Economy Chapter 13

Causes of the Business Cycle

1. External shocks 2. Changes in investment spending 3. Changes in monetary policy 4. Fiscal-policy shocks 5. Speculation and "bubbles"

the unemployment rate understates employment conditions for two reasons

1. First, the unemployment rate does not count those too frustrated or discouraged to look for work; Although they are not working and probably would like to find work, these people are not classified as unemployed because they did not actively seek a job within the previous survey period 2. people are considered employed even when they only hold part-time jobs

Sources of Unemployment

1. Frictional Unemployment 2. Structural Unemployment 3. Technological Unemployment 4. Cyclical Unemployment 5. Seasonal Unemployment

Costs of Instability

1. GDP Gap 2. Misery Index 3. Uncertainty 4. Political Instability 5. Community and Domestic Matters

Consequences of Inflation

1. Reduced Purchasing Power 2. Distorted Spending Patterns 3. Encouraged Speculation 4. Distorted Distribution of Income

major reforms resulting from the Great Depression

1. Social Security 2. Minimum wage 3. Unemployment programs 4. Securities and Exchange Commission (SEC) 5. Federal Deposit Insurance Corporation (FDIC)

Causes of Inflation

1. demand-pull 2. cost-push 3. wage-price spiral 4. excessive monetary growth

forms of instability

1. recession 2. inflation 3. unemployment

two economic indicators are used to predict the next phase of the business cycle

Dow Jones Industrial Average (DJIA) leading economic index (LEI)

Speculation and "bubbles"

Expectations about the future have always been important; When the bubble burst, the stock market crashed and the economy went into a mild recession

Encouraged Speculation

Inflation tempts some people to speculate in an attempt to take advantage of rising prices

External shocks

One potential cause of business cycles is external shocks, such as an increase in oil prices, wars, or international conflicts

Underemployed

Overqualified for the job

Political Instability

Politicians also suffer the consequences of economic instability. When times are difficult, voters are dissatisfied, and incumbents are often voted out of office

Community and Domestic Matters

Recession, inflation, and unemployment can also lead to higher rates of crime and poverty. They also contribute to domestic problems such as marital instability and divorce, especially when individuals or families face uncertainty because lost jobs and income make it difficult to pay the bills

Changes in monetary policy

Some economists point to the Federal Reserve System's policies on interest rates. For example, loans are easy to get when "easy money" policies—Fed policies that promote low interest rates—are in effect. Easy money encourages the private sector to borrow and invest, which stimulates the economy for a short time. When the stimulus stops, however, the economy stops growing and recession sets in.

The Great Depression

The stock market crash on October 29, 1929, known as "Black Tuesday," marked the beginning of the Great Depression, one of the darkest periods in American history; real GDP declined nearly 50 percent, from approximately $103 billion to $55 billion; one out of every four workers was unemployed; The average manufacturing wage, which was 55 cents an hour in 1929, plunged to 5 cents an hour by 1933; lasted 10 years

Uncertainty

When the economy is unstable, a great deal of uncertainty exists. Workers may not buy something because of concern over their jobs. This uncertainty translates into many consumer purchases that are not made, causing unemployment to rise as jobs are lost; The owner of a business that is producing at capacity may decide against an expansion even though new orders are arriving daily. Instead, the producer may try to raise prices, which increases inflation

business fluctuations

changes in real GDP marked by alternating periods of expansion and contraction that occur on an irregular basis; the rise and fall of real GDP over time in an irregular manner

stagflation

combination of stagnant economic growth and inflation

depression scrip

currency issued by towns, chambers of commerce, and other civic bodies during the Great Depression of the 1930s

recession

decline in real GDP lasting at least two quarters (6 consecutive months) or more; begins when the economy reaches a peak; ends when the economy reaches a trough

GDP gap

difference between what the economy can and does produce; annual opportunity cost of unemployed resources; the difference between the actual GDP and the potential GDP that could be produced if all resources were fully employed

demand-pull inflation

explanation that prices rise because all sectors of the economy try to buy more goods and services than the economy can produce

cost-push inflation

explanation that rising input costs, especially energy and organized labor, drive up the cost of products for manufacturers and thus cause inflation

trend line

growth path the economy would follow if it were not interrupted by alternating periods of recession and recovery; If periods of recession and expansion did not occur

Reduced Purchasing Power

happens because the dollar buys less whenever prices rise, and thus it loses value over time; can be especially hard on retired people or those with fixed incomes because their money buys a little less each month. Those not on fixed incomes are better able to cope. They can increase their fees or wages to better keep up with inflation

outsourcing

hiring outside firms to perform non-core operations to lower operating costs

consumer price index (CPI)

index used to measure price changes for a market basket of frequently used consumer items

implicit GDP price deflator

index used to measure price changes in gross domestic product

producer price index (PPI)

index used to measure prices received by domestic producers; formerly called the wholesale price index

one-third of all unemployed persons—regardless of sex, age, or race—are

long term unemployed

econometric model

macroeconomic expression used to describe how the economy is expected to perform in the future; Most models start with an "output-expenditure" model: GDP = C + I + G + (X - M)

leading economic index (LEI)

monthly statistical series that uses a combination of ten individual indicators to forecast changes in real GDP

civilian labor force

noninstitutionalized part of the population, aged sixteen and over, either working or looking for a job; the sum of all persons age sixteen and above who are either employed or actively seeking employment

Excessive Monetary Growth

occurs when the money supply grows faster than real GDP; any extra money or additional credit created by the Federal Reserve System will increase someone's purchasing power. When people spend this additional money, they cause a demand-pull effect that drives up prices

expansion

period of uninterrupted growth of real GDP, industrial production, real income, and employment lasting for several years or more; recovery from recession; continues until the economy reaches a new peak

debtors

persons or institutions that owe money; borrowers

creditors

persons or institutions to whom money is owed; people who lend money

trough

point in time when real GDP stops declining and begins to expand

peak

point in time when real GDP stops expanding and begins to decline

unemployment rate

ratio of unemployed individuals divided by total number of persons in the civilian labor force, expressed as a percentage

creeping inflation

relatively low rate of inflation, usually 1 to 3 percent annually

market basket

representative collection of goods and services used to compile a price index

The Great Recession of 2008-2009

started in December of 2007 and lasted until June of 2009. With a duration of 18 months, it was the longest and deepest recession in the United States since the Great Depression of the 1930s. Real GDP dropped about 4.5 percent during this period and did not recover its 2007 high until mid-2011, nearly four years later. unemployed more than doubling between October 2007 and October 2009

depression

state of the economy with large numbers of unemployed, declining real incomes, overcapacity in manufacturing plants, and general economic hardship

unemployed

state of working for less than one hour per week for pay or profit in a non-family-owned business, while being available and having made an effort to find a job during the past month; also classified as unemployed if they worked in a family business without pay for less than fifteen hours a week

leading economic indicator

statistical series that normally turns down before the economy turns down or turns up before the economy turns up; a statistical series that normally changes direction before the economy changes its direction

price index

statistical series used to measure changes in the price level over time

deflation

sustained decrease in the general level of the prices of goods and services

inflation

sustained rise in the general level of prices of goods and services

business cycles

systematic changes in real GDP marked by alternating periods of expansion and contraction; regular ups and downs of real GDP

series

the leading economic index

Fiscal-policy shocks

the use of federal government spending and revenue-collection measures; If a change in either spending or taxation suddenly occurs, it may affect decisions somewhere else in the economy. For example, threats by elected officials to shut down government because of policies they disagree with may cause uncertainty and worry in other parts of the economy.

structural unemployment

unemployment caused by a fundamental change in the economy that reduces the demand for some workers; when economic progress, a change in consumer tastes and preferences, or a fundamental change in the operations of the economy reduces the demand for workers and their skills; outsourcing

seasonal unemployment

unemployment caused by annual changes in the weather or other conditions that prevail at certain times of the year; unemployment resulting from seasonal changes in the weather or in the demand for certain products or jobs; takes place every year, regardless of the general health of the economy

Technological Unemployment

unemployment caused by technological developments or automation that make some workers' skills obsolete; unemployment that occurs when workers are replaced by machines or automated systems that make their skills obsolete

frictional unemployment

unemployment caused by workers changing jobs or waiting to go to new ones; he situation where workers are between jobs for one reason or another; usually a short-term condition; is natural and results from the constant changes in the economy that prevent qualified workers from immediately finding job openings

cyclical unemployment

unemployment directly related to swings in the business cycle; takes place over the course of the business cycle, which may last three to five years

misery index/discomfort index

unofficial statistic that is the sum of monthly inflation and the unemployment rate; the sum of the monthly inflation and unemployment rates

long term unemployed

workers who have been unemployed for twenty-seven weeks or more

base year

year serving as point of comparison for other years in a price index or other statistical measure

Changes in investment spending

Changes in capital expenditures are also important. When the economy is expanding, businesses expect future sales to be high, so companies may build new plants or buy new equipment to replace older equipment. At first, this generates jobs and income, but after a while, businesses may decide they have expanded enough. If they then cut back on their capital investments, layoffs and eventually recession may result

Wage-Price Spiral

a self-perpetuating spiral of wages and prices becomes difficult to stop; The spiral might begin when higher prices force workers to ask for higher wages. If they get the higher wages, producers try to recover that cost with higher prices. As each side tries to improve its relative position with a larger increase than before, the rate of inflation keeps rising

hyperinflation

abnormal inflation in excess of 500 percent per year; last stage of monetary collapse

Dow Jones Industrial Average (DJIA)

an index of 30 representative stocks used to monitor price changes in the overall stock market