LISTINGS

SUBTOPICS

One fundamental characteristic of the economy is that it is constantly experiencing alternating periods of growth and decline, though in the long run it has always been in growth. This alternating pattern of growth and decline are business cycles. Growth depends on several factors. The most important ones include: people investing in growth rather than spending everything, technological advances allowing better ways to do things, and people. There must be enough people to allow for maximum productivity, but not so much people that the huge population interferes with growth and causes inefficiency. The people must also be motivated to work. Economies over time can be seen as a graph. The economy experiences periods of expansion, technically defined as a period of growth lasting more than two quarters (a minor movement of the economy over a short period of time is insignificant), and periods of recession, technically defined as a period of decline that lasts more than two quarters (1/4 of a year). A depression is a severe recession.

Fig 1.5.1-business cycles

There are two views of this economic situation: Classical and Keynesian. We will go into this later, but in summary, Classical economists say that the fluctuations in an economy are natural and after a recession, the economy will rebound on its own. Keynesian economists say that there are fundamental problems behind the economy that should be controlled by the government. The Great Depression was a tremendous period of decline in the economy and it was so severe that it fundamentally rearranged how the economy is managed. Previously, governments had a policy of laissez-faire, which meant the government did not interfere in business. After the depression, however, government stepped up and began to regulate the economy. The government's stabilizing effect has been able to prolong the duration of economic expansions in the postwar years and shorten the length of economic depressions.

Economists have developed over time several indicators of how well the economy is doing. Leading indicators show what might happen in the future, including: the workweek of manufacturing workers, layoffs, new orders for goods, the number of vendors that report slower distribution from suppliers, new businesses, contracts for equipment and facilities, number of permits issued for private real estate development, change in inventories (stores of products waiting distribution to the market), change in prices, change in liquid assets (assets that can be immediately changed for cash), changes in money supply (amount of money in the economy). Coincidental indicators are indicators of the state the economy is in at the present, including: number of employees outside of the agriculture sector, personal income from work (minus various government-provided benefits, etc.) industrial production, sales volume.

Unemployment is used as a major indicator of how well an economy is doing, along with capacity utilization rate, a measure of how much we are using our production potential compared to what is possible. A 4 or 5 percent unemployment rate and a 85 percent capacity utilization rate are roughly the target rates. These target numbers are numbers we try to reach, but not exceed. Exceeding them, pushing the economy too fast, would let the smallest mistake trigger a catastrophic collapse of the whole economy (which is like what happened during the depression of the 1930's).

In the problem of unemployment, two type of unemployment exist: cyclical and structural. Cyclical unemployment is caused by the downturns and upturns of the ever-shifting economy. When economies go down, business activity declines and people lose jobs. When economies goes up, people get hired. Structural unemployment is caused by changes in how the economy works. For example, industrializatio initially caused a massive loss of jobs, because machines replaced people. However, as industrial employment declined, service employment increased. The U.S. economy, for example, is an economy fueled primarily by workers that provide services rather than maufacture things.

The Industrial Revolution, by moving people to fixed-wage jobs (you never got 'fired' off of a farm in the old days, because if the year's production was bad, you just reaped less crops), introduced these economic situations. At first, unemployment in industrial societies meant having nothing and to avoid starving to death, one had to find another job. However, under the new economic systems. In pure capitalism, as earlier stated, the government practiced laissez-faire and did not intefere in economic activities. However, most modern economies are a melding of capitalist and socialist ideas to form welfare capitalism, a system in which governments significantly regulate the otherwise free market.

Governments try to maintain their economies at full employment, meaning that anyone who wanted a job could have one. Full employment does not mean that everyone had a job. There are a few people who voluntarily quit their jobs and there are people who are not eligible to hold jobs (prison inmates, etc.). The target level of full employment has been constantly shifting, but the idea remains the same. This type of voluntary unemployment is called frictional unemployment.

Unemployment is another area of debate between Classical and Keynesian economists. Classical economists generally believe that unemployment is the individual's problem, and those who are unemployed are not trying hard enough. Thus, all unemployment is frictional unemployment. Keynesian economists believe that society should always be able to offer individuals jobs. Because of these discrepancies, the real unemployment numbers may not be totally accurate. Some people are working, just not officially registered anywhere, some are going off work for a while because they feel like it. The unemployment figures may also not be completely representative because they break down when the statistics are shown for various demographic groups: gender, race, age, etc.

Inflation is another important indicator of the economy. Inflation is the continuing rise in the overall price level of an economy. Inflation, in large part, guides government policy. Long-term inflation can be a major problem. Inflation is almost always existent, the price level is constantly rising, but in a sustained economy, the inflation rate is stable. There are multiple indices for measuring inflation and none are completely up-to-date and accurate, they give an accurate enough picture of inflation. These indices allow us to adjust our production numbers. (Say we produce 1 trillion monetary units worth of stuff the first year and produce 1.5 trillion the next, since the price level has risen and our production really hasn't, we may only have really produced 1.2 trillion relative to the first year.) It is important to distinguish between the real figures and nominal figures.

Inflation is the rise in price level and people set the prices, so the inflation is caused by people thinking that raising prices will get them more of the output. There are two types of inflation. Demand-pull inflation is caused by great demand and a scarcity of supply. When there is scarcity, based on the laws of supply and demand, prices go up. People are willing to pay more for a needed product or needed labor. Thus, prices go up and workers' wages go up; people are willing to charge more for everything. Demand-pull inflationary markets are at full employment. The second type is cost-push inflation. Unlike in demand-pull inflationary economies, cost-push economies may not have surplus demand. However, certain groups have the ability to force their own prices up, therefore forcing those who buy their products to raise their own prices. Both of these forces combine to form inflationary pressures on an economy. One is often supplemented by the other. People also raise their prices to keep up with the inflation they project will occur. However, the inflation is unexpected sometimes and people struggle to catch up by setting their prices higher.

Inflation has the effect of moving wealth from those who don't raise their prices to those who do. If workers increase their demands for payment, they get more money, so they can pay for the increased prices of the companies. However, if someone could not raise their prices, they lose wealth. Inflation can make it hard for people to judge prices, as it's hard for them to constantly readjust themselves to shifting price levels. When inflation goes out of control and expectations of inflation rise, inflation can potentially wreck an economy. Hyperinflation is inflation of 100% or more. Large inflation causes people to spend their money quickly and not save it for future investment (because that money wouldn't be able to buy much soon). This kind of severe inflation can destroy confidence in the economy in general.

Inflation and unemployment are interrelated to each other. When a country encourages rapid growth and unemployment goes down, this could trigger massive inflation as a result of excess demand and cost-pull as explained above. But if a country wants to cut down on inflation, the cost is often the increase in unemployment and lack of growth.