Lectures in Economics 9

Lectures following Rüdiger Dornbusch’ works (9)
Growth, unemployment, inflation
(Introduction to macroeconomics continued)

The unemployment rate is one of the chief indicators of how well the economy is doing. When the unemployment is high and rising, the economy is performing poorly; human resources, instead of being used productively, are wasted.

The labor force consists of people who are either
working or unemployed. The criterion for being counted as unemployed is that a person was available for work in the currentweek, did not actually work, and had made an effort in the preceding 4 weeks to find a job. Also included are people who are not working but are waiting to be called back to their jobs or are waiting to report to a new job the next month.

Table 4-7 shows the unemployment rates for different groups in 1980 and 1981 (omitted). Note the large differences. Unemployment tends to be much higher among nonwhite people and young people. Note the fact that unemployment increased in every group. We shall link inflation, and unemployment to low growth and recession in the following.

Inflation and growth

FIGURE 4-7 RECESSIONS AND INFLATION,1967-1981. The diagram shows the rate of CPI inflation in the United States (omitted). The shaded areas correspond to periods of recession. The evidence is that recessions slow inflation but do not stop it for good. (Source: See Figure 4-4.)
In a recession firms have trouble selling goods. They therefore pro duce less, and growth slows. At the same time, unemployment rises as firms need less labor and because firms are having trouble selling. Their prices rise less rapidly or even fall. In brief, the argument is that recession, low growth, high unemployment, and slower inflation go together. In contrast, when households want to increase their purchases, firms try to produce more goods and hire more labor. Growth increases, and unemployment falls. At the same time, because the demand for their goods has risen,firms raise prices more. Thus we expect a boom, high growth,low unemployment, and more rapid inflation to go together.

Some of these relationships can be seen in the data. Figure 4-7 (omitted) shows the rate of in flation again, except this time we have shaded in periods of recession, or falling output. We observe that when the economy is in a recession and shortly thereafter, inflation falls. Thus both in 1975 and again in 1980 recessions slowed inflation.
Some economists believe that there are no very good reasons for people to worry much about inflation and that therefore society should not do so either. Others argue that there are reasons, including increased uncertainty, why people get upset about inflation. We shall review the arguments later.But it is clear that whether or not there are good reasons, people regard inflation as a
serious problem.

Unemployment and growth

A second strong relationship exists between unemployment and growth. When  the economy grows rapidly, unemployment rates fall. When the economy grows very  slowly or even moves into recession, unemployment rates increase. This means that several years of successive high growth bring unemployment rates to very low levels as more and more people find jobs while production is increasing. In contrast, when real GNP is not growing much or is even falling, firms increase their employment of labor slowly, and unemployment rates increase. The high unemployment rates in 1982 are a reflection of the very low  growth rates of real GNP.

(Average Annual Percentage Rate)
Inflation :
1960-1973 3.2 5.1 3.3 6.1
1973-1981 9.4 15.4 4.9 9.0
1960-1973 5.0 2.9 0.8 1.3
1974-1981 6.9 6.3 3.2 1.2
Growth rate of real GNP:
1960-1973 4.2 3.2 4.8 10.5
1973-1981 2.4 0.5 2.0 4.0

Source: Economic Report of the President, 1982, pp. 355-357.
(by Dornbusch, 1982)
l Macroeconomics is the study of the operation of the whole. The major macroeconomic issues are inflation, unemployment and growth and whether there is anything the governments can do about them.
2 Macroeconomics is distinguished from microeconomics by
the interactions between the decisions made by firms and households
as summarized in Figure 4-1. Households supply the factors of production to firms, which use them to produce goods and services. In return for the services of the factors of production firms pay incomes to households, which are used by the households to buy the goods and services produced by the firms.
3 A reduction in purchases of goods by households can reduce employment of labor, reducing households’ incomes, thereby reducing spending on goods and services. An important question to be studied is what mechanisms exist to prevent these from developing into major problems.
4 Growth is an increase in the production of goods and services. Growth may occur either when unemployed resources are put to work so that the economy moves from inside the PPF to it when the PPF itself shifts out. The PPF may shift either by using more factors of production or because existing factors come more productive.
5 The inflation rate is the rate at which prices of goods and services are rising. In the United States the inflation rate started out around 1 percent in the sixties and have been above 13 percent since then. By international standards American inflation has been low. Prices may also fall sometimes, in that case there is deflation.
6 A country that has faster growth than another country will eventually have a larger real GNP, however far behind it was earlier.
7 Unemployment in the U.S. economy has risen on from the late seventies. In 1982 it stood at the highest level in the post II WW period. Unemployment rates differ sharply among different countries. Youths and blacks have particularly high unemployment rates.