment make a difference to the BLS on why you are unemployed.

Bob

Bob is a salesmen who has left his job at GM and has three weeks before he starts his job at Kroger.

What type of unemployment is this?

FrictionalShort-term unemployed

Little amount of hardship from their unemployment.

Young workers

There will always be frictional unemployment

Bob 2Bob worked really hard on the line at Ford,

but now is out of a job due to the rise in sales from BMW.

What type of unemployment is this?

Structural UnemploymentThis occurs when a fundamental change in

the economy reduces the demand for workers and their skills.

Michigan: CarsCongress decision to close some military

basesNew skills forced on old workers

Bob 3Bob got laid off from work because his

company’s sales were down

What type of unemployment is this?

Cyclical Unemployment

Business cycles.RecessionsExpansions

Bob 4Bob picks apples, but now it is December

and there are no apples to pick

What type of unemployment is this?

Seasonal UnemploymentResults from the changes in the weather or

changes in demand for certain products.

Cutting grassPicking fruitComerica Park Peanut Vendor

Bob 5

Bob studied hard at ITT Tech to become a VCR repair. He now has no job, since most of you do not even know how to use a VCR…

What type of unemployment is this?

Technological UnemploymentTechnological improvement makes jobs

obsolete.

Full EmploymentWhat is it?

How does it relate to unemployment?