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					           Day Three:
Workshop on Economic
      Towson University and the
  Maryland Council on Economic

Government tries to limit swings of Business Cycle to
   balance goals:

  1.   price stability  inflation
  2.   jobs  unemployment
  3.   output  GDP
The Labor Force

   The labor force includes all persons over age sixteen who
    are either working for pay or actively seeking paid

   People who are not employed or are not actively seeking
    work are not considered part of the labor force.

                    LF        employed  unemployed
          LFPR             
                 population         population
The Labor Force, 2000

                         Total population (275,372,000)

  Out of the labor force (133,086,000)      In civilian labor force (142,286,000)

  Under age 16
   (62,541,000)                             Civilians employed(135,208,000)
     Homemakers                              Unemploye
      (20,343,000)                           d(5,655,000       Armed forces
                                                  )             (1,423,000)
 In school (9,130,000)
       Retired (29,813,000)
            Sick and disabled
 (7,142,000) Institutionalized
(3,628,000) Other (489,000)
The Unemployment Rate

   U.S. Census Bureau surveys about 60,000
    households a month to determine how many
    people are actually unemployed.

   The unemployment rate is the proportion of the
    labor force that is unemployed:

                          number of unemployed people
    Unemployment rate =
                                  labor force
Who Are the Unemployed? (2000)
40 Unemployment rates vary . . .
         . . . by race, sex, age                                 . . . by education
       Adult Males         Adult Females          Teenagers
28                                                      24.7
20                                                             16.7
             5.9                                                            6.4
 8                                 5.4     5.3
                     3.7    3.5                                       4.0         3.5
       3.2                                                                              2.7
 4                                                                                            1.8   1.6   0.9

Duration of Unemployment:

       Duration       Percent of Unemployed
  Less than 5 weeks           45.0
  5 to 14 weeks               31.8
  15 to 26 weeks              11.8
  27 to 51 weeks               5.4
  52 weeks or more             6.0
Reasons for Unemployment

           New       leavers
         entrants      14%

                               Job losers
        Reentrants                44%
Types of Unemployment
1.   Seasonal – due to seasonal changes in labor

2.   Frictional – movement between jobs or into the
     labor market.

3.   Structural – due to mismatch between worker
     skills and job demands.

4.   Cyclical – due to lack of job opportunities (labor
     demand < supply), depressions, recessions,…
More issues of employment
   Underemployed – working in position below
    qualifications or PT when want FT. Not
    counted as UE.

   Discouraged Worker – not in LF, so not
    counted as UE.
   Inflation – increase in average level of prices,
    not specific changes.
   Causes:
       Demand pull inflation – increase in D.
       Cost push inflation – low UE increases wages 
        increases prices.

   Deflation – decrease in average level of
Price Changes in 2000

   Prices That Rose                       Prices That Fell
       (percent)                             (percent)
Gasoline                  +28.5      Coffee              –0.5
Lettuce                    +9.5      Video rentals       –1.5
Airfares                   +9.4      Women’s dresses     –6.9
Textbooks                  +7.0      Oranges            –14.7
Cable TV                   +4.8      Computers          –23.2
College tuition            +4.1
                  Average inflation rate: +3.4%
Measuring Inflation – the CPI

   Consumer Price Index (CPI):
       Market basket of 184 consumer
       Compares same prices over time

                        (CPI t - CPI t -1 )
            Inflation 
                           CPI t 1
The Market Basket

                            32.6%                 Food

 Insurance and pensions 9.3%                         Clothing 4.7%
                                              Miscellaneous 10.5%
                     Entertainment 5.1%
                                 Health care 5.3%
Value of what we produce
   Real Gross Domestic Product (GDP) ~ $11.57t in 2007 and $11.56t in

   Computed as the sum of the price of each good/service times the quantity sold:
        GDP = Σ(Price)(Quantity)

   Most common way to measure is expenditure method - total consumption
    by four major groups in economy:
          GDP = C + I + G + NX
       Consumption (C) - includes personal expenditures of households (food, rent,
        education, medical expenses). Does NOT include new housing.

       Investment (I) – investment by businesses (construction of new factory,
        equipment) or households (new housing). Does NOT include purchases of
        financial products.

       Government Services (G) – government expenditures on final goods/services
        (salaries, toilet paper, military purchases). Does NOT include transfer payments
        (social security, UE benefits).
       Net Exports (NX = Exports – Imports)
   WHAT America Produces
                                GDP = C + I + G + NX
 Net exports -5.2%

                             Consumer Goods
               15.7%              70.3%

Government       State and
 Purchases         local
   19.2%            12.3%
    Business Cycle

Business cycles are alternating periods of
  economic growth and contraction.
 Recurrent shifts of aggregate demand/supply
  cause a business cycle.

   Recession – prolonged contraction (6-18 months)
   Depression – severe and long recession.
   Stagflation – decline in GDP with increase PL
Phases of the Business Cycle
   Recession. A decline in the real GDP that occurs for at least two or
    more quarters. Businesses spend less by reducing employment, buying
    less merchandise, and postponing investment. Workers earn and
    spend less…

   Low Point, or Depression. State of the economy where there are large
    unemployment rates, a decline in annual income, and overproduction.
    The time at which the real GDP stops its decline and starts expanding;
    the lowest point.

   Expansion and Recovery. A period in which the real GDP grows;
    recovery from a recession.

   Peak. The point at which the real GDP stops increasing and begins its
    decline; the highest point. Employment, consumer spending, and
    production hit their highest levels. One of the dangers of peak periods is
    that of inflation.
The Business Cycle
U.S. Business Cycle

 20                                                                           20
 15                                                                           15
 10                                                                           10
  5                                                                           5
  3                                                                           3
  0                                                                           0
–5                                                                            –5
–10                                                                           –10
 15                                                                           –15

      1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
    Views of the Business Cycle
   The Classical Theorists: Adam Smith

       BC inevitable and govt. intervention futile.

       Market best able to deal with BC, it self-adjusts with
        flexible prices and wages.

       Say’s Law – supply creates its own demand –
        unsold goods and unemployment cannot exist in
        LR because prices and wages adjust demand.
Views of the Business Cycle
    Classical theory rocked by economy’s inability to “self-
      adjust” to events of Great Depression.

   John Maynard Keynes
       Market driven economy is inherently unstable.
       Market magnifies disturbances – govt. intervention
        necessary to prevent swings.
       Control economy with changes in taxes, money supply,
        and government spending.
   Classical economists believed flexible interest rates
    and prices equalize injections and leakages and
    lead to full employment.

   Keynes disagreed with classical economists
    concerning the role of flexible interest rates in
    reaching full employment.
       Keynes argued that investment would fall in response to
        declining sales.
Aggregate Demand

   AD represents total output level desired for every price level (includes
    consumers, government, businesses, foreign sector)
       Total output = GDP
       Prices of average good/service = Price Level

   As price levels increase, what happens to the quantity of goods/services
    consumers desire?
       Increases in PL  decreases quantity demanded of total output. Why?
           Real balances effect – lower PL increases purchasing power (Q).
           Foreign trade effect – lower domestic PL makes people substitute domestic for
            imported (X, M).
           Interest rate effect – lower PL consumers borrow less  demand for loans
            falls  interest rates drop and increase in spending/output.

   Graphing AD
Changes in AD
   Increase in AD – consumers want more of
    goods/services at every price level.
   Decrease in AD – consumers want less of
    good/services at every price level.

   What shifts AD:
       Change in preferences, spending behavior, investment
       Government policies (G, taxes, Ms)
       Population changes, war, trade.
Graphing Shifts of AD Curve

   Increase in AD  higher
    Q at every PL (AD1 

   Decrease in AD  lower
    Q at every PL (AD1 
    AD3).                                 AD2

Aggregate Supply
   AS represents total output producers will supply at various price
       Total output = GDP
       Prices of average good/service = Price Level

   As price levels increase, what happens to the quantity of
    goods/services firms will produce?
       Increases in PL  firms will want to produce larger quantities of
        goods/services so higher total output. Why?
           Profit effect – decrease in PL decreases profits, discouraging production.
           Cost effect – costs inherently rise with output (DRS), reflected in higher

   Graphing AS
Changes in AS
   Increase in AS – producers want to produce a larger
    quantity of goods/services at every price level.
   Decrease in AS – producers want to produce a
    smaller quantity of good/services at every price

   AS represents production decisions anything that
    changes the costs of production with shift the curve:
       Resource costs due to regulation or scarcity.
       Technology / innovation.
       Government policies ( business taxes, regulations of
    Graphing Shifts of AS Curve

   Increase costs  AS               AS2
    shifts left higher PL for           AS1
    every Q (AS1  AS2).                  AS3

   Decrease costs  AS
    shifts right  lower PL
    for every Q (AS1  AS3).

Macroeconomy (ASAD)
   Put together AS and AD to model
   Show how changes in AS or AD impact the
    domestic market – prices and output
       Increase in foreign desires for US goods/services
       dlf
Macro Equilibrium

                                      Aggregate              Aggregate
                                       demand                 supply
   PRICE LEVEL (average price)



Macro Failures

   There are two potential problems with macro
       Undesirability - the price-output relationship at equilibrium
        may not satisfy our macroeconomic goals.
       Instability – even if the designated macro equilibrium is
        optimal, it may be displaced by macro disturbances such
         Internal market forces – population growth, spending
          behavior, innovation.
           External market forces – wars, natural disasters, trade
           Policy levers – tax policy, government spending,
            money supply, credit regulations.
An Undesired Equilibrium

                                      Aggregate                    Aggregate
                                       demand                       supply
   PRICE LEVEL (average price)



                                            output                Full employment

                                                        QE   QF
An Undesired Equilibrium

                                         Aggregate                     Aggregate
                                          demand                        supply
   PRICE LEVEL (average price)

                                 PE   Desired
                                      price level


                                                             QE   QF
Fiscal Policy
   Fiscal policy is the use of government taxes
    and spending to keep the economy stable.

   The federal government can alter aggregate
    demand by:
       Purchasing more or fewer goods and services.
       Raising or lowering taxes.
Expansionary Fiscal Policy
    Designed to increase
     output/growth when economy in
     downswing or recession.
        Increase government spending
        Decrease taxes (workers and

    Multiplier effects:
        increases AD, causing increase P,
         encourages production, higher
Contractionary Fiscal Policies
     Designed to decrease GDP,
      slow down the economy when
      it is overheating (reduce
      inflationary pressures).
         Decrease government spending
         Increase taxes

     Multiplier effects in reverse:
         Reduces profits or incomes,
          decreases AD, decreases P and
          GDP, reduce production and
Problems with Fiscal Policy
    Government spending can “crowd
     out” private business investment.
    Discretionary spending ~25% of
    Political pressures
    Timing and delayed results… fiscal
     policy is hampered because it takes
     time to recognize that a problem
     exists and then formulate policy to
     address the problem.
    Balancing budget
Accumulating Debt
    How can government spend more than
     tax revenues?
        Borrow from Treasury by issuing bonds to private
         sector or banking system to be repaid at maturation
         with a specified interest rate.

    National Debt = sum of annual deficits.
        Prior to 1998, the most recent budget surplus
         occurred in 1969.
        Between 1982 and 1996, the deficit got as
         high as $290 billion (1992) and never got
         below $100 billion.
A String of Deficits
   String of Surpluses
                    1997     1998       1999   2000   2001

 Revenues           1579     1722       1827   2026   1990

 Outlays            1601     1653       1703   1789   1863

 Surplus            (22)       69       124    237    127

*All measured in billions of dollars.
The Debt
         Current National Debt ~ $11.29 trillion
          dollars on May 20, 2009.
         The estimated population is almost 306
          million so each citizen's share of this debt
          is $36,881.56.
         The debt has increased $3.81 billion per
          day since September 29, 2006!
         In 2003 the U. S. Government spent $318
          Billion on interest payments to the
          holders of the National Debt.

Values from: http://www.brillig.com/debt_clock/
      Ownership of Debt - 2003
                                            Public Sector
                               agencies    Social
Federal Reserve 9%               17%       Security 13%

                                                          State and local
                                                          governments 8%

                  Foreigners                  Individuals
                     20%              Banks,          6%
     Foreigners                    companies,
                                      etc, 8%           Private Sector
Taken from The Skeptical Optimist
Why Care about the Debt?

         Crowding out - Change mix of outputs – debt
          squeezes available resources for private
          sector – controls mix of output.

         Debt Service – Interest payments on debt.
      •      Refinancing – borrowing new funds to pay off
             debt that comes due (bonds maturing). Should
             we even worry – will final debt ever become

         Opportunity Costs – What could have been
          financed by debt or debt service?
Crowding Out
 Public-sector output (quantity per year)

                                            g2                                        b
                                                   Increase in
                                                   government spending . . .
                                            g1                                                 a
                                                 Crowds out private spending

                                                                                 h2       h1
                                                      Private-sector output (quantity per year)

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