eco2013 (6) - principles of economics: macro unit 4 study guides

Key Concepts and Definitions

• Unemployment refers to individuals who are actively seeking work but are unable to find employment
• Inflation is a sustained increase in the general price level of goods and services in an economy over time
  • Results in each unit of currency effectively buying fewer goods and services
• Natural rate of unemployment is the level of unemployment that exists when the economy is operating at full capacity, also known as the non-accelerating inflation rate of unemployment (NAIRU)
• Deflation is a decrease in the general price level of goods and services, the opposite of inflation
• Hyperinflation is very high and typically accelerating inflation, rapidly eroding the real value of the local currency
• Stagflation is a situation where the inflation rate is high, economic growth rate slows, and unemployment remains steadily high
• Phillips curve illustrates the inverse relationship between the level of unemployment and the rate of inflation in an economy
• Misery index is an economic indicator that adds the unemployment rate to the inflation rate to assess the degree of economic distress

Causes and Types of Unemployment

• Frictional unemployment occurs when workers are in between jobs or are searching for new ones
  • Considered voluntary and short-term
  • Results from imperfect information in the labor market and the time needed to find a job
• Structural unemployment happens when there is a mismatch between the skills of unemployed workers and the skills required for available jobs
  • Often due to technological changes or shifts in the economy
  • Requires workers to acquire new skills or relocate to find employment
• Cyclical unemployment is caused by business cycles and economic downturns
  • Occurs when there is not enough aggregate demand in the economy to provide jobs for everyone who wants to work
  • Characterized by a general decline in spending and production
• Seasonal unemployment results from regular and predictable changes in labor markets due to the weather, holidays, or other seasonal factors
  • Industries affected include tourism, construction, and agriculture
• Technological unemployment is caused by technological change, where workers are replaced by machines or automated processes
• Underemployment refers to individuals who are employed but not in the desired capacity
  • Includes those working part-time but wanting full-time work or those overqualified for their current positions

Measuring Unemployment

• Unemployment rate is calculated by dividing the number of unemployed individuals by the total labor force and expressing the result as a percentage
  • Labor force includes all employed and unemployed individuals who are actively seeking work
  • $\text{Unemployment Rate} = \frac{\text{Number of Unemployed}}{\text{Total Labor Force}} \times 100$
• Discouraged workers are individuals who have stopped looking for work due to the belief that no jobs are available
  • Not included in the official unemployment rate
• Labor force participation rate is the percentage of the working-age population that is either employed or actively seeking employment
  • $\text{Labor Force Participation Rate} = \frac{\text{Labor Force}}{\text{Total Working-Age Population}} \times 100$
• U-6 unemployment rate is a broader measure that includes discouraged workers, marginally attached workers, and those employed part-time for economic reasons
• Employment-to-population ratio is the percentage of the working-age population that is employed
  • Provides insights into the economy's ability to create jobs

Inflation: Types and Causes

• Demand-pull inflation occurs when aggregate demand grows faster than aggregate supply
  • Caused by factors such as increased consumer spending, government spending, or exports
• Cost-push inflation happens when production costs increase, leading to higher prices for finished goods and services
  • Factors include rising wages, raw material prices, or taxes
• Built-in inflation is related to adaptive expectations, where workers and firms adjust their economic behavior to the expected inflation rate
  • Creates a self-perpetuating cycle
• Monetary inflation results from an increase in the money supply, leading to higher prices
  • Occurs when the central bank prints more money or lowers interest rates
• Imported inflation is caused by an increase in the prices of imported goods and services
  • Factors include exchange rate fluctuations or rising global commodity prices

Measuring Inflation

• Consumer Price Index (CPI) measures the average change in prices paid by urban consumers for a basket of goods and services
  • Basket includes items such as food, housing, transportation, and healthcare
  • CPI is the most widely used measure of inflation
• Producer Price Index (PPI) measures the average change in selling prices received by domestic producers for their output
  • Focuses on the prices of goods at the wholesale or producer level
• GDP deflator is a measure of the level of prices of all new, domestically produced, final goods and services in an economy
  • Calculated by dividing nominal GDP by real GDP and multiplying by 100
  • $\text{GDP Deflator} = \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100$
• Core inflation excludes the prices of volatile items such as food and energy to provide a more stable measure of underlying inflation trends
• Inflation rate is calculated as the percentage change in a price index over a given period
  • $\text{Inflation Rate} = \frac{\text{Price Index (Current Period) - Price Index (Previous Period)}}{\text{Price Index (Previous Period)}} \times 100$

Economic Impacts and Consequences

• Redistribution of wealth and income
  • Inflation benefits borrowers at the expense of lenders, as the real value of debt decreases
  • Unemployment disproportionately affects low-skilled and low-income workers
• Reduced purchasing power and standard of living
  • Inflation erodes the value of money, reducing consumers' ability to purchase goods and services
  • Unemployment leads to a loss of income and a lower standard of living
• Decreased consumer and business confidence
  • High inflation and unemployment create uncertainty, causing consumers and businesses to postpone spending and investment decisions
• Strain on government budgets and social programs
  • Unemployment increases the demand for government assistance programs
  • Inflation can lead to higher government expenditures and reduced tax revenues
• Reduced economic growth and productivity
  • Unemployment results in the underutilization of labor resources and lower output
  • High inflation can discourage investment and hinder long-term economic growth
• Social and political instability
  • Prolonged periods of high inflation and unemployment can lead to social unrest and political upheaval

Policy Responses and Interventions

• Monetary policy
  • Central banks can adjust interest rates to influence borrowing, spending, and investment
  • Contractionary policy (raising interest rates) is used to combat inflation
  • Expansionary policy (lowering interest rates) is used to stimulate economic growth and reduce unemployment
• Fiscal policy
  • Governments can use taxation and spending to influence aggregate demand
  • Expansionary fiscal policy (increased spending or reduced taxes) can stimulate economic growth and reduce unemployment
  • Contractionary fiscal policy (decreased spending or increased taxes) can help control inflation
• Supply-side policies
  • Aimed at increasing the productive capacity of the economy
  • Include measures such as tax incentives, deregulation, and investment in infrastructure and education
• Labor market policies
  • Designed to improve the functioning of the labor market and reduce unemployment
  • Include job training programs, employment subsidies, and reforms to unemployment benefits
• Price and wage controls
  • Government-mandated limits on price and wage increases to control inflation
  • Considered a last resort and can lead to market distortions and shortages

Real-World Examples and Case Studies

• The Great Depression (1929-1939)
  • Characterized by high unemployment, deflation, and reduced economic output
  • Caused by a combination of factors, including stock market crash, banking failures, and contractionary monetary policy
• The Great Inflation (1965-1982)
  • Period of high inflation in the United States, peaking at 14.8% in 1980
  • Caused by expansionary fiscal and monetary policies, oil price shocks, and the breakdown of the Bretton Woods system
• The Great Recession (2007-2009)
  • Global economic downturn characterized by high unemployment and financial market instability
  • Caused by the subprime mortgage crisis and the collapse of the housing bubble
• Hyperinflation in Zimbabwe (2007-2009)
  • Zimbabwe experienced one of the most severe cases of hyperinflation in history, with prices doubling every 24.7 hours at its peak in November 2008
  • Caused by government money printing to finance public sector salaries and spending
• European Sovereign Debt Crisis (2009-2018)
  • Several European countries (Greece, Portugal, Ireland, Spain, and Cyprus) experienced high government debt levels, leading to increased borrowing costs and economic instability
  • Caused by a combination of factors, including the global financial crisis, structural economic issues, and unsustainable government spending