Introduction to Economic Growth and Instability
chapter eight
INTRODUCTION TO ECONOMIC GROWTH AND INSTABILITY
CHAPTER OVERVIEW
This chapter previews economic growth, the business cycle, unemployment, and inflation. It sets the stage for the analytical presentation in later chapters.
Economic growth is defined and the arithmetic and sources of economic growth are examined. The record of growth in the U.S. is viewed from several perspectives including an international comparison in Global Perspective. The business cycle is introduced in historical perspective and is presented in stylized form (Figure 81). While hinting at various business cycle theories, the authors stress the general belief that changes in aggregate spending, especially durable goods and investment spending, are the immediate cause of economic instability. Noncyclical fluctuations are also treated briefly before the analysis of unemployment and inflation.
In the section on unemployment, the various types of unemployment—frictional, structural, and cyclical—are described. Then the problems involved in measuring unemployment and in defining the fullemployment unemployment rate are considered. The economic and noneconomic costs of unemployment are presented, and finally, Global Perspective 8-2 gives an international comparison of unemployment rates.
Inflation is accorded a rather detailed treatment from both a cause and an effect perspective. International comparisons of inflation rates in the post-1992 period are given in Global Perspective 8-3. Demandpull and costpush inflation are described. Considerable emphasis is placed on the fact that the redistributive effects of inflation will differ, depending on whether inflation is anticipated or unanticipated. The chapter ends with historical cases of extreme inflation to remind students that inflationary fears have some basis in fact.
WHAT’S NEW
A number of subtle but significant changes have been made from the previous edition. In addition to dates and data, terminology and theoretical presentation has been revised.
Material from Chapter 7 on real per capita GDP and the Consumer Price Index has been moved to this chapter. In the discussion of the GDP price index and CPI, the previous focus on “fixed” v. “variable” weighting has been dropped in favor of a focus on the different scope of the GDP price index and CPI market baskets.
The wording relating to the GDP gap has been revised to conform to contemporary usage. A positive GDP gap refers to a situation where actual GDP exceeds potential GDP. A negative GDP represents a shortfall in actual GDP relative to potential GDP.
A new “Consider This” box on clipping coins has been added. It provides a nice illustration of the connection between money and demand-pull inflation, and appeared in the previous edition website “Analogies, Anecdotes, and Insights” section.
The discussion of demand-pull inflation has been shortened, and the use of the three-range curve (essentially an aggregate supply curve) in the explanation has been dropped. The AD-AS curve will makes it first appearance in the text in Chapter 11.
End-of-chapter-questions have been added and revised.
The “Last Word” on the stock market and macroeconomic instability has been updated.
INSTRUCTIONAL OBJECTIVES
After completing this chapter, students should be able to
1. Define two measures of economic growth.
2. Explain why growth is a desirable goal.
3. Identify two main sources of growth.
4. Explain the “rule of 70.”
5. Give average long-term growth rates for the U.S. and qualifications of raw data.
6. Summarize Global Perspective 8-1.
7. Explain what is meant by a business cycle.
8. Describe the four phases of an idealized business cycle.
9. Identify two types of noncyclical fluctuations in business activity.
10. Describe how innovation and/or random events might cause business cycles.
11. Explain why business cycles affect capital and consumer durable goods industries more than non-durable goods and service industries.
12. Describe how the Bureau of Labor Statistics (BLS) measures unemployment.
13. Evaluate the strengths and limitations of BLS unemployment statistics.
14. State the causes of frictional, cyclical, and structural unemployment.
15. Identify full employment or the natural rate of unemployment.
16. Identify the economic costs of unemployment and the groups that bear unusually heavy unemployment burdens.
17. Define inflation and list two types of inflation.
18. List three groups who are hurt and two groups who may benefit from unanticipated inflation.
19. Present three possible effects of inflation on output and employment.
20. Compare U.S. inflation and unemployment rates to one or more industrialized nations.
21. Define and identify terms and concepts at the end of the chapter.
COMMENTS AND TEACHING SUGGESTIONS
1. Many students will benefit from the use of numeric examples (real or hypothetical). A good springboard into the discussion of unemployment is to provide students with a set of profiles of individuals, where information is given as to employment status and reasons for unemployment or lack of participation in the labor force.
2. Most students have a vague idea of what is meant by unemployment or inflation. Few have considered how these problems impact the economy or themselves. Having students collect prices (at the beginning and end of term) not only provides the opportunity to construct a price index and calculate inflation, it also puts them more in tune with market conditions.
3. It makes this chapter more relevant to have students find the latest data on these measures. See web-based questions at the end of the chapter or an Internet source such as www.dismal.com.
4. To help students better understand the types of unemployment, you may want to use the following “Concept Illustration” (that appeared in the previous edition’s “Analogies, Anecdotes, and Insights.”)
Concept Illustration … Types of Unemployment
Imagine a fictitious country named Miniature that has a stable population of 120 people, of which 100 are in the labor force. Of these 100 people, 95 are employed and 5 are unemployed. That means Miniature’s unemployment rate is 5 percent (= 5/100).
Suppose we could take a group photo of the unemployed workers each month so as to obtain a continuing record of their monthly numbers and reveal whom they are. By comparing the monthly photos over long periods, we could sort out the types of unemployment occurring in Miniature.
Suppose that in a typical month there are 5 people in the photo. Also, suppose that 4 of these people are never the same individuals who were in the photo the previous month and the other person never shows up in the photo for more than two or three consecutive months.
We can reasonably conclude that Miniature is experiencing frictional unemployment and structural unemployment. The frictionally unemployed workers are quickly finding jobs, and after retraining or relocation, the structurally unemployed workers are obtaining new jobs within a few months. Taking the places of these formerly unemployed persons are newly unemployed people who are looking for new jobs, waiting for future jobs, retraining, or relocating. Five percent of the labor force is unemployed each month, but nobody is unemployed for any substantial length of time. Miniature is not suffering an “unemployment problem.”
In contrast, suppose that over a six-month period we observe that the number of people in the unemployment photo increases from 5 to 10, with no change in the size of the labor force. Thereafter, the 10 percent unemployment rate continues for a full year. A comparison of the monthly photos reveals that it is mainly the same people who are employed month after month.
We can reasonably conclude that Miniature is now experiencing cyclical unemployment. Total spending must have declined, reducing production and employment. The increase in the unemployment rate from 5 percent to 10 percent has accompanied this recession. Miniature now has a serious “unemployment problem.” Cyclical unemployment is involuntary, relatively long lasting, and creates serious financial hardship for those people unemployed. It also results in an irretrievable loss of output to society.
5. Table 83 can be used to discuss the definition of unemployment and its limitations. Current data to update the table can be found in the Monthly Labor Review, Employment and Earnings, Economic Indicators, or see Web-based question 16. Make it clear that a portion of each unemployment statistic is due to frictional and structural unemployment, which are found even in a “full employment” economy. Frictional unemployment indicates a healthy economy with labor mobility. Structural unemployment is viewed as serious, but not responsive to economic policies alone.
6. Have students consider the losses from unemployment. Perhaps they could write a feature article on losses due to GDP gap, higher inflation, or the social and personal losses incurred by those unemployed.
7. Try web-based question 17 for current inflation data. While we have been concerned with inflation since World War II, it is interesting to note that past (and now current) economists have been as concerned about deflation. A good topic is to ask students how deflation can be a problem, as it is in Japan and threatens to be in the U.S.
8. For a deeper understanding of the costs of inflation, you may wish to share the following “Concept Illustration” with your students:
Concept Illustration … Costs of Inflation
On page 147 examples of the costs of inflation are given. The following metaphors may help you distinguish and remember the three examples listed.
Menu costs Inflation requires firms to change the prices they charge from one period to another. This new pricing of products and the communication of the new prices to customers requires time and effort that could otherwise be used for more productive purposes. These inflation costs are sometimes called menu costs, because they are similar to the costs incurred by restaurants that need to print new menus when prices rise. Menu costs include all costs associated with the inflation-caused need to change prices.
Yardstick costs Inflation interferes with money functioning as a measure of value and thus requires more time and effort to determine what something is worth (in real terms). Dollar price tags lose some of their meaning when inflation occurs, because the dollar’s value has declined relative to before. It is as if a yardstick that formerly measured 36 inches now measures 34, 33, or even fewer inches. All inflation-caused costs associated with determining real versus nominal values can be thought of as yardstick costs.
Shoe-leather costs We have noted that people try to protect their financial assets against erosion from inflation by limiting the amounts of money they hold in their billfolds and in their non-interest-bearing checking accounts, putting those funds instead into interest-bearing saving accounts or stock and bond funds. But people actually need more money to buy the higher priced goods and services. So, they figuratively walk to and from financial institutions much more often in order to move money from these latter accounts to checking accounts or to get cash when it is needed. In the process they wear out their shoes—they incur so-called shoe-leather costs. These costs include all time and resource costs associated with the inflation-induced need to make more financial transactions.
9. The Wall Street Journal is a good source of information on the most current economic situation. They have a “NewspaperinEducation” program that provides various teaching aids, in addition to favorable subscription rates for students. Call 1-800-JOURNAL contact their website for more information. Among their aids is a stylized Wall Street Journal Education edition, which gives information on dates on which important economic statistics are announced each month or each quarter. Your local newspaper and periodicals may have similar education programs. The Economist includes up-to-date macroeconomic information and presents stories of U.S. macroeconomic policies and conditions that are detailed but accessible.
10. Unemployment and inflation have a human face. A dramatic reading of quotes from a book such as Studs Terkel’s Hard Times can be used to bring statistics to life. You or your students may be acquainted with individuals who lived through the depression years or who have suffered from periods of unemployment. Inviting them to discuss the impact of these experiences also helps to make this material more interesting for students.
STUDENT STUMBLING BLOCKS
1. This chapter includes lots of descriptive detail. Help your students sort out the forest from the trees—be clear about what you expect them to know from this chapter.
2. Struggling students often have difficulty because they lack very basic math skills. Sometimes, they simply have not used fractions, percentages or decimals lately. Do not take it for granted that college students will be prepared for the simple calculations in this chapter. One skill that is frequently missing is the ability to make reasonable estimates of a correct answer (a ball park guess) without actually crunching the numbers. Give students practice with simple questions first – for example, GDP loss when the unemployment rate is 1% above the natural rate (applying Okun’s Law). Then demonstrate the gap for every 1% beyond that.
3. Students often confuse being “unemployed” with being “not in the labor force.” You may need to stress to some that just because one of their parents is “not employed” (e.g. a homemaker) doesn’t mean they don’t work hard – simply that they don’t work in the paid labor force. Some students will be bothered that those in the underground economy are counted as “not in the labor force” or, in some cases, “unemployed.” Emphasize that the classification is based on the BLS survey and may not accurately represent their true status (such as we do in the discussion of discouraged workers). Keep students from reaching the conclusion that the underground economy is excluded because it produces economic “bads”. It also produces “goods,” just as the measured economy produces “bads.”
4. In anticipation of future chapters, the sections on demand-pull and cost-push inflation will be helpful. Emphasize the analysis of Figure 8-5. It also helps to reinforce Chapter 7’s distinction between nominal and real GDP.
5. Students are often confused between terms like “deflation” (falling prices) and “disinflation” (a falling rate of inflation). There may be similar confusion between “rising prices” and a “rising inflation.” As you look ahead to the policy chapters, you need to decide whether it is better now or later to define disinflation and distinguish between it and deflation, especially given that one is feared and the other is often considered desirable.