Eastlake High School Human Costs of Lost Jobs and Incomes Discussion

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PART 1Instructions: Post one significant sentence from any chapter 7-9. And please explain why it is a powerful sentence. The paragraph should have a total of 5-7 sentences.Please find the chapters 7-9 attached as a pdf.PART 2Instructions: For the following response, respond thoughtfully. Just saying “I agree” or “I disagree” does not constitute a thoughtful response. They need to be substantive to promote further discussion, new ideas, or questions and are at least 75-100 words and meaningful sentences that are also professionally written. State your opinion. Do you agree with them? If so why or why not?Chapter 9 “The higher the disposable income, the more households are willing and able to spend” (Chapter 9, page 175.)Disposable income is whatever income a households leftover after the mandatory taxes , the consumption is determined by the disposable income. the relationship of both is the consumption function. For example households that have higher disposable income will spend more budget and eventually will spend more.

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CHAPTER 7
Unemployment and Inflation
FUNDAMENTAL QUESTIONS
1. What is a business cycle?
2. How is the unemployment
rate defined and measured?
Jim West / Alamy
3. What is the cost of
unemployed resources?
4. What is inflation?
5. Why is inflation a problem?
top: ª Carsten Reisinger/Shutterstock
Preview
If you were graduating from college today, what would your job prospects be? In 1932,
they would have been bleak. A large number of people were out of work (about one in
four workers), and a large number of firms had laid off workers or gone out of business.
At any given time, job opportunities depend, not only on the individual’s ability and experience, but also on the current state of the economy.
Economies follow cycles of activity: Periods of expansion, in which output and
employment increase, are followed by periods of contraction, in which output and
117
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118
Chapter 7 Unemployment and Inflation
employment decrease. For instance, during the expansionary period of the 1990s and
2000, only 4 percent of U.S. workers had no job by 2000. But during the period of
contraction of 1981–1982, 9.5 percent of U.S. workers had no job. When the economy is growing, the demand for goods and services tends to increase. To produce
those goods and services, firms hire more workers. Economic expansion also has an
impact on inflation: As the demand for goods and services goes up, the prices of
those goods and services also tend to rise. By 2000, following several years of economic growth, consumer prices in the United States were rising by about 3 percent a
year. During periods of contraction, when more people are out of work, demand for
goods and services tends to fall, and there is less pressure for rising prices. During
the period of the Great Depression in the 1930s in the United States, consumer prices fell by more than 5 percent in 1933. Both price increases and the fraction of
workers without jobs are affected by business cycles in fairly regular ways. But their
effects on individual standards of living, income, and purchasing power are much less
predictable.
Why do certain events move in tandem? What are the links between unemployment
and inflation? What causes the business cycle to behave as it does? What effect does
government activity have on the business cycle—and on unemployment and inflation?
Who is harmed by rising unemployment and inflation? Who benefits? Macroeconomics
attempts to answer all of these questions.
7-1 Business Cycles
1. What is a business cycle?
In this chapter, we describe the business cycle and examine measures of unemployment and
inflation. We talk about the ways in which the business cycle, unemployment, and inflation
are related. And we describe their effects on the participants in the economy.
The most widely used measure of a nation’s output is gross domestic product (GDP).
When we examine the value of real GDP over time, we find periods in which it rises and
other periods in which it falls.
7-1a Definitions
business cycle
Fluctuations in the economy
between growth (expressed
in rising real GDP) and
stagnation (expressed in
falling real GDP).
recession
A period in which real
GDP falls.
This pattern—real GDP rising, then falling—is called a business cycle. The pattern occurs
over and over again, but as Figure 1 shows, the pattern over time is anything but regular.
Historically, the duration of business cycles and the rate at which real GDP rises or falls
(indicated by the steepness of the line in Figure 1) vary considerably.
Looking at Figure 1, it is clear that the U.S. economy has experienced up-and-down
swings in the years since 1959. Still, real GDP has grown at an average rate of approximately
3 percent per year over the long run. While it is important to recognize that periods of economic growth, or prosperity, are followed by periods of contraction, or recession, it is also
important to recognize the presence of long-term economic growth despite the presence of
periodic recessions. In the long run, the economy produces more goods and services. The
long-run growth in the economy depends on the growth in productive resources, like land,
labor, and capital, along with technological advance. Technological change increases the
productivity of resources so that output increases even with a fixed amount of inputs.
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Chapter 7 Unemployment and Inflation
119
FIGURE 1 U.S. Real GDP
Troughs
April 1960
February 1961
December 1969
November 1970
November 1973
March 1975
January 1980
July 1980
July 1981
November 1982
July 1990
March 1991
March 2001
November 2001
December 2007
June 2009
Real GDP (billions of dollars)
Peaks
16500.0
16000.0
15500.0
15000.0
14500.0
14000.0
13500.0
13000.0
12500.0
12000.0
11500.0
11000.0
10500.0
10000.0
9500.0
9000.0
8500.0
8000.0
7500.0
7000.0
6500.0
6000.0
5500.0
5000.0
4500.0
4000.0
3500.0
3000.0
2500.0
2000.0
0.0
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Year
The shaded areas represent periods of economic contraction (recession). The table lists the dates of business cycle peaks and troughs.
The peak dates indicate when contractions began; the trough dates, when expansions began.
Source: Bureau of Economic Analysis; www.bea.gov.
Figure 2 shows how real GDP behaves over a hypothetical business cycle and identifies
the stages of the cycle. The vertical axis on the graph measures the level of real GDP; the
horizontal axis measures time in years. In year 1, real GDP is growing; the economy is in
the expansion phase, or boom period, of the business cycle. Growth continues until the peak
is reached, in year 2. Real GDP begins to fall during the contraction phase of the cycle, which
continues until year 4. The trough marks the end of the contraction and the start of a new
expansion. Even though the economy is subject to periodic ups and downs, real GDP, the
measure of a nation’s output, has risen over the long term, as illustrated by the upward-sloping
line labeled Trend.
If an economy is growing over time, why do economists worry about business
cycles? Economists try to understand the causes of business cycles so that they can
learn how to moderate or avoid recessions and their harmful effects on standards of
living.
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Chapter 7 Unemployment and Inflation
FIGURE 2 The Business Cycle
Peak
Real GDP
Expansion
Contraction
Trend
Trough
Year 1
Year 2
Year 3
Time
Year 4
Year 5
The business cycle contains four phases: the expansion (boom), when real GDP is increasing; the
peak, which marks the end of an expansion and the beginning of a contraction; the contraction
(recession), when real GDP is falling; and the trough, which marks the end of a contraction and the
beginning of an expansion.
Margaret Bourke-White/Time Life Pictures/Getty Images
120
As real income falls, living standards go down. This 1937 photo of a Depression-era breadline
indicates the paradox of the world’s richest nation, as emphasized on the billboard in the
background, having to offer public support to feed able-bodied workers who were out of
work due to the severity of the business cycle downturn.
7-1b Historical Record
The official dating of recessions in the United States is the responsibility of the National
Bureau of Economic Research (NBER), an independent research organization. The NBER has
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121
Chapter 7 Unemployment and Inflation
identified the shaded areas in the graph in Figure 1 as recessions and the unshaded areas as
expansions. Recessions are periods between cyclical peaks and the troughs that follow them.
Expansions are periods between cyclical troughs and the peaks that follow them. There
have been 14 recessions since 1929. The most severe was the period between 1929 and
1933, called the Great Depression. During this period, national output fell by 25 percent.
A depression is a prolonged period of severe economic contraction. The fact that people
speak of “the Depression” when they talk about the recession that began in 1929 indicates
the severity of that contraction relative to others in recent experience. There was widespread
suffering during the Depression. Many people were jobless and homeless, and many firms
went bankrupt.
The NBER defines a recession as “a period of significant decline in total output, income,
employment, and trade, usually lasting from six months to a year, and marked by widespread contractions in many sectors of the economy.” People sometimes say that a recession
is defined by two consecutive quarters of declining real GDP. This informal idea of what
constitutes a recession seems to be consistent with the past recessions experienced by the
United States, as every recession through the 1990s has had at least two quarters of falling
real GDP. However, this is not the official definition of a recession. The business cycle dating
committee of the NBER generally focuses on monthly data. Close attention is paid to the following monthly data series: employment, real personal income less transfer payments, the
volume of sales of the manufacturing and wholesale-retail sectors adjusted for price changes,
and industrial production. The focus is not on real GDP, because it is measured only quarterly and does not permit the identification of the month in which business-cycle turning
points occur.
The shaded areas represent periods of economic contraction (recession). The table lists
the dates of business cycle peaks and troughs. The peak dates indicate when contractions
began; the trough dates, when expansions began.
On November 28, 2008, the NBER Business Cycle Dating Committee met and determined that December 2007 was the most recent business-cycle peak. It always takes some
time for the committee that dates business cycles to have enough evidence to be convinced that the data have identified the turning point in the business cycle. For instance,
in determining the end of the previous recession, it was not until July 17, 2003, that the
NBER announced the recession had ended in November 2001. It took more than 1.5 years
to identify the trough that marked the end of the prior recent recession. On September
19, 2010, the NBER determined that a trough in business activity occurred in the U.S.
economy in June 2009, marking the end of the recession that had begun in December
2007.
The business cycle contains four phases: the expansion (boom), when real GDP is
increasing; the peak, which marks the end of an expansion and the beginning of a contraction; the contraction (recession), when real GDP is falling; and the trough, which marks the
end of a contraction and the beginning of an expansion.
depression
A severe, prolonged
economic contraction.
7-1c Indicators
We have been talking about the business cycle in terms of real GDP. There are a number of
other variables that move in a fairly regular manner over the business cycle. These variables
are classified into three categories—leading indicators, coincident indicators, and lagging
indicators—depending on whether they move up or down before, at the same time as, or
following a change in real GDP (see Table 1).
Leading indicators generally change before real GDP changes. As a result, economists
use them to forecast changes in output. Looking at Table 1, it is easy to see how some of
these leading indicators could be used to forecast future output. For instance, new building
permits signal new construction. If the number of new permits issued goes up, economists
leading indicator
A variable that changes
before real output changes.
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122
Chapter 7 Unemployment and Inflation
TABLE 1 Indicators of the Business Cycle
Leading Indicators
Average workweek
New building permits
Unemployment claims
Delivery times of goods
Manufacturers’ new orders
Interest rate spread
Stock prices
Money supply
New plant and equipment orders
Consumer expectations
Coincident Indicators
Lagging Indicators
Payroll employment
Labor cost per unit of output
Industrial production
Inventories-to-sales ratio
Personal income
Unemployment duration
Manufacturing and trade sales
Consumer credit–to–personal income ratio
Outstanding commercial loans
Prime interest rate
Inflation rate for services
coincident indicator
A variable that changes at the
same time as real output
changes.
lagging indicator
A variable that changes after
real output changes.
can expect the amount of new construction to increase. Similarly, if manufacturers receive
more new orders, economists can expect more goods to be produced.
Leading indicators are not infallible, however. The link between them and future output
can be tenuous. For example, leading indicators may fall one month and then rise the next,
although real output rises steadily. Economists want to see several consecutive months of a
new direction in the leading indicators before forecasting a change in output. Short-run
movements in the indicators can be very misleading.
Coincident indicators are economic variables that tend to change at the same time as
real output changes. For example, as real output increases, economists expect to see employment and sales rise. The coincident indicators listed in Table 1 have demonstrated a strong
tendency over time to change along with changes in real GDP.
The final group of variables listed in Table 1, lagging indicators, do not change in
value until after the value of real GDP has changed. For instance, as output increases,
jobs are created and more workers are hired. It makes sense, then, to expect the duration of unemployment (the average length of time that workers are unemployed) to fall.
The duration of unemployment is a lagging indicator. Similarly, the inflation rate for
services (which measures how prices for things like dry cleaners, veterinarians, and
other services change) tends to change after real GDP changes. Lagging indicators are
used along with leading and coincident indicators to identify the peaks and troughs in
business cycles.
RECAP
1. The business cycle is a recurring pattern of
rising and falling real GDP.
2. Although all economies move through periods
of expansion and contraction, the duration of
the periods of expansion and recession varies.
3. Real GDP is not the only variable affected by
business cycles; leading, lagging, and coincident indicators also show the effects of economic expansion and contraction.
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123
Chapter 7 Unemployment and Inflation
7-2 Unemployment
Recurring periods of prosperity and recession are reflected in the nation’s labor markets. In
fact, this is what makes understanding the business cycle so important. If business cycles signified only a little more or a little less profit for businesses, governments would not be so
anxious to forecast or to control their swings. It is the human costs of lost jobs and
incomes—the inability to maintain standards of living—that make an understanding of business cycles and of the factors that affect unemployment so important.
2. How is the unemployment
rate defined and measured?
7-2a Definition and Measurement
The unemployment rate is the percentage of the labor force that is not working. The rate is
calculated by dividing the number of people who are unemployed by the number of people
in the labor force:
number unemployed
Unemployment rate ¼
number in labor force
This ratio seems simple enough, but there are several subtle issues at work here. First,
the unemployment rate does not measure the percentage of the total population that is not
working; it measures the percentage of the labor force that is not working. Who is in the
labor force? Obviously, everybody who is employed is part of the labor force. But only some
of those who are not currently employed are counted in the labor force.
The Bureau of Labor Statistics of the Department of Labor compiles labor data each
month based on an extensive survey of U.S. households. All U.S. residents are potential
members of the labor force. The Labor Department arrives at the size of the actual labor
force by using this formula:
unemployment rate
The percentage of the labor
force that is not working.
You are in the labor force if
you are working or actively
seeking work.
ª Richard Thornton/Shutterstock.com
Labor force ¼ all U:S: residents ” residents under 16 years of age ”
institutionalized adults minus adults not looking for work
Agricultural harvests, like this one in Mexico, create seasonal fluctuations in the employment
of labor. During the harvest period, workers are hired to help out. When the harvest has ended,
many of these workers will be temporarily unemployed until the next crop requires their labor.
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124
Chapter 7 Unemployment and Inflation
NOW YOU TRY IT
So the labor force includes those adults (an adult being someone 16 or older) who are
currently employed or actively seeking work. It is relatively simple to see to it that children
and institutionalized adults (e.g., those in prison or in long-term care facilities) are not
counted in the labor force. It is more difficult to identify and accurately measure adults who
are not actively looking for work.
A person is actively seeking work if he or she is available to work, has looked for work
in the past four weeks, is waiting for a recall after being laid off, or is starting a job within
30 days. Those who are not working and who meet these criteria are considered
unemployed.
A survey has been taken of
1,000 people in a neighborhood.
It is found that 800 people are
working full time. Of the 200 not
working, 100 are housewives or
househusbands, 50 are actively
looking for a job, 20 are retired,
and 30 are under 16 years of
age. Using the definition of the
unemployment rate and labor
force, answer the following
questions:
1. What is the size of the
neighborhood labor force?
2. What is the neighborhood
unemployment rate?
discouraged workers
Workers who have stopped
looking for work because they
believe that no one will offer
them a job.
underemployment
The employment of workers
in jobs that do not utilize their
productive potential.
Activity in the underground
economy is not included in
official statistics.
7-2b Interpreting the Unemployment Rate
Is the unemployment rate an accurate measure? The fact that the rate does not include those
who are not actively looking for work is not necessarily a failing. Many people who are not
actively looking for work—homemakers, older citizens, and students, for example—have
made a decision not to work—to do housework, to retire, or to stay in school. These people
rightly are not counted among the unemployed.
But there are people missing from the unemployment statistics who are not working
and are not looking for work, yet they would take a job if one were offered. Discouraged
workers have looked for work in the past year but have given up looking for work because
they believe that no one will hire them. These individuals are ignored by the official unemployment rate, even though they are able to work and may have spent a long time looking
for work. Estimates of the number of discouraged workers indicate that, in October 2013,
2.3 million people were not counted in the labor force yet claimed that they searched for
work and were available. Of this group, 34 percent, or over 800,000 people, were considered to be discouraged workers. It is clear that the reported unemployment rate underestimates the true burden of unemployment in the economy because it ignores discouraged
workers.
Discouraged workers are one source of hidden unemployment; underemployment is
another. Underemployment is the underutilization of workers, employing them in tasks
that do not fully utilize their productive potential; this includes part-time workers who
would prefer full-time employment. Even if every worker has a job, substantial underemployment leaves the economy producing less than its potential GDP.
The effect of discouraged workers and underemployment is to produce an unemployment rate that understates actual unemployment. In contrast, the effect of the underground economy is to produce a rate that overstates actual unemployment. A sizable
number of the officially unemployed are actually working. The unemployed construction worker who plays in a band at night may not report that activity because he or she
wants to avoid paying taxes on his or her earnings as a musician. This person is officially unemployed but has a source of income. Many officially unemployed individuals
have an alternative source of income. This means that official statistics overstate the true
magnitude of unemployment. The larger the underground economy, the greater this
overstatement.
We have identified two factors, discouraged workers and underemployment, that cause
the official unemployment rate to underestimate true unemployment. Another factor, the
underground economy, causes the official rate to overestimate the true rate of unemployment. There is no reason to expect these factors to cancel one another out, and there is no
way to know for sure which is most important. The point is to remember what the official
data on unemployment do and do not measure.
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125
Chapter 7 Unemployment and Inflation
7-2c Types of Unemployment
Economists have identified four basic types of unemployment:
Seasonal unemployment A product of regular, recurring changes in the hiring needs
of certain industries on a monthly or seasonal basis
Frictional unemployment A product of the short-term movement of workers between
jobs and of first-time job seekers
Structural unemployment A product of technological change and other changes in the
structure of the economy
Cyclical unemployment A product of business-cycle fluctuations
Frictional and structural
unemployment are always
present in a dynamic economy.
ª Indykb/Shutterstock.com
In certain industries, labor needs fluctuate throughout the year. When local crops are
harvested, farms need lots of workers; the rest of the year, they do not. (Migrant farmworkers move from one region to another, following the harvests, to avoid seasonal unemployment.) Ski resort towns like Park City, Utah, are booming during the ski season, when
employment peaks, but they need fewer workers during the rest of the year. In the nation as
a whole, the Christmas season is a time of peak employment and low unemployment rates.
To avoid confusing seasonal fluctuations in unemployment with other sources of unemployment, unemployment data are seasonally adjusted.
Frictional and structural unemployment exist in any dynamic economy. For individual
workers, frictional unemployment is short term in nature. Workers quit one job and soon
find another; students graduate and soon find a job. This kind of unemployment cannot be
eliminated in a free society. In fact, it is a sign of efficiency in an economy when workers try
to increase their income or improve their working conditions by leaving one job for another.
Frictional unemployment is often called search unemployment because workers take time to
search for a job after quitting a job or leaving school.
Frictional unemployment is short term; structural unemployment, on the other hand,
can be long term. Workers who are displaced by technological change (assembly line
Snow plow drivers are needed in the peak winter season, but may be unemployed in the warmer
times of year.
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126
Chapter 7 Unemployment and Inflation
Cyclical unemployment is a
product of recession.
workers who have been replaced by machines, for example) or by a permanent reduction in
the demand for an industry’s output (cigar makers who have been laid off because of a
decrease in demand for tobacco) may not have the necessary skills to maintain their level of
income in another industry. Rather than accept a much lower salary, these workers tend to
prolong their job search. Eventually they either adjust their expectations to the realities of
the job market or enter the pool of discouraged workers.
Structural unemployment is very difficult for those who are unemployed. But for society
as a whole, the technological advances that cause structural unemployment raise living
standards by giving consumers a greater variety of goods at lower cost.
Cyclical unemployment is a result of the business cycle. When a recession occurs, cyclical unemployment increases, and when growth occurs, cyclical unemployment decreases. It
is also a primary focus of macroeconomic policy. Economists believe that a greater understanding of business cycles and their causes may enable them to find ways to smooth out
those cycles and swings in unemployment. Much of the analysis in future chapters is related
to macroeconomic policy aimed at minimizing business-cycle fluctuations. In addition to
macroeconomic policy aimed at moderating cyclical unemployment, other policy measures—for example, job training and counseling—are being used to reduce frictional and
structural unemployment.
7-2d Costs of Unemployment
3. What is the cost of
unemployed resources?
The cost of unemployment is more than the obvious loss of income and status suffered by
the individual who is not working. In a broader sense, society as a whole loses when resources are unemployed. Unemployed workers produce no output. So an economy with unemployment will operate inside its production possibilities curve rather than on the curve.
Economists measure this lost output in terms of the GDP gap:
GDP gap ¼ potential real GDP ” actual real GDP
potential real GDP
The output produced at the
natural rate of unemployment.
natural rate of
unemployment
The unemployment rate that
would exist in the absence of
cyclical unemployment.
Potential real GDP is the level of output produced when nonlabor resources are fully
utilized and unemployment is at its natural rate. The natural rate of unemployment is the
unemployment rate that would exist in the absence of cyclical unemployment, so it includes
seasonal, frictional, and structural unemployment. The natural rate of unemployment is not
fixed; it can change over time. For instance, some economists believe that the natural rate of
unemployment has risen in recent decades, a product of the influx of baby boomers and
women into the labor force. As more workers move into the labor force (begin looking for
jobs), frictional unemployment increases, raising the natural rate of unemployment. The
natural rate of unemployment is sometimes called the “nonaccelerating inflation rate of
unemployment,” or NAIRU. The idea is that there would be upward pressure on wages and
prices in a tight labor market in which the unemployment rate fell below the NAIRU. We
will see macroeconomic models of this phenomenon in later chapters.
Potential real GDP measures what we are capable of producing at the natural rate of
unemployment. If we compute potential real GDP and then subtract actual real GDP, we have
a measure of the output lost as a result of unemployment, or the cost of unemployment.
The GDP gap in the United States from 1975 to 2012 is shown in Figure 3. The gap
widens during recessions and narrows during expansions. As the gap widens (as the output
that is not produced increases), there are fewer goods and services available, and living
standards are lower than they would be at the natural rate of unemployment. Figure 3(b) is
a graph of the gap between potential and real GDP, taken from Figure 3(a). During the
strong expansion of the late 1990s, and more recently before the financial crisis and associated recession, the gap went to zero. Following the recession the gap widened considerably
and has rema