Unit 4: Macroeconomics, Inflation & the Business Cycle
Unemployment Rate=
(Number of People Unemployed) / (Number of People in Labor Force) x 100%
Module 59: Is Inflation Always Bad?
By now, you have learned quite a bit about inflation's effect on daily life. Believe it or not, most economists favor a low, stable rate of inflation as opposed to no inflation. Why is this? Would it not be better to keep prices exactly the same from year to year? Read on to find out.
division of labor
Division of work into a number of separate tasks to be performed by different workers
Stock markets
Financial markets where equity in companies is traded
Module 64: Shifts in the AS/AD Model
In the previous modules, you saw that the AD and AS curves can shift. The focus of this module will be: What factors can cause these shifts?
anticipated inflation
Increases in the price level (inflation) that occur at the expected rate.
factors of production
Land, labor, and capital; the three groups of resources that are used to make all goods and services
unemployment rate formula
Unemployment Rate = [Number of Unemployed] ÷ [Labor Force] × 100%
cost-push inflation
When prices rise due to an increase in the cost of production.
Homework Practice
Word Bank Activity
developmental economics
a branch of economics that investigates how to promote growth in the economies of developing countries
aggregate supply curve
a curve that shows the quantity of goods and services that firms choose to produce and sell at each price level
trade war
a cycle of increasing trade restrictions
discouraged worker
a person who wants a job but has given up looking
disinflation
a reduction in the rate of inflation
budget deficit
a shortfall of tax revenue from government spending
The AS/AD graph
can be used to find the equilibrium in the aggregate economy.
Economic growth
is an increase in real GDP.
long-run inflation
is primarily determined by the rate of money supply growth while unemployment is primarily determined by labor market factors
unskilled labor
labor that requires no specialized skills, education, or training
United Nations Developmental Programme (UNDP)
mostly serves in a networking or coordination role, connecting the governments of low-income countries with development resources
Comprehension Check Select the correct answer for each choice below.
multiple choice
Homework Practice
multiple choice
bear market
occurs when the market declines for an extended period of time.
Total productivity
output quantity / input quantity
loss of welfare
when people's standard of living is harmed by inflation
bull market
which is often characterized by increasing investor confidence and greater amounts of investing.
stock exchange
A place where shares in a company or business enterprise are bought and sold.
recession
A slowdown in a nation's economy
Module 63: The AS/AD Model
Aggregate supply and aggregate demand can be combined into a single model. The AS/AD or Aggregate Supply/Aggregate Demand Model shows the price level and output. Many famous economists, such as Milton Friedman (from the University of Chicago) and Joan Robinson (from Cambridge University, England) have used this model in their work.
Full Employment:
All eligible people who want to work can find employment at current wage rates.
trade deficit
An excess of imports over exports
Module 58: Causes and Types of Inflation
In Modules 56 and 57, you learned what inflation is and how to measure it. But what causes inflation in the first place? Why does inflation occur in the long run? And, why does inflation sometimes increase or decrease in the short run? This module addresses these questions.
Human Development Index (HDI), which is calculated based on three equally weighted factors:
- gross national income per capita - average life expectancy - the education index (based on the mean, or average, - - of years of schooling for 25-year-old adults and the expected years of schooling for children)
Three of the most important economic indicators are :
- unemployment - gross domestic product (GDP) - inflation
fiscal policies
policies used by a government regarding how it collects and spends revenue
Economic freedom
refers to the rights of individuals to make their own economic choices, such as where to work, what to consume, and how much to invest.
trade barriers
restrictions to free trade
poverty trap
self-reinforcing mechanisms that cause the poor to stay poor
The aggregate supply and aggregate demand model (AS/AD model)
shows what can happen to the price level and output when aggregate supply and aggregate demand are examined together.
exchange rate
the value of a currency in one country compared with the value in another
base year
year serving as point of comparison for other years in a price index or other statistical measure
aggregate demand curve
a curve that shows the quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level
final good
a good in the hands of its final user
intermediate good
a good that is an input to the production of a final good
market basket
a hypothetical set of consumer purchases of goods and services
Consumer Price Index (CPI)
a measure of the overall cost of the goods and services bought by a typical consumer
GDP deflator
a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100
standards of living
a measurement of prosperity or wealth for the people in a country usually measured in terms of income
price index
a measurement that shows how the average price of a standard group of goods changes over time
economic contraction
a slowdown of the economy characterized by a decline in spending and during which businesses cut back on production and lay off workers
Producer Price Index (PPI)
an average of the prices received by producers of goods and services at all stages of the production process
International Monetary Fund (IMF)
an international organization that acts as a lender of last resort, providing loans to troubled nations, and also works to promote trade through financial cooperation
multifactor productivity
an overall measure of performance that indicates how much labor, capital, materials, and energy it takes to produce an output
Financial transactions
any exchange of money between two or more businesses or individuals
net exports
exports minus imports
Comprehension Check Answer the following questions based on what you have learned in this module.
good / bad times and true/false
general price levels
indices that reflect the price of goods in an economy over a period of time
monopsony
is a market form that exists as a type of imperfect competition.
Common stock
is a share of ownership in a corporation. Stockholders have a claim to a portion of the income the corporation earns and the assets it holds.
Offshoring
is when a company moves its physical productions and/or services to another country.
Outsourcing
is when it uses labor from another company.
Demand-pull inflation
occurs when aggregate demand is greater than aggregate supply (or the total supply of goods and services that businesses plan to sell during a specific time period).
investments decline
occurs when an investment results in a reduced value
Inflation
occurs when the prices of most goods and services increase. The immediate effect of inflation is that goods and services become more expensive.
GDP per capita formula
GDP per capita = (GDP) / (population)
inflation
A continuous rise in the price of goods and services
monopsonist
A firm that has market power in the factor market (a wage-setter)
aggregate supply (AS)
The total amount of goods and services that all the firms in all the industries in a country will produce at various price levels in a given period of time.
velocity of money
the average number of times each dollar in the money supply is used to purchase goods and services included in GDP
GDP growth
the increase in the value of goods and services produced within a country for a specific year
Potential output
the level of real GDP the economy would produce if all prices, including nominal wages, were fully flexible
output gap
the percentage difference between actual aggregate output and potential output
Factors that Affect Aggregate Demand
- Consumption spending (C)—this is personal consumption by consumers such as yourself. Consumption involves purchases of final goods and services, such as loaves of bread and haircuts. - Investment spending (I)—this is gross private domestic investment and involves spending on new capital goods and on additions to inventory. For example, firms build new factories and buy machinery. Firms might also add to their stock of goods that are in process or are finished. Residential construction is also included in investment. - Government spending (G)—this captures the government's consumption of goods and services, such as the postal service, roads, and textbooks for public schools. - Net exports (X − M)—this is the value of all goods and services that are sold to other countries (total exports) minus the value of all goods and services bought from other countries (total imports).
gross domestic product (GDP)
The total output of all economic activity in the nation, including goods and services.A measurement of the total goods and services produced within a country.
Module Summary
The unemployment rate is the number of unemployed people in a country divided by the labor force and multiplied by 100 to convert to a percentage. Given that the unemployment rate does not include part-time workers or discouraged workers, the results can be misleading. There are three main types of unemployment: frictional, structural, and cyclical.
productivity
The value of a particular product compared to the amount of labor needed to make it. A country's productivity is defined as the relationship between its output (GDP) and the amount and quality of inputs (workers and capital goods). Productivity is higher when either one of the following occurs: (a) you produce more output with the same amount of inputs as before, or (b) you produce the same output while using fewer inputs.
Price Stability:
This means there is no inflation, where the general level of prices increases, or deflation, where the general level of prices decreases. Price stability provides a favorable economic climate for consumers and businesses.
Module Summary
This module combined the aggregate demand curve and aggregate supply curve to analyze the short-run and long-run equilibriums. The short-run equilibrium is where the AD curve and SAS curve intersect. The long-run equilibrium is where the AD curve and LAS curve intersect.
Module Summary
This module describes how different factors influence aggregate demand and supply, shifting the AD, SAS, and LAS curves. In general, an expansionary policy increases aggregate demand and shifts the aggregate demand curve to the right. A contractionary policy decreases aggregate demand and shifts the aggregate demand curve to the left. Long-term aggregate supply is affected by the factors of production, while short-term aggregate supply is affected by these factors and the expected changes in price levels.
expansionary policies
countries aim to promote growth by increasing aggregate demand at each price level.
contractionary policies
countries aim to slow the economy's growth rate by decreasing aggregate demand at each price level.
developing countries
countries with less productive economies and a lower quality of life
developed countries
countries with relatively high levels of industrialization and income
Homework Practice
decrease increase stay the same
dividends
earnings distributed to stockholders
unanticipated inflation
increases in the price level (inflation) at a rate greater than expected
The World Bank
is an international organization dedicated to reducing world poverty. The World Bank classifies countries as low-income, middle-income, and high-income based on their gross national income per capita. As you learned earlier, gross national income per capita is one of the factors used to calculate the Human Development Index (HDI).
Economic growth
is usually defined as an increase in real GDP per capita over time. The ability of the economy to increase the production of goods and services
Short-run inflation
pushed by the economic policies to push inflation and unemployment in opposite directions
purchasing power
the ability to purchase goods and services
Aggregate demand
the amount of goods and services in the economy that will be purchased at all possible price levels
aggregate demand (AD)
the amount of total spending on domestic goods and services in an economy
full employment
the condition in which virtually all who are able and willing to work are employed.
real gross domestic product
the economy's aggregate output measured in dollars of constant purchasing power
unemployment rate
the percentage of the labor force that is unemployed
inflation rate
the percentage rate of change in price level over time
diminishing returns
the property whereby the benefit from an extra unit of an input declines as the quantity of the input increases
economic expansion
the situation that occurs when an economy is growing and people are spending more money; their purchases stimulate the production of goods and services, which in turn stimulates employment
national debt
the total amount of money that a country's government has borrowed, by various means.
labor force
the total number of workers, including both the employed and the unemployed
Seasonal unemployment
unemployment that occurs as a result of harvest schedules or vacations, or when industries slow or shut down for a season
Frictional unemployment
unemployment that occurs when people take time to find a job
frictional unemployment
unemployment that occurs when people take time to find a job
structural unemployment
unemployment that occurs when workers' skills do not match the jobs that are available
Structural unemployment
unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one
cyclical unemployment
unemployment that rises during economic downturns and falls when the economy improves
cyclical unemployment.
unemployment that rises during economic downturns and falls when the economy improves
hyperinflation
A very rapid rise in the price level; an extremely high rate of inflation.
Changes in the Factors of Aggregate Demand
A) Shifts due to consumption B) Shifts due to investment C) Shifts due to government spending D) Shifts due to net exports
workforce
All the people working or available to work, as in a nation, company, industry, or on a project
structural adjustments
Stipulations that require the country receiving an international loan to make economic changes in order to use the loan.
Economic Growth:
The overall output of goods and services increases over time.
Monetary policy
Government policy that attempts to manage the economy by controlling the money supply and thus interest rates.
Module Summary
Gross Domestic Product, or GDP, is the primary measure of an economy's health. GDP measures total production in an economy and is technically defined as the monetary value of all final goods and services produced in a country over one year. In 2010, the United States had the world's highest GDP at $14.6 trillion! GDP can be calculated by adding consumption, investment, government spending, and net exports. In the United States, consumption is the largest component of GDP, representing approximately 70%. Nominal GDP can increase due to an increase in prices and/or an increase in production. As a result, to evaluate whether an economy is growing or shrinking, it is important to consider real GDP, which accounts for price changes over time by measuring GDP in constant prices. Real GDP per capita is a commonly used measure of average income. It is calculated by dividing real GDP by a country's population. Real GDP per capita may be used to compare living standards across countries and over time. A high GDP per capita generally is associated with a high standard of living. A low GDP per capita usually is associated with a low standard of living.
GDP per capita
Gross domestic product divided by the number of people in the population.
Module 51: Measuring GDP—The GDP Equation
Gross domestic product, or GDP, is a measurement of how well an economy is doing. Whether GDP is "up" or "down" can have a great impact on your life. For example, the growth of the GDP can impact how difficult it is for you or your friends to find a job. It can also impact how much money you make if you have a job.
Module 57: Measuring Inflation
How do you know when inflation is part of a healthy growing economy or when it means trouble? The simple answer is that you need to compare the inflation rate to other economic indicators. In this module, you will learn about the methods economists use to measure inflation, including the Consumer Price Index (CPI).
Module 52: Measuring Productivity
In economics, productivity refers to output per worker. Productivity is measured by dividing output (goods and services) by input (resources). An increase in productivity occurs when the same output can be produced with fewer resources. Economists also measure an economy's labor productivity. This is the total amount of a country's output (its gross domestic product or GDP) divided by the amount of labor needed to produce it. This is usually measured as a country's total number of workers or the total number of hours worked. Over the long run, increases in labor productivity will usually raise a country's standard of living. If each worker produces more, each person can consume more. Productivity increases are responsible for the standard of living in the United States. Today, Americans work fewer hours and have more possessions compared to 100 years ago.
Module 62: What Is Aggregate Demand? What Is Aggregate Supply?
In previous modules, you learned about a basic supply-and-demand model for an individual market or industry. This module focuses on all the markets or industries in a domestic economy and the quantity of output for this entire economy. In macroeconomics, aggregate demand (AD) is an economy's total demand for final goods and services. Aggregate supply (AS) is the total supply of final goods and services that firms plan to sell during a specific time period. Aggregate demand and aggregate supply are the bases of the business cycle. This module looks at each separately. The combination of the two will be introduced in the next module.
Module Summary
In the long run, when the velocity of money and the growth of real GDP are fairly constant, inflation is largely determined by the money supply's growth rate. This means that changes in the money supply can impact long-run inflation rates. In the short run, inflation can occur as a result of increases in aggregate demand or decreases in aggregate supply. Once inflation begins to gain momentum, however, it is costly to stop it. A decrease in inflation is called disinflation. In the past, the Federal Reserve has achieved disinflation, but it has had consequences.
Module Summary
In this module, you examined two measures of economic development—GDP per capita and the Human Development Index (HDI)—as they apply to countries throughout the world. You learned about geographical patterns in levels of economic development—some areas of the world are much poorer than others. You also learned about several theories that explain why economic development is so challenging in many parts of the world. Finally, you learned about some governmental and nongovernmental organizations (NGOs) that perform development work.
Module Summary
In this module, you learned about three important economic indicators used to assess the health of an economy: unemployment, GDP, and inflation. The unemployment rate is the percentage of the labor force that is unemployed. A rising unemployment rate indicates that fewer jobs are available. Typically, a strong economy will have a relatively low unemployment rate. GDP is a measure of a nation's economic output, technically defined as the monetary value of all final goods and services produced in a country over one year. Economic growth occurs when the amount of goods and services increases. In other words, economic growth parallels an increase in real GDP. Economic growth is desirable because it can lead to an increase in living standards. Inflation is a general increase in the price level. When inflation occurs, goods and services become more expensive to buy. To calculate inflation, economists will examine changes in the CPI, which measures the average prices paid by the average urban American household. Inflation can cause people's living standards to decline if their wages and salaries do not rise by a similar amount.
Module Summary
In this module, you learned how the values of market baskets are calculated, and how price indices are constructed. You also learned how inflation is calculated from a price index. You learned about the differences between a Consumer Price Index, a Producer Price Index, and a GDP deflator. Finally, you learned that inflation can have a significantly negative impact on an economy, which underscores the importance of measuring inflation.
Module Summary
In this module, you learned that economic growth, defined as an increase in GDP per capita, is caused by one of two factors: increased use of inputs per capita and/or increases in productivity. Productivity increases come from technology improvements, which turn inputs into greater output. Technology can result from new discoveries—increased scientific or technical knowledge—or by changes in the ways a company organizes inputs to produce goods and services. Over the long run, technology improvements drive up standards of living in developed countries, such as the United States. Productivity is difficult to measure directly because many different types of inputs are used. A related measure, labor productivity, is simply the total output of goods and services (GDP) divided by the labor input. In the long run, when productivity increases, the real price of goods and services falls, and the quantity consumed increases. In the short run, technology improvements may hurt some people, such as workers who lose their jobs or owners of outdated capital goods.
Module Summary
In this module, you reviewed the basic concepts of the business cycle and learned how they relate to economic performance and factors such as employment, inflation, wages, and stock markets. Stock is a share of ownership in a corporation and a claim on a portion of that corporation's income and assets. A stock market is a place where stocks are bought and sold. In the United States, when economists talk about "the stock market," they are generally referring to the New York Stock Exchange. The values of stocks are reported using indices such as the Dow Jones Industrial Average and the S&P 500. All of these indices, particularly the Dow, are watched closely and reported on continuously during the day. A period during which a market index increases by more than 20% is known as a bull market, while a market index that declines by more than 20% is known as a bear market. Stock markets frequently are used as economic indicators. They also tend to react to news about the economy. Large swings in stock values have often coincided with changes in economic business cycles. The best-known example is the 1929 stock market crash, which preceded the Great Depression.
Module 53: Increased Productivity/Standard of Living
In this module, you will compare the GDP and GDP per capita of different countries. You will also learn why different countries develop economically at varying paces and how organizations can encourage this development.
Human Development Index
Indicator of level of development for each country, constructed by United Nations, combining income, literacy, education, and life expectancy
Module 56: Inflation
Inflation affects everyone who buys or sells goods and services within the economy. Understanding inflation can help you manage your personal finances. In this module, you will learn what inflation is and how it relates to the economy. You will also learn why people desire stable prices rather than rapid price increases.
Module Summary
Inflation is an increase in an economy's general price levels. During inflation, some people benefit, while others do not. Those who may benefit include borrowers, consumers, and owners of resources that increase in value at a rate greater than the inflation rate. Those who may not benefit include people with cash savings, lenders, and people who do not own properties that gain value from inflation. The costs related to inflation can affect the whole economy.
Module 54: Monopsony Power and Human Resources
Labor, in economic terms, is the amount of work performed by people in any industry. It is another type of input (also known as factors of production) such as capital. It is often classified as human capital, which is an individual's skills and knowledge acquired through experience in work and formal education. In general, most laborers want to be paid the maximum amount of money that is considered standard for people with their skill sets. In this module, you will learn about the interaction between laborers and employers in economic terms
Module Summary
Monopsony is a market system in which a single buyer faces numerous sellers. In the labor market, the employee generally holds the monopsonist power when the job requires extensive education and training. This would include a neurosurgeon or biochemical engineer. When the job requires little education or training, the employer generally holds the monopsony power. An example of this would be a worker at a hot dog stand.
Nominal GDP
Nominal GDP is determined by evaluating the production of goods and services at current prices. An increase in nominal GDP could be caused by an increase in production and/or an increase in prices. For example, producing the same amount of houses, but more cars, would increase nominal GDP. However, higher house prices would also increase nominal GDP. From an economist's standpoint, an increase in car production suggests increasing productivity. Higher prices, though, simply reflect inflation. To measure the actual increase in GDP, economists need to determine if the increase in GDP was caused by the production of more goods and services or by inflation. This measure is called real GDP.
Real GDP
Real GDP is determined by evaluating the production of goods and services at constant prices. Constant prices are prices adjusted to reflect inflation. This identifies the changes in GDP caused only by increased production—removing increases in nominal GDP driven by inflation. In the example about increased car production and higher house prices, only the car production would be factored into real GDP.
Module Summary
The business cycle refers to an economy's alternating periods of expansion and contraction. Although a country may experience overall growth in the long run, it will always experience fluctuations in economic output. An expansion is characterized by growing economic output with increasing incomes and decreasing unemployment. The economy eventually reaches a peak—where economic output is at its greatest—right before a slowdown or contraction. A contraction is a period of declining economic output where unemployment may increase and incomes may decrease. A contraction is characterized as a recession when it meets certain criteria, such as lasting for two or more consecutive quarters (or half a year). The economy reaches a low point, or trough when economic output hits its lowest level before beginning to recover and entering an expansionary period again. A particularly long or severe recession is referred to as a depression, such as the Great Depression of the 1930s. The NBER is the most respected authority on business cycle activity.
Module 49: National Economic Goals: Strong vs. Weak Economy
The economic goal of government policies is to respond to the ups and downs of business cycles and influence economic growth. In this module, you will learn the strategies government uses to encourage growth in gross domestic product (GDP), move toward full employment, and keep inflation low.
Module Summary
The effects of inflation differ greatly depending upon whether it is anticipated or unanticipated. The effects of unanticipated inflation also differ depending on whether increases or decreases are relative to expectations. For example, an increase in unanticipated inflation hurts lenders and helps borrowers, because the repaid money is worth less than expected. But a decrease in this inflation hurts borrowers and helps lenders, because the money being repaid is worth more than expected. One of the major costs of unanticipated inflation is that it increases uncertainty in the economy, making businesses reluctant to invest and banks reluctant to make loans. Anticipated inflation can affect the economy either positively or negatively.
Module Summary
The government sets national economic goals for economic growth, full employment, and a low rate of inflation. During business cycles of strong growth or expansion, there is a risk of inflation. During cycles of low growth or contraction, there is a risk of recession and high unemployment. The government implements fiscal policy aimed at producing full employment, low levels of inflation, and an economic growth rate that will allow for improved standards of living over time. The U.S. government currently faces the enormous challenge of trying to balance these policy goals with the need to bring down the national debt in the years ahead.
Module Summary
This module examined aggregate demand and aggregate supply. In macroeconomics (the study of the economy as a whole), aggregate demand (AD) is an economy's total demand for final goods and services in the economy (Y) at a given time and price level. At its basic definition, it is the total goods and services in the economy that will be purchased at all possible price levels. Aggregate supply is the total supply of goods and services that firms plan to sell during a specific time period at a given price level. The aggregate demand curve slopes downward, which suggests a negative relationship between overall price level and quantity of goods and services demanded. In the short run, the aggregate supply curve slopes upward, which indicates the overall quantity of goods and services will increase as the overall price level increases.
Module 61: Good Times, Bad Times
This module expands on concepts introduced in Module 60. You will explore the effects of the business cycle on different aspects of the economy, including unemployment, inflation, and equity markets (such as a stock market). Many people look to stock markets as indicators of economic performance. Shifts in stocks often coincide with shifts in economic performance and business cycle activities. These shifts have an impact on inflation and unemployment, so investors and economists closely track the performance of stock markets.
Module 50: Measuring Economic Indicators
What does it mean for an economy to be "strong" or "weak"? These terms are often used to describe how well an economy is doing. But, how do you determine if an economy is doing well? To determine if a student is doing well academically, educators look at his or her grade point average and scores on various assessments. Likewise, economists have developed indicators to assess the health of an economy. In this module, you will learn more about three of the most prominent economic indicators: unemployment, gross domestic product (GDP), and inflation.
Module 55: Meaning of Unemployment Rate
When people cannot find work, they often have trouble supporting themselves and their families. High numbers of unemployed workers also are a problem for a country and its economic system. When unemployment increases, a country has greater difficulty maximizing its production possibilities. In this module, you will learn about different types of unemployment, how it is measured, and some challenges in measuring i
Module 60: Expansion and Contraction
You may notice ups and downs in the economy. When the economy is growing, businesses may hire more employees and more stores may open. On the other hand, when the economy slows down, some businesses may close and jobs may become scarce. This module introduces the concepts of economic expansion and contraction. These fluctuations are called the business cycle, which has important implications for the economy because it affects people's incomes and their chances of finding jobs.
minimum wage
a minimum price that an employer can pay a worker for an hour of labor
at the equilibrium point
actual output equals potential output (and there are enough jobs for everyone—just like Jessica and Isabella's magic wand!)