Author: John Bouman

What’s in This Chapter? Now that we know what GDP is and how it is measured, we are ready to analyze changes in GDP. Studying business fluctuations teaches us that during most years in politically stable, mixed or capitalist economies, real GDP rises. Advances in technology, a healthy price level, low interest rates, taxes and regulations that encourage hard work and innovation, a solid financial system, a happy and healthy population, and a peaceful world, all contribute to long-term economic growth. This unit will look at reasons why real GDP decreases at times. In addition, we will take an in-depth look at the causes of the great depression of the 1930s and the 2008/2009 great recession. Later in the unit we will discuss what economists mean by “full employment”. Keynesian economists believe that the economy cannot perform better than a rate of between 5 and 6% unemployment. Some economists question this though. During the 1980s and 1990s, in the United States, unemployment was frequently close to, and sometimes even below, 4% (it is today as well). At the same time, inflation rates remained low during the 80s and 90s. This suggests that an economy can grow at a rapid pace, without causing inflation. John Maynard Keynes predicted that if unemployment drops below 5% in an expanding economy, it would cause inflation. However, while prices generally rise at a faster...

Recessions, Expansions, Peaks, and Troughs Business fluctuations are increases and decreases in economic activity, as measured by increases and decreases in real GDP. A recession (or contraction) is defined as a decrease in real GDP of at least two consecutive quarters (6 months). An expansion is any period of time during which real GDP is increasing. One full business fluctuation consists of one recession and one expansion. The height of an expansion (points A, C, and E in the graph below) is called the peak. The lowest phase of a fluctuation is the trough (points B and D in the graph below). A typical economy experiences continuous increases and decreases in economic activity. From point A to B, GDP is falling, and we are experiencing a recession if the decline is at least two consecutive quarters. From B to C, activity picks up, and there is an expansion. From C to D, the recession appears more severe, and we may even speak of a depression. A recession in the United States lasts on average approximately 1 year. An expansion usually lasts on average more than 5 years. Business Fluctuations in the United States Below is a table with nominal and real quarterly GDP changes, starting with the first quarter of 1979 (seasonally adjusted rates). For the “Chained” changes (real GDP) a base year is chosen to keep prices constant....

Before the 1920s During the latter part of the 19th century and very early 20th century, various industrialized countries around the world enjoyed mostly free market economies. Government involvement was limited to essential functions, such as the provision of a legal system, national defense, the provision of infrastructure (roads, highways, railways, etc.), education, and police and fire protection. Regulations, even though they were on the rise, were relatively modest and tax rates were low (the United States did not have an income tax before 1913). The Roaring ’20s Except for a modest recession in the early 1920s, this decade experienced economic prosperity and low unemployment. Important innovations (radio, television, automobiles, assembly lines, washing machines, airplanes, electric razors, instant cameras, refrigerators, etc.) and technologies helped propel the economies of industrialized countries. Business profits and stock prices reached record highs. Andrew Bernstein in his book, The Capitalist Manifesto points out that, due to new technologies, business profits rose by 387% between 1921 and 1929 (Bernstein A., 2005, P. 377). Industrial production more than doubled, and stock prices of U.S.-traded firms rose by 385% during this same time. Bernstein claims that contrary to common belief, stock prices increased in line with economic conditions. However, politicians and Federal Reserve officials made announcements that they would pressure banks to restrict loans to investors buying stock on margin (Bernstein A., 2005, P. 378). Bernstein continues: “Starting in...

The Unemployment Survey The unemployment rate is one of the nation’s most important measures of economic health. Some people think that the unemployment rate is measured by counting the number of persons who claim unemployment compensation under state or federal government programs. However, many persons are unemployed, yet are not eligible for unemployment compensation, or their unemployment compensation has run out. Therefore, the unemployment rate is published based on a government survey, called the Current Population Survey. There are approximately 60,000 representative American households in the sample for this survey. The survey sample may not seem very large, but government statisticians consider the survey a reliable indicator of unemployment in the United States. The Accuracy of the Unemployment Rate According to the official definition, a person is considered unemployed if (s)he is without a job, is currently available to work, and has actively looked for work in the prior four weeks. Hidden unemployment exists when someone is out of work, wants a job, but has given up looking because (s)he has become discouraged. A person who has lost her/his job, but is not looking for another one, is not counted in the unemployment statistics. This makes some people question the accuracy of the unemployment rate. Some economists have questioned the accuracy of the unemployment rate for other reasons as well. Underemployment exists when a person accepts a job (s)he...

The Four Types of Unemployment Four commonly distinguished forms of unemployment are: 1. Frictional unemployment. Frictionally unemployed people are in between jobs or are students who recently completed school and are looking for a job. This form of unemployment is usually short-lived in nature. 2. Structural unemployment. The structurally unemployed are people who are laid off and looking for work because technology advances or other structural changes in production (for example, companies moving abroad) took away their jobs. The horse-and-buggy drivers of the early 1900s lost their jobs after the automobile became popular and affordable. Many American steel, auto, electronics, and textile workers lost their jobs and became structurally unemployed due to foreign competition and American companies locating abroad (outsourcing). This form of unemployment (especially those due to technology advances) is usually permanent in nature. Even though these specific jobs may be gone forever, people unemployed for structural reasons can frequently find work in other industries after receiving training and acquiring other skills. 3. Cyclical unemployment. Cyclically unemployed people are laid off due to a decline in the demand for their product; they are also looking for a job. During recessions, the demand for cars and houses and other durable products decreases. Workers in these industries lose their jobs until demand increases again. This form of unemployment is usually temporary in nature. 4. Seasonal unemployment. Seasonally unemployed people are out of work...