So far we've been looking at what economics is all about, and studying some basic concepts and models that are used in both microeconomics and macroeconomics. Today we begin our focus on macroeconomics specifically.
Economic Growth
One of the key areas of study of macroeconomics is the issue of long-term economic growth. Economic growth is the expansion of the economy's capacity to produce goods and services (shifting out of the production-possibility frontier), and it is measured by changes in real gross domestic product (GDP). Real GDP, in turn, measures (or attempts to measure) the value of total production in the economy.
Parkin's Figure 5.1 (p. 105) shows real GDP for the period from 1960 through 1994. It highlights two of the principal concerns of macroeconomics: overall growth as indicated by the rising line (how to increase the slope? -- a question being debated hotly nowadays), and economic fluctuations as illustrated by the variations around the trend (how to avoid turndowns?). Currently, GDP stands at close to 7 trillion dollars, or roughly 25 thousand dollars per person (current prices).
Because from year to year both quantities and prices change, measurement of GDP can be done in two ways: we can measure this year's production at this year's prices (called nominal GDP), or we can measure this year's production using prices from a base year (real GDP).
Measures of nominal GDP from different years incorporate both changes in quantities produced and changes in prices (inflation). By contrast, measures of real GDP, by using prices from a single (base) year, eliminate the effects of inflation and hence give a more accurate picture of the extent of real economic growth. (Note the existence of measurement problems -- home production, the underground economy, recent adjustments to GDP calculations; these issues will be discussed soon re Ch. 6, "Measuring GDP, Inflation, and Economic Growth").
The long-term trend in the U.S. and other countries is one of economic growth, but there are clearly differences in growth rates (e.g., industrialized vs. developing countries; Asian, African, and Latin American nations) that merit study. We're interested in economic growth because long-term growth translates into increases in the real standard of living -- i.e., in the quantity of goods and services available to the average consumer. Further, differences in economic growth rates over extended periods of time result in big changes in relative standards of living (cf., Russian vs. US growth in the 1960s; US vs. Japan 40 years ago and Taiwan more recently; contemporary China; Third World 30 years ago vs. today).
In any economy there will tend to be short-term fluctuations in economic activity around the long-term trend. We use the term recession to refer to contractions of economic activity. Formally, we define a recession as having taken place when we experience two successive quarters during which real GDP declines.
Such contractions are typically followed by expansions, and the two together constitute a business cycle, with a peak marking the onset of the recession and a trough marking its end and the beginning of the expansion (see Parkin's Fig. 5.2). Recessions are typically of relatively short duration, as shown in Parkin's Fig. 5.3 (but cf., the Great Depression), while expansions vary considerably in their length. Hence, business cycles are very irregular.
Parkin notes that increased consumption possibilities are the main benefit of economic growth. Offsetting this benefit are several costs, which we will discuss in more detail later. These include forgone consumption (as we saw earlier in considering the production possibility frontier, we need to invest in capital and technology development to generate growth, and this is done at the cost of current consumption), depletion of natural resources, environmental degradation, and dislocations accompanying economic change (job destruction).
Jobs and Unemployment
Despite concerns about improvements in technology making many workers redundant (cf., Jeremy Rifkin, Triple Revolution), it is clear that associated with the long-term growth of the economy has been growth in the number of jobs. In fact, the process of growth and economic development is one characterized by a continuous stream of change, with many jobs being created (cf., old figure that 25% of jobs that will exist in 25 years don't exist now) while others are destroyed.
This process of job creation and job destruction is clearly related to the business cycle: with creation dominating destruction during periods of expansion) and vice-versa during contractions (recessions). This cyclical sensitivity is most evident in looking at unemployment. Before looking at this, however, we need briefly to take a closer look at how unemployment is defined.
The population aged 16 and over is defined as the potential labor force. This group consists of two broad and mutually exclusive categories: those who are in the labor force and those who are out of the labor force. The labor force is further subdivided into two mutually exclusive groups: the employed and the unemployed.
To be counted as unemployed, an individual must meet three criteria: not have a job, be available for work, and have made some effort to find work during the previous four weeks. Hence, there is a distinction between unemployment and nonemployment; and people who would like to work but haven't been looking -- so-called discouraged workers -- are not counted as unemployed but rather as being out of the labor force.
With these definitions behind us, we can turn back to the question of how unemployment varies over the course of the business cycle. As shown in Parkin's Fig. 5.6, in times of recession unemployment rates rise (post-WWII peak at about 10 percent in the early 1980s, estimated at 25 percent during the worst of the Depression), and then they fall during recoveries. Hence, unemployment rates are an inverse indicator of the business cycle (note leading, lagging, and concurrent or coincident indicators).
Note further that the unemployment rate has been declining since the early 1990s, and it currently is at 5.1 percent. This is the lowest that unemployment has been since 1989, just before the last recession in the U.S.
Most spells of unemployment are of relatively short duration -- one month or less. However, some workers are subject to extended spells of unemployment, and the likelihood of long spells rises sharply in time of recession. Extended spells of unemployment, in addition to the economic problems that they entail, have the potential to contribute to a variety of social problems as well. For example, numerous studies have documented the correlations between the unemployment rate and both crime and suicide rates.
© 1996 David Shapiro
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