PRINCIPLES OF MACROECONOMICS
Ranjit Dighe
SUNY-Oswego
WEEK 6 (Oct. 4-6, 1999)
LECTURES 15 & 16

[There's really only one real lecture here, that of Mon., Oct. 4. Wednesday's class was mostly devoted to going over the first exam., and Friday's was canceled because I was attending a conference. Monday's lecture overlaps with Chapter 8 of McConnell's textbook.  These notes were last revised on Wed., Oct. 13, at 5:30 pm.]

LECTURE 15
Mon., Oct. 4, 1999

Today:
I.   Business cycles (finish)
II.  Unemployment (begin)
 

I.  BUSINESS CYCLES (finish)

Where we left off on Wednesday: I continued explaining the concept of the business cycle, and told you that expansions and contractions were better terms for describing the ups and downs of the business cycle than were the book's terms, recession and recovery.
-- [We saw an overhead of McConnell's Figure 8-2, a generic graph of the long-term trend growth of GDP and the cyclical fluctuations of GDP in the short term.]
-- I also introduced two measures of maximum economic output, capacity GDP (maximum possible output) and potential GDP (maximum sustainable output, without causing accelerating inflation).

Recall:
-- potential GDP < capacity GDP
---- At potential GDP, the unemployment rate is about 4%-5%. At capacity GDP, it would be near 0%.
---- At potential GDP, the economy's CAPACITY UTILIZATION RATE (the rate at which factories and equipment are operated compared with the maximum possible rate) is about 80-85%. (At capacity GDP, the capacity utilization rate would be 100%.)
---- [We saw an overhead of McConnell's Figure 8-7, "Real domestic output (and thus employment)."  Note how potential output, Q*, is less than capacity output, which is the vertical part of the curve, labeled "Range 3."  That is capacity output because output cannot possibly be any higher than that level.]

If one looks at the U.S. economy over time, one sees a lot of business cycles -- a lot of recessions, especially in the years before 1940, and a lot of expansions.  Only rarely is GDP exactly equal to its trend level (i.e., potential GDP).
-- [We saw an overhead of McConnell's Figure 8-1, "U.S. business cycle experience," showing every business cycle from 1875 through 1997.]

Some more helpful concepts:
Defn. OUTPUT RATIO (or GDP ratio) = (Q/Q*) * 100%
Defn. OUTPUT GAP (or GDP gap) = (Q*-Q)/Q* * 100%
                                                            = (1-output ratio) * 100%
                                                            = 100% - output ratio
-- A positive GDP gap indicates a depressed economy.
-- A negative GDP gap indicates an economy operating beyond potential GDP. A negative GDP gap will cause inflation to accelerate, but otherwise is a good thing (more jobs, higher incomes).

To summarize:
 

"Ideal case Recession; 
Depressed/slack economy
Boom
Q = Q*  Q < Q* Q > Q*
Output ratio = 100%  Output ratio < 100%  Output ratio > 100
GDP gap = 0  GDP gap is positive  GDP gap is negative

-- [We saw an overhead of McConnell's Figure 8-5, which shows a timeline from 1976 to 1997 of potential GDP, actual GDP, and the GDP gap, and a corresponding timeline for the unemployment rate.  Note that when the GDP gap is positive and large (e.g., 1981-83), the unemployment rate is high.  Likewise, when the GDP gap is negative (e.g., 1979, 1988-89), the unemployment rate is very low.]
 

II.  UNEMPLOYMENT

Unemployment refers to the condition of being unable to find a job.  "Unemployed" is not quite the same thing as "jobless," because the official definition of unemployment includes only those jobless persons who are looking for work.

A flurry of definitions:
* UNEMPLOYED: a person 16+ years old who is not working, is available for work, and has made specific efforts to find work over the past four weeks.
-- By contrast, someone who isn't working and isn't looking for work either is categorized as OUT OF THE LABOR FORCE (exs.: stereotype of welfare recipients, full-time students, full-time homemakers, retirees).
* LABOR FORCE: the number of people employed plus the number of people unemployed; employed plus unemployed.
* UNEMPLOYMENT RATE: the ratio of the number of people unemployed to the total number of people in the labor force

[We saw an overhead of McConnell's Figure 8-4, which shows the different work categories that people can belong to.  McConnell divides the huge "out of the labor force" group, which comprised about half of the U.S. population in 1997, into "Under 16 and/or institutionalized" and "Not in labor force."  Those two groups are of roughly equal size, about 65 million people each.  The remaining half of the population is either employed (130 million) or unemployed (6.7 million).]

Unemployment is anything but an equal-opportunity affliction.  Certain segments of the population -- blue-collar workers, teenagers, blacks, and people with a high school education or less -- make up a disproportionate share of the unemployed.  This is true both in recession years (e.g., 1992) and in "good" years (e.g., 1996).
-- [We saw an overhead of McConnell's Table 8-2, which shows demographic breakdowns of the unemployment rate for 1992 and 1996.  In both years, the highest unemployment rates by far belonged to black teenagers, whose jobless rates of 39.8% (in 1992) and 30.6% (in 1996) were at depression levels.  In the "good" year of 1996, the following groups still had unemployment rates above 10%:  teenagers (black or white), blacks, high-school dropouts.  The groups with the lowest unemployment rates were white-collar workers (3.4%) and college graduates (2.2%).]

Q: If someone is looking for a job but has turned down a job or two, is she still unemployed?
A: Yes -- to be considered unemployed, one need only be jobless and looking for work.
---- This question does, however, point to a distinction that economists and the government make between involuntary unemployment, where one is absolutely unable to find a job in one's field, and voluntary unemployment, where one is jobless and still looking but has turned down a few offers for jobs in one's field.  A recently minted CPA who hasn't found a job yet but has turned down offers from local accounting firms in the hope of landing a job with a Big Ten accounting firm would be counted as voluntarily unemployed.
------ This distinction matters mainly because government unemployment benefits are available only to the involuntarily unemployed.  The government is not in the business of paying people to be picky about the jobs they accept.
------ At any rate, even "voluntary" unemployment is generally very unpleasant.  It involves wanting a particular type of job and not being able to get it, and perhaps wondering if a good job will ever turn up.
------ To be classified by the government as involuntarily unemployed, one must possess the requisite skills for the job one is seeking.  If I lost my job and could not find another, I would be an involuntarily unemployed economist, but I could not be an involuntarily unemployed dentist, because I do not have the requisite skills or qualifications to be a dentist.
------ There is perhaps a thin line between being "voluntarily unemployed" and "out of the labor force."  For example, if I'm out of work and looking for a job that pays $1 million per hour and can't find one, then I'm "voluntarily unemployed" (at least assuming I'm not qualified for such jobs, which indeed I am not).  If I conclude that no one will hire me for such jobs and give up looking for work altogether, then I'm "out of the labor force."
-------- The "discouraged worker" effect refers to what happens when people who want to work but can't find work eventually become discouraged and stopping looking for work.  Once a person stops looking for work, he is officially no longer part of the labor force and no longer is counted as unemployed.  Other things equal, if a lot of unemployed people become "discouraged workers," the unemployment rate would drop, but human misery would be just as great as before.

***

PRINCIPLES OF MACROECONOMICS
WEEK 6, LECTURE 16
Wed., Oct. 6, 1999

[We had a quiz.  For past quiz questions and answers, refer to the Eco 200 home page.]

News flash: Tues., Oct. 5: The Federal Reserve left short-term interest rates unchanged but altered its policy stance to one that favors raising rates down the line. The central bank said tight labor markets require policy makers to be "especially alert" to rising prices. Financial markets fell on the news.

[We spent most of the class going over the first exam, which I handed back on this date, along with a solution sheet.]

***

Fri., Oct. 8, 1999 -- CLASS CANCELED -- Dighe out of town.
-- Expect makeup lecture notes sometime in the future.