Chapter5 Econ

Chapter 4: Real GDP vs Potential GDP

  • Real GDP: Economic measure that removes the effects of rising prices and costs of living from Gross GDP comparisons. It reflects the actual value of goods and services produced in an economy, adjusted for inflation.

  • Potential GDP: Represents the maximum value of real GDP that can be achieved while maintaining economic stability. It indicates the output level of an economy without causing inflation due to shortages in labor, capital, land, or entrepreneurship.

The Uses and Limitations of Real GDP

Real GDP Fluctuations—The Business Cycle

  • Business Cycle: A cyclical pattern of fluctuation in total production and other measures of economic activity characterized by:

    • Phases:

    1. Expansion: Economic growth phase where real GDP increases.

    2. Recession: Economic downturn phase where real GDP decreases for at least two consecutive quarters.

    • Turning Points:

    1. Peak: The highest point of economic activity.

    2. Trough: The lowest point of economic activity.

Illustration of the Business Cycle

  • Figure 4.6: Depicts the business cycle visually, distinguishing between periods of recession and expansion with relevant GDP changes.

  • A recession occurs when the growth rate of real GDP is negative, while an expansion reflects growth from a trough to a peak.

Chapter 5: Monitoring Jobs and Inflation

Chapter Goals

After studying this chapter, you will be able to:

  • Explain the significance of unemployment and how to measure the unemployment rate and related labor market indicators.

  • Understand the causes of unemployment and why it persists even in a fully employed economy.

  • Comprehend the implications of inflation and how to measure the inflation rate.

Current Unemployment Data

  • Unemployment Rate (Aug. 2025): 4.3%

  • Trends from 1950 to 2025: A graphical representation showing fluctuations in unemployment rates over the decades.

Employment and Unemployment

Why Unemployment Is a Problem

  • Unemployment results in:

    • Lost Incomes and Production: Severely affects individual livelihoods and economic productivity.

    • Lost Human Capital: Prolonged unemployment diminishes skills and job prospects for individuals.

    • Employment benefits provide temporary relief but do not completely replace lost wages, and not all unemployed individuals qualify for these benefits.

Current Population Survey

  • Conducted by the U.S. Census Bureau to assess the U.S. labor force:

    • Working-Age Population: Consists of individuals aged 16 and older, excluding those in institutions.

    • Exclusions: Individuals under 16 or institutionalized are not included in the working-age population.

Breakdown of Working-Age Population

  • Divided into:

    1. Labor Force: The sum of employed and unemployed workers.

    2. Not in Labor Force: Those who are neither employed nor actively seeking employment.

Criteria for Being Counted as Unemployed

To be classified as unemployed, individuals must belong to one of these categories:

  1. Without work but actively seeking employment within the previous four weeks.

  2. Waiting to be recalled to a job after being laid off.

  3. Waiting to begin a new job within the next 30 days.

Example of Labor Force Participants

  • Person A: Currently seeking work after kids started school—counted as part of the labor force.

  • Person B: Laid off but expects to be called back—part of the labor force.

  • Person C: Recent graduate with a job starting soon—part of the labor force.

  • Person D: Laid off and has stopped searching for a job—NOT counted in the labor force despite being available for work.

Labor Market Indicators

  • Unemployment Rate: The percentage of the labor force that is unemployed.

    • Formula: ext{Unemployment Rate} = rac{ ext{Number of Unemployed}}{ ext{Labor Force}} imes 100

    • As of Aug. 2025: 4.3%.

  • The unemployment rate tends to rise during recessions and peaks after recovery.

  • Employment-to-Population Ratio: Percentage of the working-age population employed.

    • Formula: ext{Employment-to-Population Ratio} = rac{ ext{Employment}}{ ext{Working-Age Population}} imes 100

    • Current Ratio: 59.6% as of Aug. 2025.

  • Labor Force Participation Rate: Percentage of the working-age population participating in the labor force.

    • Formula: ext{Labor Force Participation Rate} = rac{ ext{Labor Force}}{ ext{Working-Age Population}} imes 100

    • Current Rate: 62.3% as of Aug. 2025.

Limitations of the Unemployment Rate

  • The official unemployment measure is imperfect as it excludes:

    • Marginally Attached Workers: Individuals who want work but are not currently searching.

    • Part-Time Workers Seeking Full-Time Jobs: Economic part-time workers, partially unemployed.

Definitions of Unemployment

  • Marginally Attached Worker: Individuals who are not currently in the workforce but want a job and have looked for work recently. Discouraged workers fall under this category but have ceased seeking employment due to repeated failures.

Types of Unemployment

Frictional Unemployment

  • Describes the temporary unemployment during job transitions in the labor market. It is common and considered healthy for a growing economy.

  • Often increases due to:

    • Growth in people entering or reentering the labor market.

    • Enhanced unemployment benefits facilitating transitions.

Structural Unemployment

  • Results from changes in the economy that alter job availability and required skills, often due to technological advancements or foreign competition.

    • Examples:

    • Automation reducing customer service jobs.

    • Factory closures prompted by international market shifts.

  • Typically lasts longer than frictional unemployment.

Cyclical Unemployment

  • Occurs due to reduced economic activity in recessionary periods and tends to be lower in periods of economic growth.

  • This type of unemployment signifies layoffs due to economic downturns, affecting workers until the cycle turns back upward.

Natural Unemployment

  • Refers to unemployment arising from frictional and structural causes when cyclical unemployment is absent.

  • Natural Unemployment Rate: The level of unemployment that exists when the economy is functioning optimally without cyclical conditions.

Full Employment

  • Defined as the situation where the unemployment rate equals the natural unemployment rate. It consists solely of:

    • Frictional and structural unemployment without any cyclical unemployment.

Output Gap and Economic Implications

  • Potential GDP: The quantity of real GDP achievable at full employment.

  • Output Gap: The difference between real GDP and potential GDP.

    • Positive Output Gap: Indicates that the economy operates above sustainable capacity, likely inducing inflation.

    • Negative Output Gap: Suggests recessionary conditions where unemployment exceeds natural unemployment rates.

Historical Context Example

  • In September 2012, the U.S. had an unemployment rate of 7.8%, with a natural unemployment rate of 6%. This indicated a negative output gap, as actual unemployment exceeded the natural rate.

Price Level, Inflation, and Deflation

Overview of Price Level

  • Price Level: The average level of prices and the relative value of money in an economy.

  • Inflation: A sustained increase in the price level over time.

  • Deflation: A sustained decrease in the price level over time.

Impacts of Inflation and Deflation

  • Problems arise particularly from unpredictable inflation or deflation, which can:

    • Redistribute income and wealth, adversely impacting social equity.

    • Diminish real GDP and employment by creating uncertainty in economic planning.

    • Divert resources away from productive activities, as entities are forced to allocate time and resources toward forecasting and navigating the unpredictability of inflationr.

  • At an extreme, rapid inflation could lead to conditions like hyperinflation, where the currency loses value so quickly that workers may need to be paid multiple times a day to maintain purchasing power.