Download Macroeconomics notes for 2nd sem and more Cheat Sheet Macroeconomics in PDF only on Docsity!
Chapter 28- Unemployment Introduction: ➢ Labor earnings to maintain a standard of living ➢ Personal accomplishment from working ➢ Politician campaigns talk about this policy to get people to vote for them ➢ Save and invest enjoy more rapid growth ➢ People that do not work, they do not contribute to production of goods and services ➢ Thousands of firms and millions of workers that quantity of unemployment is normal to exist ➢ However, we need to keep more people working ➢ Split in short and long run ➢ Natural rate of unemployment, amount of unemployment that the economy normally experiences ➢ Cyclical unemployment, year to year fluctuations in unemployment around its natural rate. Associated with short run ➢ It is not desirable, just it is normal even in long run ➢ Unemployment is not desirable, just it is normal even in the long run How is unemployment measured? ➢ Job of BLS (Bureau of labor statistics). Department of labor ➢ Every month: types of employment, length of the average workweek, duration of unemployment. ➢ Survey about 60000 households. Current population survey. ➢ Based on answers, BLS places each adult (16 and older) in three: i) Employed: paid employees or unpaid employees. Full time and part time are counted. People on vacation, illness, or bad weather. ii) Unemployed: People available to work, tried to find job in last four weeks. iii) Not in the labor force: Full time students, homemakers, and retirees ➢ Labor force= Number of employed + Number of unemployed ➢ Unemployment rate= (Number of employed ÷ Labor force) × 100 ➢
➢ Labor force participation rate= (Labor force ÷ Adult population) × 100 ➢ So, in this diagram, i) Labor force = 150.5 + 7.8 = 158.3 (ANS) ii) Unemployment = (7.8 ÷ 158.3) × 100 = 4.9% iii) Labor force participation rate = (158.3 ÷ 252 .4) × 100 = 62.7% Job Finding and Job Separation: The natural rate of unemployment is determined by looking at the rate people of finding jobs compared with the rate of job separation in any given. People are either employed or unemployed as a result the sum of structural and frictional unemployment is referred to as the natural rate of unemployment also called “full employment” unemployment rate. This is the average level of unemployment that is expected to prevail in the economy and in the absence of cyclical unemployment. Labour force = Employed + Unemployed Job separation rate: E = Employed U = Unemployed F = Job Finding Rate (This represents the fraction of unemployed people who can find a job each month) S = Job Separation Rate (This represents the fraction of employed workers who lose their job each month) Job separation rate: F × U = S × E This equation demonstrates that the unemployment rate (U/L) is positively related to the job separation rate and negatively related to the job finding rate. Therefore, a higher (S) will lead to a higher unemployment rate while a larger (F) yields a lower natural rate of unemployment. In conclusion, to reduce the natural rate of unemployment, (S) must be reduced, or (F) must be increased. Does the unemployment rate measure what we want it to? ➢ It is easy to distinguish a full time and a person who is not working ➢ Difficult between an unemployed (looking for a job but not finding) and a person who is not in the labor force (a person who is not looking for job) ➢ Movements in labor force i) Young workers are looking for a job ii) Older workers that start to look for a job again ➢ Some people declare as unemployed, but they are not looking actively for job incentives for government programs. ➢ Some individuals who would like to work but have given up looking for a job. Such individuals, called discouraged workers, do not show up in unemployment statistics, even though they are truly workers without jobs.
➢ Structural unemployment: Quantity of labor supplied exceed the quantity demanded. It is often thought to explain longer spells of unemployment. i. When wage is above equilibrium, not enough jobs ii. Due to minimum wages, labour unions, efficiency wages ➢ So, the essence of frictional unemployment is that there are jobs out there, it just takes time and effort for workers to find them. The essence of structural unemployment is that there are just not enough jobs out there for everyone who wants one. ➢ Wage above market natural equilibrium: minimum wage law, unions, and efficiency wages. Why some frictional unemployment is inevitable? ➢ One reason economies always experience some unemployment is job search. Job search is the process of matching workers with appropriate jobs. ➢ All workers have different characteristics. It takes time to match. ➢ Examples: i) Oil prices falls. Oil companies hire employees. ii) Automobile companies hire employees when there is an increase in demand for cars. This is called Sectorial shifts : are changes in the composition of demand across industries or regions of the country. Job search (Why some frictional unemployment is inevitable?) Job search is the process by which workers find appropriate jobs given their tastes and skills. The process of job search can explain why there is always some frictional unemployment: ➢ Suppose that in the market for laptop computers and PCs, Dell takes market share away from Hewlett Packard. HP lays off workers; Dell hires new ones. In the interim there is a period of unemployment in the industry. ➢ Similarly, if the price of oil rises, energy exploration companies hire more workers, while auto manufacturers and airlines lay off workers. Because of these sectoral shifts, unemployment arises. A certain amount of frictional unemployment is inevitable, simply because the economy is always changing. A century ago, the four industries with the largest employment in the US were cotton goods, woolen goods, men’s clothing, and lumber. Today the largest industries by employment are autos, aircraft, communications, and electrical components. The overall US economy has grown enormously, but along the way some industries have declined or even disappeared altogether, causing workers to have to find new jobs. However, government training and re-training programs can help reduce the amount of frictional unemployment. Through unemployment insurance programs, the government partially protects workers’ incomes when they become unemployed. Just like automobile and homeowner’s insurance, unemployment insurance makes risk averse workers better off. But it can also lead to higher levels of frictional unemployment, by making it possible for unemployed workers to search longer for the right job.
Public policy and Job search: ➢ Even if some frictional unemployment is inevitable, the precise amount is not. ➢ If people get to know about the job openings and worker availability, the more rapidly the economy can match workers and firms. E.g., Through Internet. ➢ This may help facilitate Job search and reduce frictional unemployment. ➢ Public policies can help reduce the time it takes unemployed workers to find new jobs. i) Government programs try to facilitate job search in various ways. Government- run employment agencies helps give out information about job vacancies. ii) Public training programs, helps aim ease workers transition from declining industries and help disadvantaged groups escape poverty. ➢ Supporters of these programs believe that they make the economy operate more efficiently by keeping the labor force more fully employed and that help reduce the inequities inherent in a constantly changing market economy. ➢ Critics argue that it is better to let the private market match workers and jobs. In fact, most job search in our economy takes place without intervention by the government. E.g., Job sites, newspaper articles, headhunters etc. ➢ Conclusion: Much worker education is done privately, either through schools or through on the job training, these critics believe that the government is no better and is most likely worse at disseminating the right information to the right workers and deciding what kinds of worker training would be the most valuable. They claim that these decisions are best made privately by employers. Unemployment insurance: a government program that partially protects workers’ incomes when they become unemployed. Minimum wage laws: This type of unemployment is structural as opposed to frictional, in that there are workers who want to work at the minimum wage, but who will not be able to find those jobs even after extensive search.
But whereas the “above equilibrium” wage resulting from minimum wage laws comes from government actions, and the above market equilibrium resulting from unions comes from workers’ collective action, efficiency wage theory stresses that employers themselves might want to pay their workers above equilibrium wages to raise worker productivity. Why might an employer voluntarily want to pay above equilibrium wages? Why might higher wages raise worker productivity? ➢ Worker Health: Better‐paid workers will be healthier and therefore more productive. This factor is probably not relevant in the United States, but certainly could be in developing countries. ➢ Worker Turnover: It is costly for the firm to hire and train new workers; hence it is in a firm’s interest to try to retain its existing workers. It can do this by paying them wages that are higher than they can get elsewhere. ➢ Worker Quality: Suppose that a firm wants to fill an open job and advertises a lower wage. Since the only people who will apply are those who cannot earn a higher wage elsewhere, it runs the risk of having to hire someone with less experience or lower skills. Conversely, by offering a higher wage, the firm can attract even the very best applicants. ➢ Worker Effort: If a firm’s workers are happy because they feel that they are well treated, they will be willing to work harder. Also, if they know that they will not be able to find as good a job elsewhere, they will work harder to keep their existing job. In 1914, Henry Ford offered his workers $5 per day, about twice what they could get at other jobs. Worker turnover and absenteeism fell. Ford called the decision to raise wages “one of the finest cost cutting moves we ever made.” Trends in Unemployment: ➢ Demographics : The composition of the labour force (Age differences) ➢ Sectorial shifts : The greater the amount of reallocation among regions and industries, the greater the amount of job separation and the higher level of frictional employment. ➢ Productivity
Chapter 33- Aggregate Demand and Supply Introduction: ➢ Typically increases in the labour force increases in the capital stock and advances in technological knowledge allow the economy to produce more and more overtime ➢ But in some years, this normal growth does not occur. These periods of declining incomes and rising unemployment are called recessions when they are relatively minor, and depression when they are more severe. Three Key Facts about Economic Fluctuations : ➢ Fact 1: Economic Fluctuations are Irregular and Unpredictable: fluctuations in economic activity are often called the business cycle (Recession, depression). But this term is somewhat misleading since these fluctuations do not follow a regular and predictable pattern. ➢ Fact 2: Most Macroeconomic Quantities Fluctuate Together: Although real GDP is the variable that is most commonly used to monitor the economy, other variables also fluctuate along with GDP: corporate profits, investment, consumption, retail sales, home sales, etc. But some variables fluctuate more than others. Figure (b) shows that investment spending tends to fluctuate widely. Even though investment averages only about one--seventh of GDP, its fluctuations account for about two-thirds of the decline in GDP that takes place during recessions. ➢ Fact 3: As Output Falls, Unemployment Rises: Figure (c) shows that the unemployment rate rises considerably during recessions.
This model focuses on the behaviour of two variables: a) The economy’s quantity of output, which can be measured by real GDP. b) The economy’s price level, which can be measured by the CPI or the GDP deflator Since the first of these two variables is a real variable and the second a nominal variable, the model departs from the classical assumptions that allow these variables to be considered separately. Figure 2 illustrates the model. a) The downward-sloping aggregate demand curve shows the quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level. b) The upward-sloping aggregate supply curve shows the quantity of goods and services that firms choose to produce at each price level. The Aggregate Demand Curve: In figure 2 and in 3, the aggregate curve slopes down, indicating that as the price level falls, the quantity of goods and services demand rises. Why the Aggregate Demand Curve Slopes Downward?
Economy’s GDP can be decomposed into four components: Consumption (C), Investment (I), Government purchases (G), and net exports (NX) Y = C + I + G + NX Let us take (G) as being fixed by government policy, independent of the price level. Why might the demand for consumption, investment, and net exports fall as the price level rises? ➢ The price level and consumption (The wealth effect): the nominal value of money is fixed, but the real value is dependent upon the price level. This is because for a given amount of money, a lower price level provides more purchasing power per unit of currency. When the price level falls, consumers are wealthier, a condition which induces more consumer spending. Thus, a drop in the price level induces consumers to spend more, thereby increasing the aggregate demand. ➢ The price level and investments (The interest rate effect): the quantity of money demanded is dependent upon the price level. That is, a high price level means that it takes a relatively large amount of currency to make purchases. Thus, consumers demand large quantities of currency when the price level is high. When the price level is low, consumers demand a relatively small amount of currency because it takes a relatively small amount of currency to make purchases. Thus, consumers keep larger amounts of currency in the bank. As the amount of currency in banks increases, the supply of loans increases. As the supply of loans increases, the cost of loans that is, the interest rate decreases. Thus, a low-price level induces consumers to save, which in turn drives down the interest rate. A low interest rate increases the demand for investment as the cost of investment falls with the interest rate. Thus, a drop in the price level decreases the interest rate, which increases the demand for investment and thereby increases aggregate demand. ➢ The price level and net exports (The exchange rate effect): as the price level falls the interest rate also tends to fall. When the domestic interest rate is low relative to interest rates available in foreign countries, domestic investors tend to invest in foreign countries where return on investments is higher. As domestic currency flows to foreign countries, the real exchange rate decreases because the international supply of dollars increases. A decrease in the real exchange rate has the effect of increasing net exports because domestic goods and services are relatively cheaper. Finally, an increase in net exports increases aggregate demand, as net exports is a component of aggregate demand. Thus, as the price level drops, interest rates fall, domestic investment in foreign countries increases, the real exchange rate depreciates, net exports increase, and aggregate demand increases.
Why the Aggregate Supply Curve is Vertical in the Long Run? In the long run, an economy’s production of goods and services depends on its supplies of capital, labor, and natural resources as well as its stock of technological knowledge. The long-run neutrality of money implies that if two countries are identical except that one has a money supply that is twice as large, then the price level in that economy will be twice as large too, but the output of goods and services will be the same. The way of depicting the classical dichotomy and the neutrality of money in the aggregate demand aggregate supply model is to draw the aggregate supply curve as vertical in the long run, as shown in figure
Why the Long-Run Aggregate Supply Curve Might Shift? The position of the vertical long-run aggregate supply curve is often called potential output , full employment output , or the natural rate of output. The last term captures the idea that this is the level of output that results when the unemployment rate is at its natural rate, or normal level. And just as the unemployment rate tends to gravitate towards its natural rate over time, so too will the level of output tend to gravitate towards its natural rate. What causes the aggregate supply curve to shift? ➢ Changes in the supply of labor, due to immigration. ➢ Changes in natural rate of unemployment, due to changes in minimum wages, changes in unionization, etc. ➢ Changes in the stock of capital, physical or human. ➢ Discoveries or depletion of stocks of natural resources. ➢ Changes in technological knowledge.
Using Aggregate Demand and Aggregate Supply to Depict Long-Run Growth and Inflation Figure 5 uses the aggregate demand and aggregate supply model to describe the behavior of output and prices over long periods of time. The initial aggregate demand curve is downward sloping. The aggregate supply curve is vertical, as the graph focuses on the long run. In the long run, growth in the labor force and, more importantly, growth in the stocks of capital and technological knowledge shift the aggregate supply curve to the right, as the natural rate of output rises. If the Federal Reserve keeps the money supply constant, this long-‐‐run economic growth will tend to reduce the price level, that is, cause deflation. But historically, the federal reserve has acted to increase the money supply over long periods of time. This increase in the money supply has shifted the aggregate demand curve to the right, too. Indeed, the money supply has grown at a rate that has caused the aggregate demand curve to shift rightward at a pace that is associated with inflation.
Menus and mail order catalogs provide literal examples of menu costs to changing prices. But other prices may be slow to change because of managerial costs. For example, executives at Dunkin Donuts may decide at the beginning of the year that $1.49 is the “right price” to charge for a cup of coffee. They may meet again later in the year to reconsider the pricing decision, but until then the price stays fixed. So, suppose that Dunkin Donuts sets its price at $1.49 but the price level, reflecting mainly the prices of other goods and services, turns out to be unexpectedly high. A cup of coffee now looks “cheap” to consumers. More will visit Dunkin Donuts and buy coffee. Dunkin Donuts will hire more workers and produce more output. Hence, the unexpectedly high price level leads to an increase in output above its natural rate. And the same story works in reverse: if the price level turns out to be unexpectedly low, a cup of coffee with a “sticky” price of $1.49 will look expensive. People will buy less; Dunkin Donuts will hire fewer workers and produce less. The unexpectedly low-price level leads to a decrease in output below its natural rate. But, like sticky wage theory, sticky price theory also suggests that in the long run, prices will adjust, and output will return to its natural rate. Misperceptions Theory A third story to explain the upward-‐‐sloping short-‐‐run aggregate supply curve is the misperceptions theory. Another example illustrates how this theory works: ➢ Suppose at the beginning of the year, everyone expects the price level P to equal 100. ➢ But instead, the price level rises to P = 110. ➢ This means that, on average, the prices of all goods and services have risen by 10 percent. ➢ In the short run, however, individual firms may mistakenly believe that it is just the price of their good that is rising. ➢ Believing that it is an especially good time to produce, those firms will hire more workers. ➢ As a result, the unexpectedly high price level will lead to an increase in output above its natural rate. ➢ Conversely, if the price level unexpected falls, each individual firm might mistakenly believe that it is just the price of its own output that is falling. The firm will hire fewer workers. The unexpectedly low price will lead to a decrease in output below its natural rate. Although some economists debate over which of these three theories – sticky wages, sticky prices, or misperceptions comes closest to describing actual economies, there is probably an element of truth in each of them. And they are not mutually inconsistent, that is, they could all work together to describe why the aggregate supply curve slopes upward. And all three imply a short-run relationship of the form: Quantity of Output Supplied = Natural Rate of Output + a (Actual Price Level − Expected Price Level) Where a is a number that governs the extent to which actual output responds to unexpected changes in the price level. This same equation and each of the three theories also captures the idea that in the long run, after expectations have shifted to recognize actual changes in the price level, the long‐run aggregate supply curve is vertical.
Why the Short-Run Aggregate Supply Curve Might Shift The equation from above also allows us to identify factors that will shift the short-‐‐run aggregate supply curve: ➢ Anything that shifts the natural rate of output (and hence the long-run aggregate supply curve). ➢ Changes in the expected price level. The equation indicates that an increase in the expected price level causes the quantity of output supplied at any given actual price level to decrease. How? Consider the answer given by sticky wage theory: ➢ If the expected price level increases, firms will set higher wages to compensate workers for the higher cost of living. ➢ But, if the actual price level is held constant, this means higher real wages. ➢ Firms will hire fewer workers, and produce less output, at the given price level. ➢ The short-run aggregate supply curve shifts to the left. ➢ Conversely, if the expected price level falls, firms will be able to set lower wages, hire more workers, and produce more output, all at any given price level. The short-‐‐run aggregate supply curve shifts to the right. Two Causes of Economic Fluctuations: Figure 7 depicts in the economy in its long-run equilibrium: ➢ Aggregate demand intersects with long-run aggregate supply, determining output and the price level. ➢ But here, the short-run aggregate supply passes through the equilibrium point as well, indicating that the expected price level has adjusted to this long-run equilibrium as well.
In this example, we implicitly assumed that the government does not respond to any of these events. Another possibility is that the Federal Reserve could respond to the initial fall in aggregate demand by increasing the money supply: ➢ As discussed earlier, a monetary policy easing, associated with an increase in reserves and the money supply and a decrease in interest rates, will shift the aggregate demand curve to the right, offsetting the initial leftward shift. ➢ In this case, the economy can move back to its initial long-run equilibrium point A without a shift in the expected price level and without a shift in aggregate supply. The Effects of a Shift in Aggregate Supply Let us suppose again that the economy starts out in its long run equilibrium, in which aggregate demand, long-run aggregate supply, and short-run aggregate supply all intersect. Now suppose that there is a disruption to worldwide oil supplies. What happens to the economy as a result?
- Because the availability of natural resources affects firms’ ability to produce goods, the aggregate supply curve shifts.
- Because the reduction in oil supplies makes it more difficult and costly for firms to produce goods, the aggregate supply curve shifts to the left.
- Figure 10 shows that in the short run, output falls and the price level rise. The economy experiences stagflation : stagnation of economic growth and inflation.
- Assuming that oil supplies are eventually restored in full, however, the long-‐‐run aggregate supply curve remains fixed. Instead, as oil supplies come back, the short-‐‐run aggregate supply curve will shift back to its original position.
This example assumes that government policymakers do not respond to the oil supply shock. ➢ Figure 11 shows what happens when, instead, the Federal Reserve expands the money supply or Congress increases government spending to counteract the short-run decline in output. ➢ Now, in the short run, the aggregate demand curves to the right. If the monetary and/or fiscal stimulus to demand is sufficiently strong, the government can bring output back to its natural rate even in the short run. ➢ But, as the figure shows, this comes at the cost of making the inflation even worse. ➢ In cases like this one, the government is said to accommodate the shift in aggregate supply, accepting a permanently higher price level to insulate output and employment from the effects of the shift in aggregate supply. ➢ Some economists use this story to explain the high inflation experienced in the US during the 1970s: The Organization of Petroleum Exporting Countries (OPEC) cartel acted repeatedly to curtail the supply of oil to world markets to increase the price of oil. The Fed, wishing to avoid a deep recession, eased monetary policy: it accommodated the shift in aggregate supply, but at the cost of subjecting the economy to higher and higher rates of inflation.
