APMacro: Unemployment and Inflation Review




Unemployment and Inflation Review



  • Economic growth may be defined as either a) an increase in real GDP over time or b) an increase in real GDP per capita over time. Growth lessens the burden of scarcity and provides increases in real GDP that can be used to resolve socioeconomic problems.
  • The US and other industrial economies have gone through periods of fluctuations in real GDP, employment, and price levels. Although they have certain phases in common – peak, contraction, trough, expansion – business cycles vary greatly in duration and intensity.
  • Although economists explain the business cycle in terms of such causal factors as major innovations, political events, and money creation, they generally agree that changes in the level of total spending are the immediate causes of fluctuating real output and employment.
  • The business cycle affects all sectors of the economy, though on varying ways and degrees. The cycle has greater effects on output and employment in the capital goods and durable consumer goods industries than in the services and nondurable goods industries.
  • Economists distinguish between frictional, structural, and cyclical unemployment. The full employment or natural rate of unemployment, which is made up of frictional and structural unemployment, is currently between 4 and 6 percent. The presence of part time and discouraged workers makes it difficult to measure unemployment accurately.
  • The GDP gap, which can be either a positive or a negative value, is found by subtracting potential GDP from actual GDP. The economic cost of unemployment , as measured by the GDP gap, consists of the goods and services forgone by society when its resources are involuntarily idle. Okun’s law suggests that every 1 percentage point increase in unemployment above the natural rate causes an additional 2 percent negative GDP gap.
  • Inflation is a rise in the general price level and is measured in the US by the Consumer Price Index (CPI). When inflation occurs, each dollar of income will buy fewer goods and services than before. That is, inflation reduces the purchasing power of money.
  • Unemployment rates and inflation rates vary widely globally. Unemployment rates differ because nations have different natural rates of unemployment and often are in different phases of their business cycles. Inflation and unemployment rates in the US recently have been in the middle to low range compared with rates in other industrial nations.
  • Demand-pull inflation results from an excess of total spending relative to the economy’s capacity to produce. The main source of cost-push (supply-side) inflation is the abrupt and rapid increases in the prices of key resources. These supply shocks push up per unit production costs and ultimately raise the prices of consumer goods.
  • Unanticipated inflation arbitrarily redistributes real income at the expense of fixed-income receivers, creditors, and savers. If inflation is anticipated, individuals and businesses may be able to take steps to lessen or eliminate adverse redistribution effects.
  • When inflation is anticipated, lenders add an inflation premium to the interest rate charged on loans. The nominal interest rate thus reflects the real interest rate plus the inflation premium or the expected rate of inflation.
  • Cost-push inflation reduces real output and employment. Proponents of zero inflation argue that even mild demand-pull inflation(1 to 3 percent) reduces the economy’s real output.Other economists say that mild inflation may be a necessary by-product of the high and growing spending that produces high levels of output, full employment, and economic growth.
  • Hyperinflation, caused by rapid expansions of the money supply, may undermine the monetary system and cause severe declines in real output.

1) Chapter 6 p.122 #3, 8a, 9a, 11, 12, 13
2) Chapter 7 p.144 #2, 6, 8, 11, 14
3) Economic Indicators Quiz – Tuesday 3/1



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