Economic Growth,
Business Cycles,
Unemployment, and
Inflation
Chapter 6
© 2003 McGraw-Hill Ryerson Limited.
6-2
Central Problems of
Macroeconomics
Macroeconomics is the study of the
aggregate moods of the economy.
 The four central issues of
macroeconomics are growth, business
cycles, unemployment, and inflation.

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6-3
Two Timeframes: The Long
Run and the Short Run

Issues of growth are considered in a
long-run framework.
 Long-run
growth focuses on supply (also
called supply-side economics).
 Supply is so important in the long run,
policies that affect production - such as
incentives that promote work, capital, and
technological change - are key.
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6-4
Two Timeframes: The Long
Run and the Short Run

Business cycles are generally
considered in a short-run framework.
 The
short-run fluctuation framework
focuses on demand.
 Much of the policy discussion of short-run
fluctuations focuses on ways to increase or
decrease components of aggregate
expenditures.
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6-5
Growth
Generally the Canadian economy is
growing or expanding.
 The primary measurement of growth is
change in real gross domestic product
(GDP).

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6-6
Growth

Real gross domestic product (real
GDP) – the market value of final goods
and services stated in the prices of a
given period.
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6-7
Growth

Canadian economy has grown at an
annual rate of 4 percent per year over
the last 130 years., but more recently it
has been growing at about 2.5-3.5
percent a year.

This average annual growth rate is
called the secular trend growth rate.
© 2003 McGraw-Hill Ryerson Limited.
6-8
Growth
Another measure of growth is change in
per capita real output.
 Per capita real output is real output
divided by the total population.

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6-9
Global Experience with
Growth
Global experiences with growth vary
across time and among nations.
 Today's growth rates are high by
historical standards.
 The range of growth rates among
nations is wide.

© 2003 McGraw-Hill Ryerson Limited.
6 - 10
Average Annual Per Capita
Income, 1820-2000, Table 6-1, p 136
Growth Rates
Income levels
(1990 international Dollars)
1820-1950
1950-2000
1820-2000
1820
1950
2000
The world
0.9
1.8
1.1
675
2,108
5,672
Western Europe
1.1
2.5
1.5
1,269
6,546
19,846
North America
1.6
1.8
1.6
1,233
9,463
26,224
Japan
0.8
4.8
1.9
675
1,927
20,438
Eastern Europe
1.1
1.0
1.0
803
3,162
5,967
Latin America
1.0
1.4
1.1
671
2,478
6,797
China
-0.2
3.4
0.8
600
439
3,442
Other Asia
0.3
2.4
0.9
560
848
3,269
Africa
0.6
0.8
0.6
400
1,307
1,291
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6 - 11
The Benefits and Costs of
Growth
Per capita economic growth allows
everyone in society, on average to have
more.
 Growth, or predictions of growth, allows
governments to avoid hard questions.
 A growing economy creates jobs.

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6 - 12
The Benefits and Costs of
Growth
The costs of growth include pollution,
resource exhaustion, and destruction of
natural habitat.
 Since many believe the environmental
costs of growth are important, the result
is often an environmental-economic
growth stalemate.

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6 - 13
Business Cycles
There are numerous fluctuations around
the secular growth trend,called the
business cycle.
 The business cycle is the upward and
downward movement of economic
activity that occurs around the growth
trend.

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6 - 14
Canadian Business Cycles, Fig.
6-1a, p 138
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6 - 15
U. S. Business Cycles, Fig. 6-1b, p 138
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6 - 16
Business Cycles

There are a number of theories
regarding the nature and causes of
business cycles.
Classicals are a group of economists
who generally favour laissez-faire or
noninterventionist policies.
 Keynesians generally favour activist
policies.

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6 - 17
Business Cycles
Classical economists argue that
business cycles are to be expected in a
market economy.
 Keynesian economists believe that
fluctuations can and should be
controlled.

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6 - 18
The Phases of the Business
Cycle
The peak is the top of the business
cycle.
 A boom is a very high peak,
representing a big jump in output.
 The downturn is the phenomenon of
economic activity starting to fall from a
peak.

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6 - 19
The Phases of the Business
Cycle
A recession is a decline in real output
that persists for more than two
consecutive quarters in a year.
 A depression is a large recession.
 The bottom of the recession or
depression is called the trough.

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6 - 20
The Phases of the Business
Cycle
As total output starts to expand, the
economy comes out of the trough into
an upturn, which may turn into an
expansion.
 An expansion is an upturn that lasts at
least two consecutive quarters of a year.

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6 - 21
Business Cycle Phases, Fig. 6-2, p 140
Expansion
Recession
Expansion
Total Output
Peak
0
Trough
Secular
growth
trend
Jan.- Apr.- July- Oct.- Jan.- Apr.- July- Oct.- Jan.- Apr.Mar June Sept. Dec. Mar June Sept. Dec. Mar June
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6 - 22
Why Do Business Cycles
Occur
Recessions and expansions are caused
primarily by demand-side shocks.
 A debate exists about whether these
fluctuations can and should be reduced.

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6 - 23
Why Do Business Cycles
Occur
Most economists believe that potential
depressions should be offset by
economic policy.
 This general view was built into
economics in the Great Depression of
the 1930s.

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6 - 24
Why Do Business Cycles
Occur

During this period there were changes
in the economy's structure, with
government playing a much more active
role.
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6 - 25
Leading Indicators

Leading indicators are a set of signs
that indicate what is likely to happen 12
to 15 months from now.
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6 - 26
Leading Indicators

Variables that make up the leading
indicator include:
 Average
workweek for production
workers in manufacturing.
 An index of housing starts.
 The U.S. composite leading index.
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6 - 27
Leading Indicators

Variables that make up the leading
indicator include :
 The
money supply M1 divided by the price
index.
 New orders for durable goods.
 Retail trade in furniture and appliances.
 Durable goods sales excluding furniture
and appliances.
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6 - 28
Leading Indicators

Variables that make up the leading
indicator include:
 The
ratio of shipments to inventories or
finished products.
 The TSE 300 stock price index.
 Employment in business and personal
service sector.
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6 - 29
Leading Indicators

Economists use indicators in making
forecasts about the economy. They are
indicators, not predictors.
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6 - 30
Unemployment
Business cycles and growth are directly
related to unemployment in the
economy.
 Unemployment occurs when people are
looking for a job and cannot find one.

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6 - 31
Unemployment

The unemployment rate is the
percentage of people in the economy
who are willing and able to work but
who are not working.
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6 - 32
Unemployment

Cyclical unemployment results from
fluctuations in economic activity.

It did not exist in pre-industrial society.
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6 - 33
Unemployment
Structural unemployment is caused
by economic restructuring, making
some skills obsolete.
 It existed in pre-industrial society.

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6 - 34
Unemployment as a Social
Problem
The Industrial Revolution was
accompanied by a change in how
families dealt with unemployment.
 What had previously been a family
problem, now became a social problem.

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6 - 35
Unemployment as
Government’s Problem
The Federal Unemployment Insurance
Act of 1940 assigned government the
responsibility for providing assistance to
the unemployed.
 Full employment – an economic
climate in which just about everyone
who wants a job can have one.

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6 - 36
Unemployment as
Government’s Problem
Initially government regarded 3 percent
unemployment as a condition of full
employment.
 The 3 percent was made up of frictional
unemployment.

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6 - 37
Unemployment as
Government’s Problem

Frictional unemployment is the
unemployment caused by new entrants
into the job market and people quitting a
job just long enough to look for and find
another one.
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6 - 38
Unemployment as
Government’s Problem

The target rate of unemployment
(sometimes called the natural rate of
unemployment) is the lowest
sustainable rate of unemployment that
policymakers believe is achievable
under existing conditions.
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6 - 39
Unemployment as
Government’s Problem

In the 1980s and 1990s, the target rate
of unemployment was been between 6
and 8 percent.
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6 - 40
Why the Target Rate of
Unemployment Changed

The target rate of unemployment has
changed over time for the following
reasons:
 In
the 1970s and early 1980s, a low inflation
rate seemed to be incompatible with a low
unemployment rate.
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6 - 41
Why the Target Rate of
Unemployment Changed

The target rate of unemployment has
changed over time for the following
reasons:
 Demographics
have changed – different
age groups have different rates of
unemployment.
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6 - 42
Why the Target Rate of
Unemployment Changed

The target rate of unemployment has
changed over time for the following
reasons:
 Social
and institutional structures have
changed.
 Governmental institutions also changed.
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6 - 43
Whose Responsibility Is
Unemployment?
Classical economists believe that
individuals are responsible for their own
employment.
 They argue that every person can find
some job at some wage, so all
unemployment is frictional.

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6 - 44
Whose Responsibility Is
Unemployment?
Keynesian economists tend to say that
society owes a person a job
commensurate with the individual's
training or past job experience.
 They argue that jobs should be closer to
home, so people do not have to move.
According to this view, unemployment is
mainly cyclical and structural.

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6 - 45
How Is Unemployment
Measured?

The unemployment rate is published by
Statistics Canada.
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6 - 46
Calculating the
Unemployment Rate

The unemployment rate is calculated
by dividing the number of unemployed
individuals by the number of people in
the labour force and multiplying by 100.
number unemployed
unemployme nt rate =
×100
labour force
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6 - 47
Calculating the
Unemployment Rate
The labour force is those people in an
economy who are willing and able to
work.
 The labour force excludes those
incapable of working and those not
looking for work.

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6 - 48
Unemployment Rate Since
1946, Fig. 6-3, p 146
Percentage fluctuations in unemployment rates
14
12
10
8
6
4
2
0
1946
1956
1966
1976
1986
1996
Years
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6 - 49
How Accurate Is the Official
Unemployment Rate?
The unemployment rate does not
include discouraged workers.
 Discouraged workers – people who do
not look for a job because they feel they
do not have a chance of finding one.

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6 - 50
How Accurate Is the Official
Unemployment Rate?
The unemployment rate counts as
employed those who are
underemployed.
 Underemployed – part-time workers
who would prefer full-time work.

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6 - 51
How Accurate Is the Official
Unemployment Rate?

Some supplemental measures are used
by economists for better accuracy of
unemployment measures, such as the
labour force participation rate and the
employment rate.
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6 - 52
How Accurate Is the Official
Unemployment Rate?
The labour force participation rate
measures the labour force as a
percentage of the total population at
least 15 years old.
 The employment rate measures the
number of people who are working as a
percentage of the labour force.

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6 - 53
How Accurate Is the Official
Unemployment Rate?

Both Classicals and Keynesians agree
that unemployment figures are
imperfect, for different reasons.
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6 - 54
Unemployment/Employment
Figures, Fig. 6-4, p 147
Population (31.08 million)
Population 15 or older (24.6 million)
Labor force (16.25 million)
Employed (15.08 million)
Unemployed (1.17 million)
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6 - 55
Unemployment and Potential
Output

The capacity utilization rate is the rate
at which factories and machines are
operating compared to the maximum
sustainable rate at which they could be
used.
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6 - 56
Unemployment and Potential
Output

The capacity utilization rate indicates
how much capital is available for
economic growth.
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6 - 57
Unemployment and Potential
Output

Potential output is the output that
would materialize at the target rate of
unemployment and the target rate of
capacity utilization.
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6 - 58
Unemployment and Potential
Output

Potential output is defined as the
output that will be achieved at the target
rate of unemployment and at the target
level of capacity utilization.
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6 - 59
Unemployment and Potential
Output

There is debate about where the actual
level of potential income is.
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6 - 60
Unemployment and Potential
Output

To determine the effect changes in the
unemployment rate will have on output,
we use Okun's rule of thumb.
 The
rule states that a 1 percentage point
change in unemployment will cause output
to change in the opposite direction by 2
percent.
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6 - 61
Unemployment and Capacity
Utilization Rates (%), Table 6-2, p 148
Capacity utilization
Unemployment
Annual
growth in real
output
1975
1985
2000
1975
1985
2000
1975-2000
Canada
83.1
82.5
85.8
6.9
10.5
6.6
2.5
U.S.
74.6
79.8
80.4
8.5
7.2
4.0
2.9
Japan
81.4
82.5
74.6
1.9
2.6
4.4
2.5
Germany
76.9
79.6
85.1
3.4
8.2
10.0
3.0
U.K.
81.9
81.1
81.8
4.6
11.2
5.7
2.2
Mexico
85
92.0
85.7
-
-
2.0
1.6
Korea
86.5
86.4
83.3
-
10.9
4.8
7.7
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6 - 62
Microeconomic Categories of
Unemployment
Macroeconomic measures of
unemployment may be too crude.
 Different types of unemployment are
susceptible to different types of policies.

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6 - 63
Microeconomic Categories of
Unemployment

Some microeconomic categories of
unemployment are reasons for
unemployment, demographic
unemployment, duration of
unemployment, unemployment by
industry,and unemployment by age
group.
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6 - 64
Unemployment by
Microeconomic Subcategories, Fig.
6-5, p 150
Total unemployment rate
Total unemployment (1.17 million (7.2%))
Unemployment rate by sex
Male (659,500 (7.5%))
Female (510,000(6.8%)
Unemployment by age
15-24
12.8%
25 and over
6.1%
55 and over
5.5%
65 and over
3.3%
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6 - 65
Inflation
Inflation is a continual rise in the price
level.
 Since World War II, the Canadian
inflation rate has remained positive and
relatively stable.

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6 - 66
Measurement of Inflation
Inflation is measured with changes in
price indexes.
 A price index is a composite of prices.

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6 - 67
Measurement of Inflation

A price index is a series of numbers
that summarizes what happens to a
weighted composite of prices of a
selection of goods (often called a
market basket of goods) over time.
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6 - 68
Measurement of Inflation

A price index can be created by looking
at a market basket of goods.
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6 - 69
Inflation in Canada Since
1915, Fig. 6-6, p 151
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6 - 70
Real-World Price Indexes

Real-world price indexes include the
raw materials price index, the CPI, and
the GDP deflator.
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6 - 71
The Raw Materials Price
Index

The raw materials price index
measures the prices of a number of
important raw materials, such as steel.
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6 - 72
The Raw Materials Price
Index
This index does not accurately measure
what most consumers are interested
in—final goods.
 It gives an early indication of which way
inflation is headed.

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6 - 73
The GDP Deflator

The GDP deflator (gross domestic
product deflator) is an index of the
price level of aggregate output, or the
average price of the components in total
output (GDP) relative to a base year.
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6 - 74
The GDP Deflator
The GDP deflator is the measure of
inflation most economists favour since it
includes the widest number of goods.
 Since it is difficult to compute, it is
published only quarterly and with a fairly
substantial lag.

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6 - 75
The Consumer Price Index
(CPI)

The consumer price index (CPI)
measures the prices of a fixed basket of
consumer goods, weighted according to
each component's share of an average
consumer's expenditures.
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6 - 76
The Consumer Price Index
(CPI)
The CPI is the measure of inflation most
often presented in news reports.
 Many economists believe that the CPI
as currently constituted, overstates
inflation by one percentage point.

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6 - 77
Composition of CPI, Fig. 6-7, p 153
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6 - 78
Real and Nominal Concepts

Nominal output is the total amount of
goods and services measured at current
prices.
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6 - 79
Real and Nominal Concepts

Real output is the total amount of
goods and services produced, adjusted
for price level changes.
nominal output
real output =
X 100
price index
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6 - 80
Real and Nominal Concepts

The “real” amount is the nominal
amount adjusted for inflation.
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6 - 81
Expected and Unexpected
Inflation
Expected and unexpected inflation
affect behavior differently.
 Expected inflation is that which people
anticipate.
 Unexpected inflation is that which
surprises people.

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6 - 82
Expected and Unexpected
Inflation

Expectations of inflation play an
important role in further exacerbating
inflation.
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6 - 83
Costs of Inflation

There are two main costs of inflation:
redistribution costs and blurring of price
information.
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6 - 84
Costs of Inflation
Inflation causes income to be
redistributed from those who do not
raise their prices to those who do.
 Inflation can reduce the amount of
information that prices are supposed to
convey.

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6 - 85
Costs of Inflation

Despite redistributive costs and a
blurring of price information, inflation is
usually accepted by governments as
long as it stays at a low level.
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6 - 86
Costs of Inflation
The danger is when inflation becomes
hyperinflation.
 Hyperinflation – exceptionally high
levels of inflation of, say, 100 percent or
more a year.
 Canada has not experienced
hyperinflation.

© 2003 McGraw-Hill Ryerson Limited.
Economic Growth,
Business Cycles,
Unemployment, and
Inflation
End of Chapter 6
© 2003 McGraw-Hill Ryerson Limited.