As a college student you have probably noticed in your lifetime that there are times when the economy seems to be performing well, and other times when it appears to be struggling. How do we know when it is a time of prosperity and a time of economic hardship? Economists use a variety of statistics to guide them in making a judgment about the economy. They may differ from your own. There is an old saying that goes: “A recession is when your neighbor loses a job, a depression is when you lose your job”. Click on the link below to have access to the most current statistics to gauge for yourself how the economy is performing.
The term business cycle refers to the expansions and contractions in economic activity that take place over time. Although the importance of business cycles has decreased in the field of economics, it is still important to study its influence on macroeconomic policy. The business cycle refers to the nature of capitalist societies to swing between periods of prosperity and depression. The term “Boom and Bust” is associated with the business cycle. Business cycles are not regular or predictable.
The Four Stages of the Traditional Business Cycle
There are four stages of the traditional business cycle. The first is called the peak. This is represented in the graph as point “C”. This is a time when output, employment, and incomes are at an all time high. There exists a high degree of consumer and business optimism. This is matched by high levels of consumption and investment. The second stage is a recession. A recession is a downswing in economic activity. This is represented in the graph by points “A” and “B” Employment, output, consumer spending, are decreasing. Consumer and business confidence is also declining. The United States is officially in a recession when the GDP drops two or more calendar quarters in a row. The next stage is the trough. This phase of the business cycle is represented by point “D”. This phase is a lengthy period of low business activity. Prices are low, purchasing power is cut, and unemployment is high. The Great Depression of the 1930’s is an example of being in a trough stage. The final stage is the recovery. This is an upward swing in economic activity. Employment, output, and purchasing power are on the rise, represented in the graph by letter “E”. Business and consumer confidence is also increasing.
There is no fixed length to the business cycle. Some recoveries are longer than other recoveries, and some recessions are longer than other recessions. Business cycles may be measured peak to peak or trough to trough. The table below looks at post-World War II recessions in the United States.
|Period||Duration in Months||Percentage Decline in Real GDP|
|1953 – 1954||10||-3.7%|
|1957 – 1958||8||-3.9%|
|1960 – 1961||10||-1.6%|
|1969 – 1970||11||-1.1%|
|1973 – 1975||16||-4.9%|
|1981 – 1982||16||-3.4%|
|1990 – 1991||8||-1.8%|
Source: National Bureau of Economic Research, available at http://www.nber.org/cycles/cyclesmain.html
The Stock Market
It is hard to get through a newscast without there being frequent mention of how the stock market has performed for the day. Such frequent reporting would indicate that the stock market plays an important role in the American economy. The information below should help the student to better understand the importance of the stock market in the American economy.
What Are Stocks?
Corporations can raise funds through the sale of stock to the general public. Stock is sold so that a corporation can raise money primarily as a form of capital investment. But there is also the benefit of having the risk of a new venture spread out amongst many people. A stock is a share in the ownership of a corporation. Stockholders are owners of the company and are entitled to a voice in the selection of the Board of Directors, as well as a share in the profits. For example, if a company sells 1,000,000 shares of stock, then each share represents 1/1,000,000 ownership of the business.
According to a recent Gallup survey, the percentage of Americans saying they hold individual stocks, stock mutual funds, or stocks in their 401(k) or IRA fell to 54% in April 2011- the lowest level since Gallup began monitoring stock ownership annually in 1999. Stock ownership peaked in 2002 at 67% and has since been on a steady decline. However, the disappearance of the individual stockholder as the backbone of the U.S. stock market has been one of the least recognized but most profound trends of the last half-century. In 2007, the wealthiest 1% of households owned an average of $4.2 million in stocks (in 2009 dollars). The next 9% owned an average of $526,100. By comparison, the average stock holdings of the middle 20% of households was just $10,200, and the average for the bottom 40% was $1,700. These data confirm that stock ownership is not very pervasive in the middle and lower wealth classes. The unprecedented growth, for the most part, was enjoyed by wealthy investors: 81.1% of the rise in the overall value of stocks holdings over the period went to the wealthiest 10% of households, compared with 1.5% to the middle 20% and 0.5% to the bottom 40%.
Direct ownership of stocks by American households has declined from 91% in 1950 to just 14% in 2013. In 1950, financial institutions owned 9% of stock. In 2005 they owned 68% of all stock. Institutional investing is now largely the business of giants. America’s 100 largest money managers alone now hold 58% of all stocks. Of course individual investors remain major participants in the stock market, but now do so largely through mutual funds and public and private pension plans. But such participation lacks the traditional attributes of ownership such as selection of individual stocks and engagement in the process of corporate governance.1
Protecting the Investing Public There are opportunities for corruption in the stock market. Insider trading, disinformation, and false rumors, create the need to protect investors. The Securities and Exchange Commission is an agency which tries to protect investors from wrong doing the sale of securities. Corporations need to provide accurate information to both current and potential stockholders. They are required to provide a prospectus whenever a corporation sells new securities. A prospectus is a financial statement of the corporation, covering such things as assets, liabilities, and sales. The SEC has been under a great deal of criticism because of its cozy relationship with the businesses they are supposed to regulate. A report from the Project on Government Oversight found that former employees of the SEC routinely help corporations try to influence SEC rulemaking, counter the agency’s investigations of suspected wrongdoing, soften the blow of SEC enforcement actions, block shareholder proposals, and win exemptions from federal law. 2
The Role of the Stock Exchange
Once the stocks of a corporation have been sold to the public, all future sales are handled through the stock exchanges. The New York Stock Exchange and the NASDAQ (National Association of Securities Dealers Automated Quotations) are the two most widely used stock exchanges in the United States. The stock exchange is run like an auction. Buyers and sellers compete (bid ) for the price of the stock. The stock market is where stocks are bought and sold. For example, Microsoft’s trading symbol is MSFT. The major stock exchanges include the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), and the Nasdaq Stock Market. Each imposes specific requirements that companies must meet before their stock can be listed, or traded, on the market. Companies that meet the requirements of multiple exchanges may choose where they are traded. Brokerage houses such as Merrill Lynch and Dean Witter, are companies that are permitted to actually buy and sell stocks in the above listed exchanges. The Standard and Poors 500 (S&P 500) is an index made up of five hundred different stocks. Each is selected for liquidity, size, and industry. The index is weighted for market capitalization. The S&P 500 is the benchmark of the overall market, and frequently used as the standard of comparison in terms of investment performance. The Dow Jones Industrial Average (DJIA) is an index of thirty, blue chip stocks that are traded in the United States. It is believed that by looking at the companies on the list, a person can get a general picture of how the market as a whole is performing.
|Exchange||Requirements include||Typical Daily Volume||Number of listed companies|
|NYSE||1.1 million publicly held shares minimum; $40 million minimum market capitalization||1.4 billion shares||2,800|
|NASDAQ||Various quantitative and qualitative requirements||1.9 billion shares||3,200|
|AMEX||500,000 publicly held shares minimum, $3 million minimum market capitalization||51 million shares||765|
As of April 22, 2013
Why Some People Buy and Sell Stocks
Some people are interested in making money in a short amount of time in the stock market. These people are known as speculators. Those who look to make money over a long period of time are known as investors. Corporations give investors an extra benefit for their confidence in the corporation. This benefit is called a dividend. A dividend is a periodic payout of profits given to investors. The value of a stock is determined by the supply and demand for the stock of a company. The demand for a stock, as well as the price of the stock, reflect people’s perceptions of a corporation’s future profitability. When people are optimistic about a business’s future, the demand and price of the stock goes up. If people are pessimistic, the opposite is true.
The use of high frequency trading has grown substantially over the past 10 years: estimates hold that it accounts for roughly 55% of trading volume in U.S. equity markets and about 40% in European equity markets. Likewise, HFT has grown in futures markets—to roughly 80% of foreign exchange futures volume and two-thirds of both interest rate futures and Treasury 10-year futures volumes.
Types of Markets
A Bull market refers to speculators who anticipate making money from the increase in the price of a stock. This happens when a large number of stocks traded on the exchanges go up over an extended period of time. Bull markets can be sustained over a long time span. However, many investors achieve gains in short spurts. Bulls markets are desirable for many reasons. A bull market means the economy is generally doing well, gross domestic product is increasing, the job market is heating up, and people are spending money. A Bear market refers to speculators who anticipate making money from the decrease in the price of a stock. This happens when a large number of shares in the exchanges decline over an extended period of time. For people who invest in the stock market over the long term, they will probably encounter at least one bear market. There is no one agreed upon definition of a bear market. A bear market is generally defined as a decline of 20% or more in broad market indexes over at least a two month period. The worst bear market occurred from September 1929 through July 1932 when stock prices fell 86%.
The Stock Market’s Impact on the Economy
Many people follow the stock market to see how their individual stocks are performing. But the stock market also can be used as an indicator to how the economy is performing. If the stock market is believed to be a good investment, then many people will put their money into it as an investment. This means American corporations have a sizable pool of money to use for capital investment. If the opposite is true, then investors will keep their money out of the market. This means American businesses would have less money for investment, which means they might lose their competitive advantage to other countries. This in turn would mean lay offs down the road for American workers. The stock market is also related to interest rates. If interest rates rise, investors may pull their money out of the stock market and invest it elsewhere. If interest rates are low, investors may pour money into the stock market in hopes of getting a higher return. The general connection between the stock market and interest rates, then is that when interest rates are high, stock prices decline. When interest rates are low, stock prices increase.
When you watch the news and here reports that the stock market has gone down in value, is that always bad? Not according to Dean Baker, Co-director of the Center for Economic and Policy Research. In a speech on February 28, 2007, he said:
“A lower stock market is good for a lot of people. If corn prices fell 30 percent, that would be bad for you if you’re a corn farmer, but good for you if you weren’t and ate a lot of corn. Stock ownership is highly concentrated; 75 percent of the population holds little or no stock (including retirement accounts), so if stocks go down and you don’t own any, you’re better off.
“When stocks plunge in value, it’s similar to a situation where there are trillions of dollars in counterfeit currency, held by a small group of people, and the police seize and burn it. This is good news for the rest of us because the trillions of dollars of counterfeit money will not be bidding up the prices of things like houses and cars. Any honest economist would have to concede this point — it’s elementary economics, but many economists tend to cheer the stock market, in effect favoring the wealthy at everyone else’s expense.”
“Greenspan, as head of the Federal Reserve in 1987 intervened to bail out the stock market. The federal government takes as a goal higher stock prices — they don’t have higher wages as a policy. In retrospect, this intervention set the stage for the stock bubble of the 1990s. The U.S. government in effect subsidizes stock owners, who tend to be wealthier.”
Components of Gross Domestic Product
For economists, measurement of the economy is an important job. Economists like to peer into their crystal balls and try to predict the future. From the earliest days of our nation’s history, the government has kept statistical records on the performance of our economy. As our economy has grown larger and more complex, the importance of keeping economic statistics has increased. One such statistic is Gross Domestic Product. One way to measure a nation’s economic performance is to look at output, or who is doing the purchasing. This is where gross domestic product comes in. Gross domestic product measures the sum of the final value of goods and services produced domestically by a nation in a year. Gross domestic product is calculated by adding three components, and then either adding or subtracting exports, based on the nation’s trade balance. GDP = C + I + G + ( X – M ) where C equals consumption, I equals investments, G equals government, X equals exports and M equals imports. Let’s take a closer look at the individual components of gross domestic product.
Consumption. This component of GDP refers to consumer spending. There are three categories for consumer spending: 1) durable goods (items that last longer than 3 years, such as cars and furniture, 2) non-durable goods (items that typically last less than 3 years, such as clothing and food, and 3) services (recreation, education, medical treatment). Services include commodities that cannot be stored and are usually consumed when purchased. Consumer spending accounts for 70% of all economic activity.
Investment Spending. This is the spending by the private business sector on finished goods and services. There are two categories: 1) purchase of new capital (tools, equipment, buildings) for production, and 2) inventories, which are goods already produced but unsold. When orders for inventories increase, it usually means that companies are receiving orders for goods they don’t have in stock, and so are ordering more to have enough on hand. It’s important for companies to have enough inventory so they don’t disappoint and turn away potential customers. These customers may find what they need elsewhere, and never return. Therefore, a business would rather have just a little too much on hand than not enough. Therefore, an increase in private inventories is a contribution to GDP.
The wages and salaries that businesses pay to workers are not counted as businesses investment (“I”). That money is already counted in consumption (“C”) because that is the money that households are spending. Investment (“I”) includes only spending by businesses on goods and services, including raw materials, vehicles, offices and factories, and computers, furniture, and machinery.
Government Spending. Spending by the government for finished goods and services. This includes federal, state, and local governments. Government accounts for about 18% of total purchases. Exports. This category refers to goods and services sold to other countries. Currently this category is negative, because we import more from other countries than they buy from us ( trade deficit). Because we import more than we export, we need to include (X – M) in computing GDP.
What Gets Counted in GDP
1) The GDP for a particular year includes only goods and services produced within the year. Sales of items produced in previous years are excluded. For example, if in the year 2008 you purchase a car made in 2004, it might bring you happiness, but it does not add to the GDP of 2008. That car was counted in the year 2004’s GDP.
2) Only final goods and services count in the GDP. This is done to avoid double counting. For example, glass sold to automobile plants or hardware stores is not counted. The glass gets counted in the final sale of a car or a window pane.
3) The word “domestic” means that the goods and services must be produced within the geographical boundaries of the United States. Trucks produced at the General Motors plant in Janesville are counted in the United States GDP. Trucks produced at the plant in Mexico are not counted, even though they are produced by an American company.
To sum up, GDP measures only the value of new, domestic production. It is a quantitative, rather than a qualitative, measuring tool.
Criticisms of Using GDP to Measure the Economy
All statistics have their faults. Using gross domestic product as an evaluative tool for our economy has its problems. Many economists and social commentators have criticized its use. The information below will describe some of the reasons why people have a problem with using GDP.
1. One of the first problems associated with gross domestic problem is how to account for the effect of inflation. This brings up the difference between Real and Nominal gross domestic product. Nominal GDP measures the current value ( today’s prices) of all new domestically produced final goods and services. Real GDP measures the value of current total production using fixed prices (former prices of a base year). For example, if shoes cost $25 this year, but only cost $20 last year, then 100 shoes will contribute $2,500 to this year’s nominal GDP, whereas they contributed only $2000 to last year’s nominal GDP. But attention should be given to production. In both years 100 shoes were produced. Output had not grown.
2. A second problem in using GDP to measure the nation’s economic performance is that it doesn’t take into account goods and services not for sale (non-market transactions). There are two major areas that go uncounted. The first is the household. Unpaid, do-it-yourself activities such as painting your house, growing a garden or fixing your car are not counted in the GDP. Nor are household chores, even if they contribute to an individuals and a nation’s well being.. The second source is the underground economy. For example illegal transactions such as drugs or bartering goods to avoid paying taxes are not counted in the GDP. Some economists estimate that the underground economy may be as large as 10% of the measured GDP. In poorer countries the underground economy’s share of GDP is even higher. This factor helps to explain the large gap in GDP between a developed country like the United States, and a less developed country. Many people in poorer countries work at home, and so the work is not counted. People in these countries will also engage in barter, or purchase needed items through a underground economy.
3. A third problem is that GDP doesn’t say anything about how the goods and services are distributed amongst the population. The GDP can show an increase in a particular year, but it might mean that those in the top 20% made a great deal of money, while those in the bottom 80% lost a little. But the statistic only shows the entire nation benefiting.
4. A final shortcoming of using GDP is that quality changes are not reflected. For example, leisure time is not considered. If someone retires, GDP decreases, even though that person believes their life improved. “Bads” as well as “goods” get counted. For example, if a tornado destroys a town, and money is spent to rebuild it, it shows up as a positive in the GDP, even though the people living in such a town would not consider tornado damage a positive. Environmental and other social costs are also not considered. Air and water pollution, as well as garbage and waste from the production of goods have a cost to society that is not counted in the GDP. Below is a quote that looks at what the GDP does and does not cover:
“Our gross national product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors, and the jails for the people who break them. It counts the destruction of the redwoods, and the loss of our natural wonder in chaotic sprawl. It counts napalm, nuclear warheads, and armored cars for the police to ﬁght the riots in our cities. Yet the gross national product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public ofﬁcials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile.” – Robert Kennedy
Anyone who believes that exponential growth can go on forever in a finite world is either a madman or an economist.” Kenneth Boulding
Per Capita Real GDP
Per capita real GDP is a more accurate measurement of how countries are doing relative to one another. It is easy to say that the United States is doing better than Japan, which has the second largest GDP, but that is because the United States has over twice the population of Japan. To calculate per capita real GDP, all that is needed is to divide the gross domestic product of a country by its population. The example below is for per capita real GDP in the United States for 2015.
GDP = $17,970,000,000 = $56,300 (est.)
International Comparison of GDP
The question is often asked, which country in the world has the largest gross domestic product? Figuring this out requires some work. In order to find out, the GDP of one country has to be converted into the same currency units as the real GDP of another country. Remember, exchange rates fluctuate, and so exact precision is difficult. However, once the calculations have been completed, the United States has the largest GDP in the world.
Summary of Gross Domestic Product
The economic significance of using GDP in undeniable. A decline in GDP means unemployment is increasing. It also means that we have limits on what social problems can be addressed by the government. Conversely, a good GDP can give businesses confidence. Not everyone believes that GDP is the most accurate tool for measuring the economy. GDP does a good job at measuring growth, but doesn’t do a good job in measuring sustainability. In the mid 1990’s a new tool was developed called the Genuine Progress Indicator (GPI) as an alternative to the gross domestic product (GDP). The GPI enables policymakers at the national, state, regional, or local level to measure how well their citizens are doing both economically and socially. The GPI starts with the same personal consumption data that the GDP is based on, but then makes some crucial distinctions. It adjusts for factors such as income distribution, adds factors such as the value of household and volunteer work, and subtracts factors such as the costs of crime and pollution.
When you here a news report about GDP statistics, you may want to wait a little longer for accuracy. The reason is because: Each quarterly GDP report gets three releases:
- Advance Report Comes out one month after the quarter ends. This can often be wildly different from the final report, simply because all of the trade and business inventory data is not in yet.
- Preliminary Report Comes out two months after the end of the quarter. This is usually pretty realistic.
- Final Report Comes out three months after the end of the quarter. Usually only tweaks the Preliminary Report
Our country experienced double digit unemployment rates during the Great Depression. Since then, our government has made it a priority to focus on how to keep the unemployment rate down. That means to promote long term economic growth, we first have to fix any short term unemployment problems. To achieve economic growth, governments focus on a number of economic indicators including unemployment. The unemployment situation focuses on the number of workers in the labor force. Unemployment results in hardships for individuals and families. Besides imposing a cost on individuals, unemployment also is a burden for an economy. Fewer goods and services are produced. When the economy does not provide enough jobs to individuals who are seeking work, the productivity of that unemployed labor is lost. Finally, during periods of unemployment, governments increase social spending, such as unemployment compensation.
The Labor Force
The United States labor force consists of anyone who is 16 years or older, not in an institution, and is working. The Civilian labor force is the labor force minus the military. In economic terms, unemployment then refers to idle labor.
The Unemployment Rate
To be counted in the unemployment rate, a person must be at least 16 years of age and without work, but actively looking for a job. The unemployment rate then, is the ratio of the number of unemployed persons to the number of persons in the labor force. For example, if there are 128 million people in the labor force, and their are 8.7 million people unemployed, then the unemployment rate would be 6.8 percent.
Unemployment rate = number of unemployed 8.7 million = 6.8%
labor force 128 million
Types of Unemployment
There are four main types of unemployment. Of the four, structural and cyclical are of the most concern to economists and government officials.
Frictional Unemployment. Temporary unemployment due to imperfections in the labor market. It occurs when people are in between jobs or just entering or reentering the labor force. Frictional unemployment is brief. It takes time to post a position, go through the interview process, and then to finally get a person to the business to work. At any given time, 2 – 3 percent of the labor force is frictionally unemployed. Examples of frictional unemployed workers include those who get fired, quit, or are looking for new jobs, students, homemakers reentering the labor force, and servicemen and women who have recently been discharged from the armed services.
Structural Unemployment. Long term unemployment due to changes in the structure of the economy. Demand for some kinds of goods gives way to demand for other types of goods. For example, telegraph operators have lost their jobs to technology. Other reasons that contribute to structural unemployment include: 1) workers lacking required skills, 2) unable to move out of depressed areas, 3) displaced because of changing technology, 4) discrimination, and 5) employers laying off workers because the cost exceeds the return. The affect of structural unemployment in an economy is sometimes hard to measure. If a worker loses a high paying job, say at $15 per hour, and gets rehired at say $7 an hour, statistically this worker shows up as employed. But such a statistic is misleading. That worker will have to adjust his/her living standards accordingly. If this is happening to tens of thousands of workers simultaneously, then the country’s living standard is decreasing.
Cyclical Unemployment. Caused by a downward swing in the business cycle. It affects workers in many different industries simultaneously, and is usually accompanies a recession or depression. As income drops, spending drops, which eventually leads to workers being laid off. The government tries to avoid cyclical unemployment through the promotion of growth and efficiency.
Seasonal Unemployment. In our society, at any given time, there are thousands of people out of work because it is the “slow season”. There is a “tourist season” and a “harvest season”. When the season is over, the workers may collect unemployment benefits or remain out of the workforce until the new season begins.
Full Employment. Full employment refers to when an economy operates at an unemployment rate equal to the sum of frictional and structural unemployment rates, which most economists consider essentially unavoidable. The definition of full employment has changed over the years. It has increased. It used to be 3%. Now it ranges between 4 and 5 % depending on the economist or the current administration. It is another way of underestimating the impact of unemployment.
Limitations of Using the Unemployment Rate as a Measuring Tool
There are a number of problems with using the unemployment rate as a method to assessing our economy. First, the unemployment rate can sometimes overstate the number of people unemployed. Some people who claim to be unemployed and actively looking for work may not be actively looking. a person might claim to be actively looking for a job to remain eligible for government payments to the unemployed. In this case, a person who is actually not in the labor force is counted as unemployed. Other people might be engaged in illegal activity, such as drug dealing, or want to conceal a legitimate job to avoid paying taxes. The opposite can also be true. Sometimes there is understating of the number of people unemployed. For example, discouraged workers, those workers who would like to have a job but have given up looking, are not counted as unemployed because they are not included in the labor force. Where are these discouraged workers? They are in depressed rural areas and in our nation’s largest cities. If you visit these places during the day you will find many teenagers and adults standing around with nothing to do. From a statistical point of view, these people are not considered unemployed. It is as if they are not part of our economy. To be counted as unemployed by the Bureau of Labor, you have to be looking for work. A third problem is that the official unemployment rate includes part-time workers as fully employed. A fourth problem is dealing with underemployed. These are workers who are working at jobs that they are overqualified for. The traditional person with a Ph.D driving a taxi cab is an example. The economy does not benefit from the full range of their skills.
To sum up, the U3 measure of unemployment only measures unemployment among those who are actively seeking a job. Those who have become discouraged by the inability to find a job and have ceased looking are not counted as being among the unemployed, and the U3 measure makes no adjustment for those who are forced into part-time jobs because there is no full-time employment.
The government knows that the U3 “headline” unemployment rate is seriously understated and provides a broader measure known as U6. This measure, which is seldom reported by the financial media, includes short-term discouraged workers (those who have not looked for jobs for six months or less) and an adjustment for those who wish full time employment but can only find part time work.
Add long-term discouraged workers. No official unemployment rate includes long-term (more than six months) discouraged workers as unemployed.
John Williams from shadowstats.com estimates this number and adds it to the U6 measure to produce a current rate of US unemployment of 22.5 per cent (January 2012), an unemployment rate 2.5 times higher than the official rate. John Williams also believes there are problems with the Bureau of Labor Statistics seasonal adjustments and “birth-death” model where the BLS overestimates new jobs and underestimates lost jobs. Seasonal adjustments and the “birth-death” model were designed with a growing economy in mind and result in miscounts during downturns. For example, the “birth-death” model estimates new jobs that are created from new start-up companies that are not yet reporting, and it estimates the job losses from companies that have gone out of business. In a growing economy, start-ups exceed jobs losses, but the situation reverses during downturns or during periods of sub-normal job growth.
An Alternative Perspective on Unemployment
What has been explained above is the textbook definition and the traits and features of unemployment that can be found in most economic textbooks. But what does “unemployment” mean to individual workers? How does unemployment come to exist? Unemployment is an indicator of the enormous increase in the productivity of labor. More and more products are generated with fewer and fewer people. Millions are not needed because the workers who are still needed are so productive that everything the employers want to have produced at a profit has already been produced. In other words: people are unemployed, made “redundant,” because of abundance. The means to produce wealth have become so highly developed that society needs less and less workers. Productivity advances throw millions of people out of work and into destitution. By using workers more efficiently and more intensely, employers cut down on their costs – and that is what workers are for them, costs to be reduced and minimized. In our modern economy, productivity increases mean that more is produced for the companies with cheaper labor. When this happens, their wealth grows. On the other side, the poverty of those who are no longer needed grows.
So as more workers lose their jobs, a transformation occurs on how to view unemployed workers. What begins as a concern for the plight of the unemployed ends as a concern for profit and the health of the economy. What begins as a show of sympathy for the hardships of the unemployed turns into a criticism of the burden that the unemployed put on the state and its budget. What begins as the self-criticism of the government, that it has not done enough to provide workers with opportunities, ends as a criticism of the unemployed (keywords: “skills shortage” or “education gap”). The unemployed workers themselves are blamed for their lack of work. No discussion is allowed on how the economic system (capitalism) might be responsible for persistent unemployment.
Because of the manipulation of the official unemployment rate, many people are suggesting that the Civilian Labor Force Participation Rate is a more reliable statistic for measuring unemployment. According to the Household Survey Report of October 2014, 232,000 people found jobs. What is more disturbing is that the people not in the labor force, rose to a new record high, increasing by 315,000 to 92.6 million. The official unemployment rate for October 2014 fell to 5.9%. The official Civilian Labor Force Participation Rate also fell from 62.8% to 62.7%. How can that be? This is explained because more people have given up looking for work and no longer fall on the Bureau of Economic Statistics radar.
2. Shadow Stats
As mentioned in the previous unit on unemployment, our country tries to support policies that will improve our long term economic growth. Another goal of our government is to strive to keep prices stable. Every administration tries to avoid inflation problems because they know voters tend to blame higher prices on whoever is in office. This section will explain what inflation is, how the government measures it, and the consequences to inflation.
Inflation refers to the increase in the average price of goods and services in the economy. It represents an increase in the overall average level of prices and not an increase in the price of any specific product. During the late 1970’s and early 1980’s the United States experienced a time of rising prices. The opposite of inflation is deflation. Deflation is a decrease in the average price level of goods and services. During the Great Depression of the 1930’s, the United States experienced a period of deflation. Since the 1950’s, the United States’ inflation rate has ranged from a low of zero to a high of thirteen percent, with most years averaging around 4 percent. Is this good or bad? To some people (especially those on a fixed income like retirees), any increase is bad. But compared to other countries, (Brazil in 1989 1,700% or Bolivia in 1985 at 50,000%) are inflation rates are low.
If you have watched the business section of the evening news, you will have noticed a new term being used recently to describe a way of understanding the effect of inflation. That term is “core inflation”. Core inflation is generally defined as a chosen measure of inflation (e.g., the Consumer Price Index or CPI) that excludes the more volatile categories of food and energy prices. There are reasons why these items are removed. Food and energy are more sensitive to price changes. With respect to food, there might be a drought or a natural disaster, such as a hurricane or frost, might destroy an entire crop, creating a shortage, and thus driving up prices. Energy prices too, are subject to rapid rate increases. If there is a terrorist attack somewhere in the world, or if the OPEC cartel decides to limit production or raise prices, the price of oil and gas can climb upward quickly. This means that quick increases in the prices for food and energy do not necessarily mean that inflation is affecting the economy as a whole. In other words, it might mean that the price of food and energy is increasing, but the price of everything else is staying the same or going down. So the argument is used that if we were to include food and energy that economists would be overstating the affect of inflation. But by excluding food and energy, can economists be also “understating” the affects of inflation? Don’t most families spend a good portion of their income on food and energy? And if so, does not using the “core inflation” rate as a measuring tool, understate the problem of inflation on the economy?
The United States government uses the consumer price index to measure the rate of inflation. The consumer price index (CPI), measures changes in the average price of consumer goods and services. This index is compiled monthly by the Bureau of Labor Statistics (BLS). Each month officials at the BLS contact retail store, homeowners, and tenants in selected cities around the country to record average prices for a “market basket” of different goods purchased by the typical family (approximately 90,000 items). So the CPI then looks at the average prices paid by a variety of people, in a variety of locations, buying a variety of products.
Criticisms of the CPI
There are a number of criticisms about using the CPI. The first criticism is that many consumers have a different “market basket” of goods than the CPI’s market basket. This difference may over or under state the impact of inflation. An example would be retired persons. They may buy some products (prescription drugs) that the average family does not. Another problem is the CPI does not make adjustments for changes in quality. For example, look at new computers. A new computer can do significantly more work than an older one and probably costs less. Finally, the CPI does not make allowances for the law of demand and the substitution of goods. For example, if the price of oranges increases, the demand will decrease, and consumers could then buy cheaper apples, thus overstating the rate of inflation.
In order to reduce cost-of-living adjustments to Social Security checks and to hold down other inflation adjustments, the Clinton administration accepted the Boskin Commission’s recommendation to introduce substitution into what had been a fixed, weighted, basket of goods used to measure the cost of a constant standard of living. In the new “reformed” measure, if the price of an item increases, say New York strip steak, the index assumes that consumers switch to a less expensive cut, such as round steak. Thus, the price increase doesn’t show up in the CPI. The US government’s measure of inflation then no longer measures a constant standard of living. Instead, the government’s inflation measure relies on substitution of cheaper goods for those that rise in price. In other words, the government holds the measure of inflation down by measuring a declining standard of living. This permits our rulers to divert cost-of-living-adjustments that should be paid to Social Security recipients to our wars of aggression, the police state, and banker bailouts.
Consumers, or a number of them, do tend to behave in this way. However, since the basket of goods comprising the CPI is no longer constant, but changes with price changes, the CPI has become a variable measure of the cost of living that reduces the inflation rate by measuring a lower standard of living.
John Williams, from shadowstats.com, estimates the CPI according to the previous official methodology that used a fixed basket of goods. He finds the rate of inflation to be much higher than is reported by the substitution-based methodology.
When John Williams adjusts US GDP with the former or traditional measure of inflation, he finds that there has been no growth in real GDP for several years. In other words, during the period of “economic recovery” the economy has actually been declining.
Consequences of Inflation- Who Does it Hurt?
There are a number of problems associated with inflation. Some groups are negatively affected by inflation. They are:
1) Workers and those on fixed incomes. Why? Because inflation shrinks income. If the percentage change in income is less than the inflation rate, then your purchasing power is shrinking. For example, if your income rises 3%, but the inflation rate is 5%, then your purchasing power is declining.
2) Owners of wealth benefit if their assets increase faster than inflation. In most cases it does. An example would be those who own real estate or stocks. The poor, who don’t own much real estate or stock, therefore feel the pain of inflation more.
3) People who save their money. If you are a saver and inflation rates are higher than interest rates, then you are losing purchasing power. For example, if the bank is paying 2% interest on your money, but the inflation rate is 5%, then your money has lost 3% of its value.
4) Finally, if you lend money to someone, and the inflation rate is higher than the interest rate, then you as a lender are losing purchasing power. For example, if a parent lends money to a son or daughter at 5% interest, and the inflation rate is 10%, then the lender is losing purchasing power.
Types of Inflation
The first type of inflation is demand-pull. Demand-pull inflation is a rise in prices due to too much spending (demand). In other words it is ” too many dollars chasing too few goods”. Demand pull inflation occurs when sellers are unable to supply all the goods and services buyers demand. Demand-pull inflation usually occurs when the economy is at or near full employment. An example of demand-pull inflation occurred after World War II when there was more money in the economy than there were goods for sale. The second type of inflation is cost-push. Cost-push inflation is a rise in prices due to an increase in the cost of production. Increases in the cost of labor, raw materials, equipment, and borrowing money, push up the cost of production. An example of cost-push inflation occurred in the 1970’s when the price for oil increased, which caused oil related products to increase in price as well.
Sometimes there is an extremely rapid rise in prices. This is called hyperinflation. Inflation rates of over 100% per year are generally considered hyperinflation. There are many causes to hyperinflation. The first is that consumers lose confidence in the economy and begin hoarding goods. They buy today because they think it might cost more to buy tomorrow. The debtor-lender contracts are also jeopardized. For example, homeowners might find it increasingly difficult to make payments when interest rates rise unexpectedly. A wage-price spiral also occurs. This is when workers ask for an increase in wages to meet the increase in prices, which causes prices to rise again, which causes workers to ask for more wage increases, which causes prices to rise…. During periods of hyperinflation, wealthy people will often put their money into safer investments such as gold, jewelry, art, or other currencies looking for a return that is higher than the inflation rate, rather than into capital investment like new factories or machines which might help the country. Finally, hyperinflation is often the result of a government’s decision to increase the money supply. Governments hope for a short term solution, but get instead a long term problem. This occurred in Germany after World War I in the 1920’s, and in Latin American countries such as Bolivia in the 1980’s. In Yugoslavia in 1993-1994, the currency (dinar) experienced severe hyperinflation. The picture below is a $500 billion note.
Below is a $100 Trillion Dollar Bank Note from Zimbabwe which was put into circulation in 2010.
1923 Weimar Republic inflation: A German woman feeding a stove with Papiermarks, which burned longer than the amount of firewood people could buy with them.
Stagflation is a condition when an economy experiences both high unemployment (stagnation)and high inflation. It was long assumed by economists that an economy could not experience both high periods of unemployment and high periods of inflation at the same time. A country would only experience one economic problem at a time. However, this theory was disproven in the 1970’s. During the 1970’s the United States experienced both high unemployment and high inflation at the same time. Because of rising oil prices, in 1974-1975, the United States experienced an inflation rate of 12 percent and an unemployment rate of 9 percent.
Parkin, Michael 2000 Economics (5th Edition) New York: Addison- Wesley
Slavin, Stephen L. 1999 Economics (5th Edition) New York: Irwin McGraw-Hill
Taylor, John B. 2001 Economics. Boston: Houghton Mifflin Company
Tregarthen, Timothy. 2000 Economics (2nd Edition) New York: Worth Publishers
Tucker, Irvin B. 2008 Survey of Economics New York: Southwestern Publishing Company
1. Of Mice and Men. A mentally retarded giant and his level-headed guardian find work at a sadistic cowboy’s ranch during the Great Depression.
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