Chap14 Fundamental Economic Concepts

Do you worry about

the future? If you are

concerned about getting a job,

earning a decent income, or

keeping up with inflation, the

concept of economic stability is

important to you. To learn more

about the effects of unemploy-

ment and inflation, view the

Chapter 21 video lesson:

Fighting Unemployment,Inflation, and Poverty

Chapter Overview Visit the Economics: Principlesand Practices Web site at epp.glencoe.com andclick on Chapter 14—Chapter Overviews to pre-view chapter information.

Downturns in the economy resultin some businesses failing.Downturns in the economy resultin some businesses failing.

http://epp.glencoe.com

Business Cycles and Fluctuations

Main IdeaThe term “business cycle” refers to alternating increasesand decreases in the level of economic activity.

Reading StrategyGraphic Organizer As you read the section, completea graphic organizer similar to the one below by list-ing factors that can cause changes in the businesscycle.

Changes in the business cycle

Key Terms business cycle, business fluctuation, recession, peak,trough, expansion, trend line, depression, depressionscrip, econometric model, index of leading indicators

ObjectivesAfter studying this section, you will be able to:1. Explain the phases of the business cycle.2. Identify five causes of business cycles.

Applying Economic ConceptsEconomic Security Do you have a job and a paycheckon which you depend? Read to find out how econo-mic instability can threaten your income.

Cover StoryLeading Indicators Rise in July

WASHINGTON–A

key U.S. forecasting gauge

rose in July for the fourth

consecutive month, mark-

ing the best economic con-

ditions since the recession

started two years ago, a pri-

vate research firm said on

Thursday. The Conference Board

said the index of leading

indicators rose 0.4 percent

in July . . . after a 0.3 per-

cent increase in June.

“With export growth

still months away, the burden now falls on consumer spend-

ing and business investment,” [said] Conference Board

Chief Economist Ken Goldstein. “The bottom line is that the

leading economic indicators are more favorable now than

at any time since the recession started more than two

years ago.” —Reuters, August 21, 2003

Leading indicators may signal

end of recession.

E conomic growth is something that is beneficialto almost everyone. However, we cannot takeeconomic growth for granted. Sometimes eco-

nomic growth is interrupted by business cycles—largely systematic ups and downs of real GDP. Atother times economic growth is interrupted bybusiness fluctuations—the rise and fall of real GDPover time in a nonsystematic manner.

Either way, economic growth—even the record-setting expansion that took place during the 1990s—always comes to a halt before it begins to take offagain. The inevitable ups and downs of the econ-omy are among the reasons why economists havedeveloped tools like the monthly index of leading indicators featured in the cover story.

Business Cycles in the UnitedStates

Economic activity in the United States fol-lowed an irregular course throughout the

twentieth century. The worst and most prolongeddownturn was the Great Depression of the 1930s.The years since World War II have taken on a spe-cial pattern of their own.

CHAPTER 14: ECONOMIC INSTABILITY 375

375_GLENEPP 11/5/03 5:26 PM Page 375

Phases of the Business Cycle The two phases of the business cycle are illus-

trated in Figure 14.1. The first phase is recession, aperiod during which real GDP declines for twoquarters in a row, or six consecutive months. Therecession begins when the economy reaches apeak—the point where real GDP stops going up. Itends when the economy reaches a trough—theturnaround point where real GDP stops goingdown.

As soon as the declining real GDP bottoms out,the economy moves into the second phase of thecycle, expansion—a period of recovery from arecession. Expansion continues until the economyreaches a new peak. If periods of recession andexpansion did not occur, the economy would fol-low a steady growth path called a trend line. AsFigure 14.1 shows, the economy departs from, andthen returns to, its trend line as it passes throughphases of recession and expansion.

If a recession becomes very severe, it may turninto a depression—a state of the economy withlarge numbers of people out of work, acute short-ages, and excess capacity in manufacturing plants.

Most experts agree that the Great Depression of the1930s was the only depression the United Stateshas had in the twentieth century.

The Great Depression The stock market crash on October 29, 1929, or

“Black Tuesday,” marks the beginning of the GreatDepression. Between 1929 and 1933, GDP fellfrom approximately $103 to $55 billion—a declineof nearly 50 percent. At the same time, the numberof people out of work rose nearly 800 percent—from 1.6 to 12.8 million. During the worst years ofthe Depression, one out of every four workers wasjobless. Even workers who had jobs suffered. Theaverage manufacturing wage, which had reachedfifty-five cents an hour by 1929, plunged to fivecents an hour by 1933.

Many banks across the country failed. TheFDIC did not exist at the time, so depositors werenot protected. To prevent panic withdrawals, thefederal government declared a “bank holiday” inMarch of 1933. Every bank in the country closedfor several days, and many banks never reopened.

E C O N O M I C SA T A G L A N C EE C O N O M I C SA T A G L A N C E Figure 14.1Figure 14.1

Using Graphs The business cycle is marked by alternating phases of recession and ex-pansion. What does a trough indicate?Using Graphs The business cycle is marked by alternating phases of recession and ex-pansion. What does a trough indicate?

Phases of the Business Cycle

RECESSION

Peak

Peak

Trough

EXPANSION EXPANSION

Trend Line

RECESSION

Real GDP

376 UNIT 4 MACROECONOMICS: POLICIES

The money supply fell by one-third. Currencywas in such short supply that towns, counties,chambers of commerce, and other civic bodiesresorted to printing their own money, known asdepression scrip. Several billion dollars of scripwas used to pay teachers, firefighters, police offi-cers, and other municipal employees.

Causes of the Great Depression Several factors contributed to the Great

Depression. One was the disparity in the distribu-tion of income. A great number of very poor andvery rich people lived in America. The poor couldnot stimulate the economy with consumer spend-ing because they had little or no income. The richhad the income, but often used it for such non-productive activities as stock market speculation.

Easy and plentiful credit also appears to haveplayed a role. Many people borrowed heavily in thelate 1920s, which made them vulnerable to creditcontractions, high interest rates, and even minorbusiness fluctuations. When the crunch came, heav-ily indebted people had nothing to fall back on.

Global economic conditions also played a part.During the 1920s, public and private institutions inthe United States made many foreign loans to helpsupport a high level of international trade. Shortlybefore the Depression began in the United States,the private institutions withdrew many of theseloans. Without the loans, some foreign nationscould no longer buy American goods, so Americanexports fell sharply.

At the same time, high American tariffs onimports kept many countries from selling goods tothe United States. Many countries that depended

RUBLES? WHO NEEDSRUBLES?During difficult economic times, barter can serveas a medium of exchange. Many economies alsorevert to barter when people lose faith in themoney supply––and that’s exactly what hap-pened in Russia.

The chart shows how Yuri Neyolov, governor ofRussia’s Yamal-Nenets Autonomous Region,“bought” an airplane for his government. Thisstory––and thousands like it––are commonplacethroughout Russia.

1. Analyzing Information Which functions ofmoney did the gas owned by Gazpromperform?

2. Drawing Conclusions Are there any bartertransactions that take place in theAmerican economy? Why would anyoneprefer barter to money transactions?

Critical Thinking

AVIACAR, lacking cash, can’t buy components to make the plane. TOLMACHEV trades more than 100 cars, tractors, and buses to acquire a $2 million engine and swaps $250,000 of electricity and tires to secure electrical equipment from different companies.

GOVERNOR gets his plane six months after the transaction begins. TOLMACHEV earns a commission equal to 10% of the $17 million plane.

GAZPROM, claiming to lack cash, offers to pay in gas.

TOLMACHEV then signs contract with aircraft manufacturer AVIACAR.

GOVERNOR asks barter specialist, ANDREI TOLMACHEV, to trade the gas for an airplane.

GOVERNOR of Yamal-Nenets Region demands payment of energy royalties from gas monopoly, GAZPROM.

Portrait of a Deal

Source: Business Week, April 13, 1998


heavily on sales to the United States were soon facedwith economic crises. As the Depression spreadfrom country to country, world trade declined, andAmerican exports dropped even further.

Business Cycles Since World War II Massive government spending during World War

II added a huge stimulant to the economy for mostof the early 1940s. Recession returned in 1945, but itdid not last. As soon as the war was over, consumerswent on a buying binge that stimulated expansionagain. The economy experienced several more reces-sions after that, but each downturn was short com-pared with the length of the recovery that followed.The average recession lasted about 11 months, whilethe average expansion lasted 43 months.

Figure 14.2 shows the recurring pattern of reces-sions and expansions since 1965. With few excep-tions, most of the earlier recessions occurred on afairly regular basis. After 1980, however, recessionsoccurred less frequently. The expansion that beganin 1991 is the longest expansion in United Stateshistory.

Causes of the Business CycleNo one theory seems to explain past busi-ness cycles, or serves as a way to predict

future ones. In many cases, several factors areworking together to create a cycle.

Capital Expenditures Changes in capital expenditures are one cause of

business cycles. When the economy is expanding,

businesses expect future sales to be high, so theyinvest heavily in capital goods. Companies maybuild new plants or buy new equipment to replaceolder equipment in their plants. After a while, busi-nesses may decide they have expanded enough.They begin to pull back on their capital invest-ments, causing layoffs in the capital goods indus-tries and, eventually, recession results.

Inventory Adjustments Inventory adjustments, or changes in the level

of business inventories, are a second possible causeof business cycles. Some businesses cut back oninventories at the first sign of an economic slow-down and then build them back up again at thefirst sign of an upturn. Either action causes invest-ment expenditures—and therefore real GDP—tofluctuate.

The influence of inventory adjustments showedup clearly in the business cycle of the late 1940s.Right after World War II, businesses in the UnitedStates invested heavily in inventories to fillshelves depleted during the war years. By 1948consumer demand caught up with the backlogand people stopped buying. Inventories built upon store shelves, so businesses stopped buyinginventory. The resulting recession of 1949 lastedfor about a year.

Innovation and Imitation A third possible cause of business cycles is inno-

vation. An innovation may be a new product or anew way of performing a task. When a businessinnovates, it often gains an edge on its competitorsbecause its costs go down or its sales go up. Ineither case, profits increase, and the business grows.If other businesses in the same industry want tokeep up, they must copy what the innovator hasdone or come up with something even better.

The imitating companies must invest heavily todo this, and an investment boom follows. After theinnovation takes hold in the industry, however, thesituation changes. Further investments are unnec-essary, and economic activity may slow.Meanwhile, the fluctuation of investments has pro-duced a business cycle.

INFOBYTEINFOBYTE

The Business Cycle The term “business cycle”describes economy-wide fluctuations in output,incomes, and employment. Generally, periods ofexpansion follow periods of low output.


Monetary Factors A fourth possible cause of business cycles is the

credit and loan policies of the Federal ReserveSystem. When “easy money” policies are in effect,interest rates are low and loans are easy to get.Easy money encourages the private sector to bor-row and invest, which stimulates the economy fora short time. Eventually the increased demand forloans causes interest rates to rise, which in turndiscourages new borrowers.

As borrowing and spending slow down, the levelof economic activity declines. Lenders think twiceabout making new loans or renewing old ones, andthe business cycle begins again.

External Shocks A final potential cause of business cycles is

external shocks, such as increases in oil prices,

wars, and international conflict. Some shocks drivethe economy up, as when Great Britain discoveredNorth Sea oil in the 1970s. Other shocks can benegative, as when high oil prices hit the UnitedStates in mid 2003.

Predicting Business CyclesEconomists use a number of methods topredict business cycles. One popular tech-

nique involves macroeconomic modeling. Anothermakes use of statistical predictors.

An econometric model is a macroeconomicmodel that uses algebraic equations to describehow the economy behaves. Most models usedtoday are based on some adaptation of the output-expenditure model we examined earlier:

GDP � C � I � G � (X � M)

Figure 14.2Figure 14.2

Using GraphsUsing Graphs The index of leading indicators is one of the tools used to predict future economic activity. How do economists use this index to predict recessions?

The Index of Leading Economic IndicatorsIn

dex

of L

eadi

ng I

ndic

ator

s: 1

996

= 10

0 120

100

60

80

Year1965 1970 1975 1980 1985 1990 1995 2000 2005

Recession years

Source: The Conference Board

On average, the indexturns down 9 months before

the recession begins.

Occasionally, the index predicteda recession that never occurred.

On average, the indexturns up 4 months before

the recovery begins.

Visit epp.glencoe.com and click onTextbook Updates—Chapter 14 foran update of the data.


379_GLENEPP 11/5/03 5:28 PM Page 379


For example, an economist might use F to standfor exports, and S for imports (instead of (X – M)for the foreign sector) to get:

GDP � C � I � G � (F � S)

Other equations in the model also may be substi-tuted for some of the variables. Suppose that house-holds annually spend a fixed amount of money,designated as a, along with 95 percent of their dis-posable personal income. In this case, C � a � .95(DI). If this were substituted for the C in the output-expenditure model, the equation would read:

GDP � a � .95(DI) � I � G � (F � S)

The equation is then broken down into smallerand smaller components to the point where it mayhave as many as 1,000 variables.

To predict GDP, forecasters put in the latest fig-ures for the variables on the right side of the equa-tion. Because most econometric models are solvedusing a computer, little time is needed to obtain asolution.

As the quarter unfolds, actual changes in theeconomy are compared to the model’s predictions.The model is then updated. Some models give rea-sonably good forecasts for up to nine months.Overall, short-term econometric models haveproven their value and are used extensively.

Another tool used to predict the turning pointsof business cycles is the index of leading indicators,a monthly statistical series that usually turns downbefore real GDP turns down, and turns up beforereal GDP turns up. As we saw in the cover story, theindex is widely used to predict the direction offuture economic activity.

Some statistical indicators, such as the length ofthe average workweek—which tends to shrink justbefore a recession begins—are fairly good predictorsof real GDP changes. Still, no single series hasproven completely reliable. To resolve this prob-lem, 10 individual series are combined into anoverall index that closely patterns the behavior ofreal GDP, making the index of leading indicators auseful tool.

The behavior of the composite index can beseen in Figure 14.2, where the shaded areas repre-sent recessions. As you can see, the average timebetween a dip in the index and the onset of reces-sion is about 9 months. The average time between a rise in the index and an expansion isabout four months. The information it supplies isused along with results from other econometricmodels. Together, the results generally let the fore-caster predict how real GDP will behave in theshort run.

Checking for Understanding1. Main Idea Explain the difference between

a business cycle and a business fluctuation.

2. Key Terms Define business cycle, business fluc-tuation, recession, peak, trough, expansion,trend line, depression, depression scrip, econo-metric model, index of leading indicators.

3. Identify the two main phases of a businesscycle.

4. Explain how the Great Depression comparedto other recessionary periods.

5. List five causes of business cycles.

Applying Economic Concepts6. Economic Security Suppose you were the

head of a household. How would you plan

your spending for your family’s needs if youhad an accurate prediction of future businesscycles? Include examples in your response tothe question.

7. Understanding Cause and Effect If businessinventories are falling, the average hoursworked per week is going up, and there isan increase in the number of new buildingpermits, we would expect the economy tobe in an expansion phase of the businesscycle. Explain why each of these indicatorswould show that the economy would growin the near future.

Practice and assess key social studies skills withthe Glencoe Skillbuilder Interactive Workbook,Level 2.


380_GLENEPP 11/5/03 5:29 PM Page 380


ChampioningEconomic Freedom:

Walter E.Williams

(1936–)

Walter E. Williams is an econo-mist, author, and professor ofeconomics at George MasonUniversity. Williams’s views aredecidedly free market—and oftencontroversial.

FREEDOM IS KEY

“Economic freedom” is the cor-nerstone of Williams’s beliefs. Heargues that economic freedom isthe key to both economic growthand the fair distribution of wealth.Williams often points to HongKong, Korea, Taiwan, andSingapore as evidence of the spec-tacular economic growth that canbe achieved when there is littlegovernment intervention. This hasled him to become an outspokencritic of many popular governmentprograms.

Many Americans, for example,support the minimum wage. ToWilliams, however, it is a cause ofeconomic problems.

One example he cites involves acomparison between unemployment

levels of African American andwhite teenagers: “In 1948, blackteenage unemployment was lessthan that of whites. Compare itwith today and it’s the opposite,”Williams explains. “You can’texplain it by saying there was lessracism in 1948 than there is today.You can’t explain it by saying thatblacks had more education thanwhites in 1948. You have toexplain it by increases in both thelevel and coverage of the mini-mum wage law.” The implication isthat if employers had the freedomto pay lower wages, then moreblack teenagers would have jobs.

AFFIRMATIVE ACTION

Perhaps Williams’s most con-troversial stand is his oppositionto affirmative action. He views itas a violation of his cherished ideaof economic freedom, and worse:

“I think many government pro-grams have harmed blacks in mak-ing achievements less credible,” heargues. “For example, whateverinspiration Harvard or theUniversity of Virginia has inrequiring so many articles in thelaw journals to be written bywomen or by minorities reducesthe credibility of a black studentor a female student having writtenfor the law journal.”

Examining the Profile1. Summarizing Information Write a

short paragraph that identifies anddescribes Williams’s basic views.

2. Applying the Writing Process Writea response to what Williams saidabout unemployment levels amongwhite and African Americanteenagers. Explain why you agree ordisagree with his analysis.

Unemployment

Main IdeaFrictional, structural, cyclical, seasonal, and techno-logical are the general types of unemployment.

Reading StrategyGraphic Organizer As you read the section, completea graphic organizer similar to the one below by listingtwo ways that structural unemployment takes place.

Key Terms unemployed, unemployment rate, frictional unemployment, structural unemployment,

cyclical unemployment, seasonal unemployment, technological unemployment, automation

ObjectivesAfter studying this section, you will be able to:1. Explain how the Bureau of Labor Statistics deter-

mines if a person is employed.2. Describe five kinds of unemployment.

Applying Economic ConceptsEmployment Did you work for at least one hour perweek for pay or profit last month? Read to find outhow your answer to this question determines youremployment status.

Structuralunemployment

Cover Story

June Unemployment Rate Hits

9-year HighThe nation’s unemployment rate rose to 6.4 per-

cent in June, marking a nine-year high and separate-

ly marking the largest one-month increase since the

Sept. 11 attacks.Across the country, 30,000 jobs were cut in the

one-month period, with the deepest cuts in manufac-

turing—56,000 jobs were lost in that sector in June.

Construction jobs, by contrast, added 101,000 slots

since February, particularly in the housing sector.

Since March, unemployment has risen by 913,000,

with 2 million unemployed for more than 27 weeks as

of June.—San Francisco Business Times,

July 3, 2003

N early one-half of the population of theUnited States belongs to the civilian laborforce, and at any given time millions of

these people are without jobs. This issue is so impor-tant that full employment is one of the seven eco-nomic and social goals of the American economy.

Measuring UnemploymentTo understand the severity of joblessness, weneed to know how it is measured, as well as

what the measure overlooks. The measure of job-lessness is the unemployment rate, one of the mostclosely watched statistics in the economy.

The Unemployment Rate In the middle of any given month, thousands

of specialists from the Bureau of the Censusbegin their monthly survey of about 50,000households in nearly 2,000 counties, coveringall 50 states. Census workers are looking for theunemployed—people available for work whomade a specific effort to find a job during thepast month and who, during the most recent

382

The unemployment rate is

the percentage of the labor

force that is out of work.

382_GLENEPP 11/5/03 5:33 PM Page 382

survey week, worked less than one hour for pay orprofit. People are also classified as unemployed ifthey worked in a family business without pay forless than 15 hours a week.

After the Census workers collect their data, theyturn it over to the Bureau of Labor Statistics foranalysis and publication. This data is then pub-lished on a monthly basis.

Unemployment also is expressed in terms of theunemployment rate, the number of unemployedindividuals divided by the total number of personsin the civilian labor force. As Figure 14.3 shows, theunemployment rate tends to rise dramatically dur-ing recessions and then come down slowly after-ward. With a civilian labor force of approximately150 million people, a one-tenth of one percent rise

in the unemployment rate would mean that nearly150,000 people had lost their jobs. This number ismore than the population of cities such as KansasCity, Kansas; Syracuse, New York; Bridgeport,Connecticut; or Savannah, Georgia.

Limitations of the Unemployment Rate It might seem that a measure as comprehensive as

the unemployment rate would summarize the prob-lem. If anything, however, the unemployment rateunderstates employment conditions for two reasons.

First, the unemployment rate does not countthose who have become too frustrated or discour-aged to look for work. These labor force“dropouts” may include nearly a million people


Using GraphsUsing Graphs The unemployment rate goes up sharply during a recession and then comes down slowly thereafter. When the rate moves as little as 0.1 percent, approximately 140,000 workers are affected. How would you characterize the unemployment rate during the period from 1990 to 2002?

The Unemployment Rate

Perc

ent

Une

mpl

oyed

12

9

6

3

0

Year1965 1970 1975 1980 1985 1990 1995 20052000

Recession years

Civilian unemployment rate

Source: Bureau of Labor Statistics, United States Department of Commerce



383_GLENEPP 11/5/03 5:33 PM Page 383


Working in the NewEconomy

For generations, the economy was organized aroundmass production. Today, the new economy is fast becominga high-technology, service, and office economy. This doesnot mean that mass production is no longer important.Higher rates of productivity in manufacturing and farminghave resulted in fewer people producing more goods thanever before.

As the shift from a manufacturing to a service andknowledge-based economy continues, the rise of newindustries is creating new jobs. In addition, moderntechnology is changing the nature of many existingjobs, requiring new knowledge and a new set of skills.Now, more than 100 million Americans (nearly 80 per-cent of the total workforce) work in occupations thatare service-related or information-related.

The Virtual Workplace As electronic commerce andInternet business grows, fewer people will work in cen-tral offices, retail stores and other facilities. Analystsbelieve that the virtual workplace, allowing employees to

work from any locationwith a computer andInternet connection,will become more preva-lent. Ideally, the virtualworkplace makes use oftechnology and otherwork innovations toenable employees towork together acrossspace and time. Workersin a virtual workplacerequire a highly cus-tomized set of skills,ranging from highly technical specialties to workingindependently in a network or on a string of virtualteams.

Job Trends Jobs requiring postsecondary, vocational,or higher education are expected to grow as a share oftotal employment. Positions calling for individuals withat least an associate’s degree are expected to increasefrom 31 percent of all jobs in 1996 to 32.4 percent in2006. Along with an increase in the number of high-skilled jobs, the number of low-skilled jobs is expectedto grow. Occupations predicted to show the largest

More and more people areworking at home.

during recessionary periods. Although they are notworking, these people are not classified as unem-ployed because they did not try to find a jobwithin the previous four-week period.

Second, people are considered employed evenwhen they hold part-time jobs. Someone who haslost a high-paying job, but is working just one houra week at a minimum-wage job, would still be con-sidered employed. As a result, being employed isnot the same as being fully employed.

Kinds of UnemploymentEconomists have identified several differentkinds of unemployment. The nature and

cause of each affect how much unemployment canbe reduced in the economy.

Frictional Unemployment One kind of unemployment is frictional

unemployment—unemployment caused by work-ers who are between jobs for one reason oranother. These workers are short-term unemployedand will suffer little economic hardship from theirlack of employment. With freedom to chooseoccupations, many choose to leave their old jobsto look for better work. Others have lost their jobs,but will quickly find others.

Some frictional unemployment is the result ofnew people moving into the labor force, particu-larly young workers searching for their first jobs.Unemployment of this nature is a minor problemthat cannot be completely eliminated. It is neces-sary for workers to be able to move to the jobswhere they are most needed. Because there are


always some workers who are in the process ofchanging jobs, there will always be some frictionalunemployment in the economy.

Structural Unemployment Structural unemployment—unemployment that

occurs when a fundamental change in the opera-tions of the economy reduces the demand forworkers and their skills—is a more serious type ofunemployment.

Changes in technology and changes in con-sumer tastes often cause structural unemployment.Workers are structurally unemployed because theirskills and the skills required by employers who arehiring workers do not match. In the early 1900s,for example, people reduced their demand for

horses, buggies, and buggy whips in favor ofdomestic automobiles. Later, tastes changed infavor of foreign-made automobiles, causing consid-erable unemployment in Michigan, Ohio, and theindustrial Northeast.

Industries may also change the way they oper-ate. During the 1990–1991 recession, a series ofmergers and cost reductions trimmed the white-collar labor force in the banking and computerindustries. This change was sudden and left mil-lions of highly skilled people out of work. Many ofthese workers had to develop new skills beforethey could find employment in other industries.

Sometimes the government contributes to struc-tural unemployment when it changes the way itdoes business.

increases include cashiers, janitors,retail salespersons, and restaurantworkers. Low-skilled occupations areexpected to account for 13 percent ofall new job growth.

Job Skills in the Information AgeA survey of more than 400 of thefastest-growing U.S. firms over a five-year period points to the importanceof education and training. Over one-half of the entry-level positionsoffered by the firms require a highschool diploma and often at least twoyears of post-high school studies.Nearly 40 percent of the firms requirea four-year college degree, and anadditional 7 percent require comple-tion of postgraduate studies. Thecompanies’ CEOs place great impor-tance on math skills. “Mastering chal-lenging mathematics is moreimportant than ever before for ourstudents,” noted U.S. Secretary ofEducation Richard W. Riley. “Algebra isconsidered a new basic.”

Perc

enta

ge o

f To

tal

Empl

oym

ent

Perc

enta

ge o

f To

tal

Wor

kfor

ce

1960

50%40%30%20%10%0%

1970 1980 1990 2000

OfficeLow-Skilled ServicesFactoryHigh-Skilled ServicesFarm

1996

40%

35%

30%

25%2002 2006*

Short-Term On-the-Job TrainingMid- to Long- Term On-the- Job TrainingAssociate’s Degree and Above

*Projected

Employment by Type of Job

Occupational Change by Skill Level

Did You Know?Job Trends For the next few

years, most of the new jobs will be inthe services and retail trade industries.By 2005 these industries are expected toaccount for 16.2 million out of a total

projected growth of 16.8 millionwage and salary jobs.


Congress’s decision to close military bases in the1990s is a prime example. Military bases are muchlarger than most private companies, and the impactof the base closings was concentrated in selectregions and communities. Some areas were able toattract new industry that hired many of the unem-ployed workers, but most workers either developednew skills or moved to other regions.

Cyclical Unemployment A third kind of unemployment is cyclical

unemployment—unemployment directly related toswings in the business cycle. During a recession, forexample, many people put off buying durablegoods such as automobiles, refrigerators, washers,and dryers. As a result, some industries must lay offworkers until the economy recovers.

This happened in 2001 when more than 2 millionjobs were lost. Laid-off workers may get their jobsback eventually when the economy improves, butthe pain of unemployment is still there.

Seasonal Unemployment A fourth kind of unemployment is seasonal

unemployment—unemployment resulting fromchanges in the weather or changes in the demandfor certain products. Many carpenters andbuilders, for example, have less work in the winterthan during the spring and summer because sometasks, such as replacing a roof or digging a foun-dation, are harder to do when the weather is cold.

The difference between seasonal and cyclicalunemployment relates to the period of measure-ment. Cyclical unemployment takes place over thecourse of the business cycle, which may last threeto five years. Seasonal unemployment takes placeevery year, regardless of the general health of theeconomy.

Technological Unemployment A fifth kind of unemployment is technological

unemployment—unemployment caused whenworkers with less skills, talent, or education arereplaced by machines and other equipment that dotheir jobs. Technological unemployment happenswhen workers face the threat of automation—pro-duction with mechanical or other processes thatreduce the need for workers.

In some cases, automation results in a drasticreduction in the number of workers needed forproduction. Japan, for example, pioneered the useof large mechanized factories. Entire assembly linesin industries such as automobiles and steel arestaffed by one-fifth of the workers needed in simi-lar U.S. plants. In the United States, the use ofautomated teller machines by banks has reducedthe need for bank tellers.

Employment Trends Every spring, the unemploy-ment rate slightly rises as college graduates enterthe labor force. The high unemployment rates in themid-1980s were caused in part by the baby boomerswho had graduated from college and were enteringthe work force.

Technological Unemployment When techno-logical unemployment occurs, many workersfind they have to learn new skills. What causestechnological unemployment?

Unemployment


386_GLENEPP 11/5/03 5:40 PM Page 386

Checking for Understanding1. Main Idea Why is structural unemployment a

more difficult problem for the economy andfor individual workers than other types ofunemployment?

2. Key Terms Define unemployed, unemploy-ment rate, frictional unemployment, struc-tural unemployment, cyclical unemployment,seasonal unemployment, technological unem-ployment, automation.

3. Describe how the government collectsmonthly data on employment.

4. Differentiate between the five major kinds ofunemployment.

Applying Economic Concepts5. Employment Examine the similarities and

differences between structural and techno-logical unemployment. Give an example ofeach. Why are these kinds of unemploymentserious problems for an economy?

6. Drawing Inferences What factors make itdifficult to determine the unemploymentrate?

7. Categorizing Information Make a list ofthree reasons that could cause a person tobecome a discouraged worker.


The Concept of FullEmployment

Economists have long wrestled withthe concept of full employment. Full

employment does not mean zero unemploy-ment. Instead, full employment is the lowestpossible unemployment rate, with the econ-omy growing and all factors of productionbeing used as efficiently as possible.

While opinions may vary, it appears as iffull employment is reached when theunemployment rate drops below 4.5 per-cent. Unemployment rates do, however, getmuch lower. In late 2000, the rate reached arecord low of 3.9 percent and stayed therefor two months.

Consistently low unemployment is diffi-cult to maintain because of the businesscycle. Figure 14.3 shows that the 1969–1970recession drove the unemployment rate to6.1 percent. The 1974 recession drove the rateto 9.0 percent, and the 1981–1982 recessiondrove the rate to 10.8 percent. The 1991recession drove it up to 7.8 percent, and the2001 recession drove the rate to 6.4 percent.


Using Tables These occupations are projected to beUsing Tables These occupations are projected to be the 10 fastest-growing occupations from 1998 to 2008. Other than technology, in what fields are many of the fastest-growing jobs concentrated?

The Fastest-Growing Occupations,1998–2008

Source: Bureau of Labor Statistics (Number in thousands of jobs)

Computer engineersComputer support specialistsSystems analystsDatabase administratorsDesktop publishing specialistsParalegals and legal assistantsPersonal care and home health aidesMedical assistantsSocial and human service assistantsPhysician assistants

108

1029477

73

62

5858

5348

Occupation299

42961787

26

136

746252

26866

622

8691,194

155

44

220

1,179398

41098

% Increase1998–20081998 2008

Employment


387_GLENEPP 11/5/03 5:40 PM Page 387

Can we safely put away our books on theGreat Depression, 19th century deflations,and Japanese economic history? Hardly.Deflation isn’t a temporary consequenceof the 2000–03 downturn. It’s a signal thatthe age of inflation is over.

This Time, It Really Is aNew Economy

The strong recovery is finally here. The econ-omy’s momentum is unmistakable, despite theEast Coast blackout, the jump in long-terminterest rates, the spike in gasoline prices, and amammoth federal budget deficit. Orders are up,and business is investing for growth. . . .

[T]he age of inflation is over. Deflation’s emer-gence reflects the spread of market capitalism andthe rise of the global financial markets. Bothtrends will only gain influence in coming years.

Prices have risen by some 1,000%—or an aver-age annual rate of 4.1%—during the lifetime ofbaby boomers. . . . Little wonder everyonethinks inflation is an economy’s natural condi-tion.

. . .Yet from 1776 to 1965, America’sprice level was essentially flat. Infla-tionary outbursts weremostly associated withmajor wars, an erup-tion quickly extin-guished in peacetime. . . .

The global financialmarkets also won’t allowfor resurgence in infla-tion. And technologies

like the Internet allow consumers to shop for thelowest price anywhere in the world.

. . . [E]very once in a great while, the estab-lished economic order is indeed overthrown.Within a span of decades, technological changes,organizational upheavals, and new ways of think-ing transform economies. . . .

This time is different, too. The U.S. is still inthe middle of the transition from a world of per-

sistent inflation to one of persistent defla-tion. . . .

—Reprinted from August 29, 2003 issue of Business Week,by special permission, copyright © 2003 by TheMcGraw-Hill Companies, Inc.

N e w s c l i p

Examining the Newsclip1. Analyzing Information With a strong

recovery, what may be the new threat tothe economy?

2. Analyzing Information What is prevent-ing resurgence in inflation?

3. Drawing Conclusions From 1776 to1965, why were price levels in America flat?


388_GLENEPP 11/5/03 5:41 PM Page 388

Cover Story

Inflation

Main Idea“Inflation” is a rise in the general level of prices.

Reading StrategyGraphic Organizer As you read the section, complete a graphic organizer similar to the onebelow by identifying the steps in a wage-price spiral.

Step 1

Step 2Higher prices

Key Terms price level, deflation, creeping inflation, gallopinginflation, hyperinflation

ObjectivesAfter studying this section, you will be able to:1. Explain how inflation is measured.2. Discuss five causes of inflation.3. Analyze the destabilizing consequences of inflation.

Applying Economic ConceptsInflation Have you ever wondered if you should buysomething before the price of the item goes up? Readto find out how inflation changes our spending habits.

I nflation is a special kind of economic instability,one that deals with changes in the level of pricesrather than the level of employment and output.

Even so, as we saw in the cover story, changes inprices, employment, and output are all linked.

Inflation in the United StatesTo better understand inflation, we must firstexamine how it is measured. Then we can

examine the causes of inflation and its consequences.In order to find inflation, we start with the price level,the relative magnitude of prices at one point in time.

Measuring Inflation To measure the price level, economists select a

market basket of goods. They then construct aprice index such as the consumer price index(CPI), the producer price index, or the implicitGDP price deflator.

Inflation is reported in terms of annual ratesof change of the price level. For example, if theCPI at the beginning of one year is 111, and ifit reaches 115 by the beginning of the next,inflation would be computed as follows (with


Cover Story

Consumer Prices Edge Higher

NEW YORK–

The Labor Depart-

ment reported that

the consumer price

index, the broad

measure of prices

paid by consumers,

rose 0.2 percent in

the month.After years of

worrying about the

threat of inflation,

the Federal Reserve and others have voiced greater

concern lately about the threat that lower prices could

lead to deflation, a trend of falling prices that could hit

corporate profits and the economy. So, slightly higher

than expected price readings could be seen as a sign of

strength for the economy.

—CNN/Money, August 15, 2003

Higher price readings show a

strengthening economy

389_GLENEPP 11/19/03 6:18 PM Page 389

everything multiplied by 100 to convert the decimalto a percent):

change in price levelinflation rate � � 100

beginning price level

or,(115 � 111)

inflation rate � � 100 � 3.6%111

Figure 14.5 shows the rate of inflation from1965 to the present. As you can see, prices tend torise faster during expansions and then slow downduring recessions.

On rare occasions, unusual circumstances maycause deflation, or a decrease in the general pricelevel. Only two significant deflations have takenplace in the 1900s. One was during the post–WorldWar I recession of the early 1920s. The other wasduring the Great Depression of the 1930s.

Degrees of Inflation Several terms describe the severity of inflation.

One is creeping inflation—inflation in the range of 1to 3 percent per year. Another is galloping inflation,a more intense form of inflation that can go as highas 100 to 300 percent. Many Latin American coun-tries and many countries in the former communistbloc have experienced rates in this range in recentyears. When inflation gets totally out of control,hyperinflation—inflation in the range of 500 percenta year and above—occurs. Hyperinflation, however,does not happen very often and generally is the laststage before a total monetary collapse.

The record for hyperinflation was set in Hungaryduring World War II, when huge amounts of cur-rency were printed to pay the government’s bills. Bythe end of the war, it was claimed that 828 octillion(828,000,000,000,000,000,000,000,000,000) pengösequaled 1 prewar pengö.


Using Graphs Using Graphs Inflation tends to increase at the end of expansions, and tends to decrease during periods of recession. How would you characterize the inflation rate during the period from 1990 to 2003?

The Rate of Inflation

Annu

al R

ate

of I

nfla

tion

in P

erce

nt 16

12

–4

Year1965

Recession years

1970 1975 1980 1985 1990 1995 2000 2005

8

4

0

Source: Bureau of Economic Analysis, United States Department of Commerce



390_GLENEPP 11/19/03 6:18 PM Page 390


Causes of InflationSeveral explanations have been offered forthe causes of inflation. Nearly every period

of inflation is due to one of the following causes.According to demand-pull theory, all sectors in

the economy try to buy more goods and servicesthan the economy can produce. As consumers,businesses, and governments converge on stores,shortages occur and prices go up. Thus prices are“pulled up” by excessive demand.

Another explanation involves the federal govern-ment’s deficit. Basically, this explanation is a variantof the demand-pull theory. While demand-pullblames excess demand on all sectors of the economy,this explanation blames inflation only on the federalgovernment’s deficit spending.

A third explanation claims thatrising input costs—especially labor—drive up the cost of products formanufacturers and cause inflation.This situation might take place, forexample, when a strong nationalunion wins a large wage contract,forcing producers to raise prices torecover the labor costs. Or, as notedin the cover story, labor costs couldgo up when labor markets are tightand the unemployment rate is excep-tionally low.

An unexpected increase in thecost of nonlabor inputs also couldcause the price level to rise. Such aprice rise occurred during the 1970swhen oil prices went from $5 to $35a barrel.

Still another explanation saysthat no single group is to blame forinflation. According to this view, aself-perpetuating spiral of wages andprices begins that is difficult tostop.

Higher prices force workers to askfor higher wages. If they get the higherwages, producers try to recover thatcost with higher prices. As each sidetries to increase its relative positionwith a larger price hike than before,the rate of inflation keeps rising.

The final and most popular explanation forinflation is excessive monetary growth. This occurswhen the money supply grows faster than realGDP. According to this view, any extra money thatis created by the Federal Reserve System willincrease some group’s purchasing power. Whenthis money is spent, it causes a demand-pull effectthat drives up prices.

Advocates of this explanation point out thatinflation cannot be maintained without a growingmoney supply to fuel it. For example, if the priceof gas goes up sharply, and if the amount of moneypeople have does not change, then they will simplyhave to buy less of something else. So, while theprice of gas may rise, the prices of other things willfall, leaving the price level unchanged.


The Declining Value of the Dollar$1.00

.90

.80

.70

.60

.50

.40

.30

.20

.10

.00

1900

1910

1920

1930

1940

1950

1960

1970

1980

1990

2000

Valu

e in

Ter

ms

of 1

900

Spen

ding

Pow

er

Years

Using Graphs

Source: U.S. Department of Commerce

price level goes down, the dollar purchases more. What happens to the purchasing power of the dollar dur-ing a period of inflation?

Using Graphs When the price level goes up, the purchasing power of the dollar goes down. When the





Checking for Understanding 1. Main Idea What is the difference between

the price level and the rate of inflation?

2. Key Terms Define price level, deflation,creeping inflation, galloping inflation,hyperinflation.

3. Describe how the CPI is used to compute the inflation rate.

4. List five explanations for the causes of inflation.

5. Identify four ways inflation destabilizes the economy.

Applying Economic Concepts6. Inflation What does an inflation rate of

4 percent mean?

7. Categorizing Information What kind ofinflation might be described as “too manydollars chasing too few goods”?

8. Understanding Cause and Effect In 1974the price of crude oil increased greatly.What type of inflation did this cause?

Consequences of InflationInflation involves more than rapidly risingprices. When inflation is present, it can

have a disruptive effect on an economy for severalreasons.

The most obvious effect of inflation is that thedollar buys less. Because the purchasing power ofthe dollar falls as prices rise, a dollar loses valueover time. Figure 14.6 shows how the dollar lost itsvalue as inflation eroded its purchasing power.

Decreased purchasing power is especially hardon retired people with fixed incomes because theirmoney buys a little less each month. Those not onfixed incomes are better able to cope. They canincrease their fees to secure additional income.

A second destabilizing effect is that inflationcan cause people to change their spending habits,which disrupts the economy. For example, whenprices went up in the early 1980s, interest rates—

the price of borrowed money—also went up. Thiscaused spending on durable goods, especiallyhousing and automobiles, to fall dramatically.

To illustrate, suppose that a young couple wantedto borrow $60,000 over 20 years to buy a house. Atan 8 percent interest rate, their monthly mortgagepayment would be $501.86. At 14 percent, the pay-ment would be $746.11. In 1981 some mortgagerates reached 18 percent, which meant a monthlypayment of about $926 for the same loan! As aresult, the housing industry almost collapsed.

A third destabilizing effect of inflation is that ittempts some people to speculate heavily in anattempt to take advantage of a higher price level.People who ordinarily put their money in reasonablysafe investments begin buying luxury condomini-ums, diamonds and gemstones, and other exoticitems that might be expected to increase in price.

Finally, inflation alters the distribution ofincome. During long inflationary periods, lendersare generally hurt more than borrowers. Loans madeearlier are repaid later in inflated dollars.

Suppose, for example, that a person borrowsmoney to buy bread that costs fifty cents a loaf. Ifthe amount borrowed was $100, the person couldbuy 200 loaves of bread. If inflation set in, and ifthe price doubled by the time the loan was paidback, the lender would only be able to buy 100loaves of bread. Inflation in the long run, then,favors debtors over creditors.

Student Web Activity Visit the Economics: Principlesand Practices Web site at epp.glencoe.com and clickon Chapter 14—Student Web Activities for an activ-ity on working with economic statistics.



CHAPTER X: CHAPTER TITLE 393

Using the InternetTo learn more about almost any topic imaginable, use the Internet—aglobal network of computers. Many features, such as E-mail, interactiveeducational classes, and shopping services are offered on the Net. To get onthe Internet, you need three things: (a) a personal computer, (b) a modem(a device that connects your computer to a telephone line), and (c) anaccount with an Internet Service Provider (ISP). An ISP, such as AmericaOnline, is a company that enables you to log on to the Internet, usuallyfor a fee.

searching until you find the information that you want.

4. If you get “lost” on the Internet, click on the back-arrow key at the top of the screen until you find a sitethat looks familiar.

5. Continue selecting sites until you have enoughinformation to write a short report on inflation trendsover the past three months.

Learning the SkillAfter you are connected, the easiest way to access

Internet sites is to use a “Web browser,” a programthat lets you view and explore information on theWorld Wide Web. The Web consists of manydocuments called “Web sites,” each of which has itsown address, or Uniform Resource Locator (URL).Many URLs start with the keystrokes http://

If you don’t know the exact URL of a site,commercial “search engines” such as Yahoo! orAltaVista, can help you find information. Type asubject or name into the “search” box, then pressEnter. The search engine lists available sites that mayhave the information you are looking for.

Practicing the SkillFollow these steps to learn more about the

inflation rate.

1. Log on to the Internet and choose a searchengine to use.

2. Search by selecting one of the listed categories orby typing in the subject you want to find, suchas “inflation” or “the inflation rate.”

3. Continue your search by scrolling down the listthat appears on your screen. When you select anentry, click on it to access the information.Sometimes the information you first access willnot be exactly what you need. If so, continue

Follow the above procedures to locate informationabout the population of your state. Use the infor-mation you gather to create a chart or graphdepicting changes in population from 1960 to the present.

A search engine can help youquickly locate information onthe World Wide Web.

Poverty and the Distribution of Income

Main IdeaReasons for income inequality include ability differ-ences, education and training, and discrimination.

Reading StrategyGraphic Organizer As you read the section, completea graphic organizer similar to the one below by list-ing three explanations for a growing income gap.

Key Terms Lorenz curve, poverty guidelines, welfare, foodstamps, Earned Income Tax Credits (EITC), enterprisezone, workfare, negative income tax

ObjectivesAfter studying this section, you will be able to:1. Explain how economists measure the distribution

of income.2. Discuss the reasons for the inequality of income.3. Discuss antipoverty programs.

Applying Economic ConceptsDistribution of Income Do you compare what youmake to the earnings of others? Read to find out moreabout how income is distributed in the United States.

Incomegap

I n the United States, as in other parts of theworld, people do not all have the sameincome. A large number of people live in

poverty despite the efforts of programs such as theone featured in the cover story.

The Distribution of IncomeTo evaluate the distribution of income, theincomes of all households are ranked from

highest to lowest. The ranking is then divided intoquintiles, or fifths, for examination. The table inPanel A of Figure 14.7 shows household incomequintile data for two different years. Only moneyincome is counted; other aid such as food stamps,medicaid, or subsidized housing is excluded. Usinga recent year as our example, the percent of incomeearned by each quintile is added to the lower quin-tiles and plotted as a Lorenz curve. The Lorenzcurve—a curve that shows how much the actual dis-tribution of income varies from an equal distribu-tion—appears in Panel B.

Cover Story

Census: Poverty Climbs by 1.4M

WASHINGTON–The nation’s rocky economy

sent 1.4 million more people into poverty last year, a

Census Bureau survey found. Nearly half of the

newly impoverished

were children.Roughly 17.2 per-

cent of children, or

12.2 million, lived in

poverty in 2002, up

from 16.4 percent, or

over 11.5 million, in

2001, according to

the American Com-

munity Survey results

released today. Overall, 12.4 percent of the population, or nearly

34.8 million people, lived in poverty in 2002, up from

12.1 percent, or 33.4 million, the previous year.

—Cincinnati Post, September 3, 2003

Poverty rate rises.

394

394_GLENEPP 11/5/03 5:48 PM Page 394

To illustrate, the 3.5 percent oftotal income received by the lowestquintile is plotted in Panel B as pointa. This amount is combined with theincome the next quintile earns andthen plotted as point b. This processcontinues until the cumulative val-ues of all quintiles are plotted.

If all households received exactlythe same income—so that 40 percentof the households would earn 40 per-cent of the total income and so on—the Lorenz curve would appear as adiagonal line running from one cor-ner of the graph to the other. Becauseall households do not receive thesame income, however, the Lorenzcurve is not a diagonal. As you cansee in the figure, the distribution ofincome recently has become moreunequal than it was in 1980.

Reasons for IncomeInequality

A number of reasons explainwhy the incomes of various

groups may be different. Theyinclude education, wealth, discrimi-nation, ability, and monopolypower.

Education Some people have higher incomes

than others because they have moreeducation. Although exceptionsexist, there is generally a strong relationship betweenmedian income and level of education. Educationputs people in a better position to get the higher-paying jobs that require a higher level of skills.

Wealth Income also varies because some people hold

more wealth than others—and the distribution ofwealth is even more unequal than the distributionof income. When wealth holders are ranked from

highest to lowest, the top fifth has 75 percent of allthe wealth in the country. The bottom two-fifths,which is 40 percent of the people in the country,have less than 2 percent of the total wealth.

This inequality has an impact on people’s abilityto earn income. Wealthy families can send theirchildren to expensive colleges and universities. Thewealthy can also afford to set their children up inbusinesses where they can earn a better income.Even if the wealthy choose not to work, they canmake investments that will bring them income.


Categorizing Information Categorizing Information Economists use the Lorenz curve to contrast the distribution of income at different points in time. What percentage of income is received by the richest quintile in 1980? In 2001?

The Distributions of Income

1980 2001

Quintiles

4.3%10.3%16.9%24.9%43.7%15.8%

3.5%8.7%

14.6%23.0%50.1%22.4%

3.5%12.2%26.8%49.9%100%

Lowest FifthSecond FifthThird FifthFourth FifthHighest FifthTop 5 Percent

Quintiles Cumulative20011980

Source: U.S. Bureau of the Census

100

80

60

40

20

080 1004020 60

Perc

ent

of T

otal

Inc

ome

Percent of Total Households

BB The Lorenz Curve

AA Household Income Ranked by Quintiles

Equality of Income

4.3%14.6%

31.5%

56.4%

a = 3.5%b = 12.2%

26.8%

49.9%



395_GLENEPP 11/5/03 5:48 PM Page 395


Discrimination Discrimination is another factor influencing

income. Women may not be promoted to execu-tive positions in some companies because maleexecutives simply are not accustomed to women inroles of power. Some unions may deny immigrantsor ethnic minorities membership on the groundsthat they “don’t belong” in the professions.

Although discrimination is illegal, it still takesplace. When it does occur, discrimination causeswomen and minority groups to be crowded intoother labor markets where oversupply drivesdown wages.

Ability Some people earn more income because they

have certain natural abilities, such as professionalathletes who sometimes earn millions of dollarsevery year. Such athletes as Shaquille O’Neal andAlex Rodriguez earn high incomes because theyhave unique abilities or talents. The same is true ofpopular performers such as Oprah Winfrey, JimCarrey, and Harrison Ford.

Monopoly Power Another factor is the degree of monopoly power

that some groups hold. Recall from Chapter 8 thatunions have been able to obtain higher wages fortheir members. Some white-collar workers—clerical,business, or professional workers who generally aresalaried—also hold a degree of monopoly power.The American Medical Association, for example,has been successful in limiting the number of peo-ple in its profession by limiting enrollments inmedical schools. More recently, the AMA voted tounionize in order to be in a better position to dealwith the health maintenance organizations(HMOs) that employ them.

PovertyPoverty is a relative measure that dependson prices, the standard of living, and the

incomes that others earn. Poverty is a major prob-lem in America—and one that is extremely difficultto resolve. Families and individuals are defined as

living in poverty if their incomes fall below certainlevels. Poverty guidelines are annual dollaramounts used to evaluate the money income thatfamilies and unrelated individuals receive. In2003, poverty was defined as having an income ofless than $18,400 for a family of four.

People in Poverty Poverty in the United States is more extensive

than most people realize. According to recent sta-tistics, nearly 35 million Americans live inpoverty—or approximately 12.4 percent of the totalpopulation.

As Figure 14.8 shows, even the record economicexpansions of the 1980s and 1990s failed to make asignificant dent in the percent of Americans livingin poverty. In fact, the proportion of the popula-tion living in poverty was about the same in thelate 1960s and 1970s as it is today.

Of those in poverty, slightly more than two-thirds are white and approximately one-quarter areAfrican American. Finally, children of all racesmake up approximately 36 percent of the people inpoverty even though they account for only 26 per-cent of the total population.

The Growing Income Gap One reason for the continued high poverty num-

bers is the growing gap in the distribution of income.According to the Census Bureau, the growing spreadthat has taken place since 1980 has several causes.

The first involves a structural change in theeconomy as industry changes from goods produc-tion to service production. Because wages are typi-cally lower in the service industries such asfast-food chains, movie theaters, and entertainmentparks, weekly paychecks tend to be lower.

The second reason for the spread in income dis-tribution is the growing gap between well-educatedand poorly educated workers. During the 1990s,wages for the highly skilled soared, while wages forthe less skilled remained about the same.

A third reason—declining unionism (especiallyamong low-skilled workers)—is adding to the grow-ing differential. The decline of unions means thatmany low-skilled workers have to work elsewherefor less pay.


396_GLENEPP 11/5/03 5:48 PM Page 396

The fourth reason for the income gap concernsthe changing structure of the American family.The shift from two-parent families to single-parentfamilies and other nonfamily household livingarrangements tends to lower average familyincome. All of these factors contribute to the trendof the rich getting richer and the poor gettingpoorer.

Antipoverty ProgramsOver the years, the federal government hasinstituted a number of programs to help the

needy. Most come under the general heading ofwelfare—economic and social programs that pro-vide regular assistance from the government or pri-vate agencies because of need.

Income Assistance Programs that provide direct cash assistance to

those in need fall into the category of incomeassistance. One such program is the TemporaryAssistance for Needy Families (TANF), whichreplaced the Aid to Families with DependentChildren (AFDC) in 1997. Although provisionsand benefits vary from state to state, many fami-lies are able to receive cash payments because ofthe death, continuous absence, or permanent dis-ability of a parent.

Another income assistance program is theSupplemental Security Income (SSI), which makescash payments to blind or disabled persons or topeople age 65 and older. Originally, the statesadministered the program because benefits variedso much from state to state. The federal govern-ment took it over to assure more uniform coverage.

General Assistance Programs that assist poor people but do not

provide direct cash assistance fall into the cate-gory of general assistance. One example is thefood stamp program that serves millions ofAmericans. Food stamps are government-issuedcoupons that can be redeemed for food. Theymay be given or sold to eligible low-income per-sons. If, for example, a person pays 40 cents for a

$1 food stamp, that person is getting a dollar’sworth of food for a fraction of its cost. The pro-gram, which began in 1961 and became law in1964, is different from other programs because eli-gibility is based solely on income.

Another general assistance program is medicaid—a joint federal-state medical insurance program for low-income people. Under the program, thefederal government pays a majority of health-care


Using Graphs

ulation below the poverty line greater in the 1990s than in the 1980s?

Using Graphs The dividing line between those officially considered poor and thosenot officially considered poor is the poverty line. Was the percentage of the pop-

Poverty in the United States:Total Number and Rate

Source: U.S. Bureau of the Census

50

40

30

20

10

0

1959

1965

1970

1975

1980

1985

1990

1995

2001

Perc

ent

Mill

ions

Year

Number in Poverty

Poverty Rate



397_GLENEPP 11/5/03 5:49 PM Page 397


costs, and the state governments pay the rest of thecost. Medicaid serves millions of Americans,including children, the visually impaired, and thedisabled.

Social Service Programs Over the years, the individual states have devel-

oped a variety of social service programs to helpthe needy. These include such areas as child abuseprevention, foster care, family planning, job train-ing, child welfare, and day care.

Although the states control the kinds of serv-ices the programs provide, the federal governmentmatches part of the cost. To be eligible for match-ing funds, a state must file an annual service plan.If the plan is approved, the state is free to selectsocial issues it wishes to address, set the eligibilityrequirements for the programs, and decide howthe programs are to be carried out.

Tax Credits Many working low-income Americans qualify

for special tax credits. The most popular is theEarned Income Tax Credit (EITC) which pro-vides federal tax credits and sometimes cash tolow-income workers. The credit was created in1975 to partially offset the payroll tax burden onworking families. The credit is applied first to fed-eral income taxes, but low-income workers cantake the remainder of the credit in cash if thecredit is larger than the taxes owed. The credit hasproved to be popular, with approximately 20 mil-lion working families receiving nearly $30 billionannually.

Enterprise Zones Special enterprise zones are areas where compa-

nies can locate free of some local, state, and federaltax laws and other operating restrictions. Manyenterprise zones are established in run-down ordepressed areas. This benefits area residentsbecause they can find work without worrying abouttransportation, thereby helping depressed areas togrow again.

Nearly everyone agrees that a healthy and grow-ing economy helps alleviate poverty. The enter-prise zone concept is an attempt to focus some ofthat growth directly in the areas that need it most,making more employment opportunities available.

Workfare Programs Because of rising welfare costs, many state and

local governments require those individuals whoreceive welfare to provide labor in exchange for ben-efits. Workfare is a program that requires welfarerecipients to exchange some of their labor for bene-fits. People on workfare often assist law enforcementofficials or sanitation and highway crews, or performother types of community service work.

Most states that have workfare programsrequire almost everyone except for the disabled,the elderly, and those with very young children towork. If the workfare assignments are welldesigned, then recipients have a valuable oppor-tunity to learn new skills that will eventually helpthem get other jobs.

Most urban and regionalplanners work for com-munity, county, and city governments.

The WorkPlanners develop compre-hensive plans for the devel-opment and rebuilding ofcommunities. Planners rec-ommend strategies on howto effectively utilize land

and resources to meet the needs of the community.They also take part in decisions about transportationsystems, resource development, and protection of theenvironment. Planners often specialize in a single area such as transportation, demography, housing, orurban design.

QualificationsMost jobs in government agencies require a master’sdegree in urban or regional planning or urban design.

Urban Planners



Using Graphs and Maps Average per capita personal income varies considerably from state to state, ranging from a low of $18,998 to a high of $37,700. The average rate of growth, after adjusting for inflation, amounted to 1.48 percent. One state—Alaska—had a negative annual rate of growth from 1990 to 1996. In what range was the per capita personal income in your state?

Using Graphs and Maps Average per capita personal income varies considerably from state to state, ranging from a low of $22,370 to a high of $43,371. The average rate of growth, after adjusting for inflation, amounted to 1.42 percent. One state—Hawaii—had a negative annual rate of growth from 1990 to 2002. In what range was the per capita personal income in your state?

Per Capita Personal Income by State

$0–$24,999

$25,000–$27,999

$28,000–$29,999

$30,000–$31,999

$32,000–$34,999

$35,000 and up

Negative growth

0%–0.99%

1.0%–1.21%

1.36%–1.47%

1.47%–1.73%

1.21%–1.36%

1.73+%

DCA.

NJMA

CT

MDNY

DE

MNNH

CA

IL

WAVA

CO

AKPA

US

NV

WY

NE

MI

VT

RI

HI

FL

OH

GA

MOKS

WI

OR

IAME

IN

NCTN

TX

AZNDSD

KY

LASC

MT

ALOK

ID

UTNMWVARMS

U.S. Average Annual Per Capita Personal Income

Source: Survey of Current Business, various issues

Per CapitaPersonal Income

C. Average Annual Percentage Growth of Real Per Capita Personal Income, 1990–2002

B. Per Capita Personal Income, 2002

FL

NM

TX

OK

KS

NE

SD

NDMT

WY

COUT

ID

AZ

NV

WA

CA

OR

KY

ME

NY

PAMI

VT

VAWVOHINIL

NCTN

SCALMS

AR

LA

MO

IA

MNWI

GA

FL

NM

DE

MD

TX

OK

KS

NE

SD

NDMT

WY

COUT

ID

AZ

NV

WA

CA

OR

KY

ME

NY

PAMI

VTNHMARI

CT

VAWVOHINIL

NCTN

SCALMS

AR

LA

MO

IA

MNWI

NJ

GA

DC

DE

MD

NHMARI

CTNJ

DC

HIAK

HIAK

0 5 10 15 20 25 30 35 40 45


399_GLENEPP 11/5/03 5:49 PM Page 399

Many welfare-to-work programs have had promis-ing results. In many cases, companies can even earn federal tax credits when they hire workersdirectly from the welfare rolls, making the employ-ment a win-win situation for both employer andemployee.

Negative Income Tax The negative income tax is a proposed type of

tax that would make cash payments to certaingroups below the poverty line. These cash pay-ments would take the place of existing welfare pro-grams rather than supplement them. Also,everyone would qualify for the program, not justworking people as with the EITC.

Under the negative income tax, the federal gov-ernment would set an income level below whichpeople would not have to pay taxes. Then, the gov-ernment would pay a certain amount of money toanyone who earned less than that amount.

For example, suppose that an individual’s tax lia-bility was computed using the following formula:

taxes � (25% of income) � $8,000

Under this formula a person with no incomewould have a tax of minus $8,000—which is

another way of saying that the person will receive$8,000 from the government. Or, if the personearned exactly $12,000, then the person wouldreceive an additional $5,000 under the formula fora total of $17,000. Under this formula, a personwould have to make $32,000 before any taxes wereactually paid.

The negative income tax is different from otherantipoverty programs in two respects. First, it is amarket-based program designed to encourage peo-ple to work. The object of the negative income taxis to make the minimum payment large enough tobe of some assistance, yet small enough toencourage people to work. Then, when people dogo to work, the taxes they actually pay need to besmall enough so as not to discourage them fromworking.

Second, the negative income tax would be cost-effective because it would take the place of othercostly welfare programs. In the end, individualswould have money to spend as they saw fit.Government would also save because it wouldhave fewer welfare programs and administrativecosts than it does currently. Although the negativeincome tax is currently not used, many economistsbelieve it would be a reasonable alternative to theexisting welfare structure.

Checking for Understanding 1. Main Idea Using your notes from the graphic

organizer activity on page 394, list the rea-sons for the growing income gap.

2. Key Terms Define Lorenz curve, povertyguidelines, welfare, food stamps, EarnedIncome Tax Credit (EITC), enterprise zone,workfare, negative income tax.

3. Describe how the distribution of income ismeasured.

4. List the five main reasons for inequality ofincome.

5. Identify the major programs and proposalsdesigned to alleviate the problem of poverty.

Applying Economic Concepts6. Distribution of Income What would happen

to the Lorenz curve if nonfinancial aid such asfood stamps and medicaid were treated asincome? Explain why this would occur.

7. Analyzing Information Some people havesaid that “the rich got richer” in the 1990s.What factors can you cite to explain thatwhat actually happened was more complexthan this simple statement?



400_GLENEPP 11/5/03 5:50 PM Page 400

S e c t i o n 1

Business Cycles and Fluctuations(pages 375–380)

• Business cycles are systematicincreases and decreases in realGDP; unsystematic changes are business fluctuations.

• The two phases of the cycle arerecession and expansion; apeak is when the expansionends, while a trough is when the recession ends.

• The Great Depression of the 1930s was the worsteconomic decline in U.S. history; income distribu-tion inequalities, risky credit practices, weak interna-tional economic conditions, and tariff wars allcontributed to the Depression.

• Several short, mild recessions have occurred sinceWWII.

• Business cycles are caused by changes in capital andinventory spending by businesses, stimuli suppliedby innovations and imitations, monetary factors, andexternal shocks.

• Econometric models and the index of leadingindicators are used to predict changes in futureeconomic activity.

S e c t i o n 2

Unemployment (pages 382–387)

• Unemployed persons are identified monthly by theCensus Bureau. The number of unemployed isdivided by the civilian labor force to arrive at theunemployment rate.

• The unemployment rate does not count dropouts,nor does it distinguish between full- and part-timeemployment.

• Frictional, structural, cyclical, seasonal, andtechnological are different forms of unemployment.

S e c t i o n 3

Inflation (pages 389–392)

• Inflation is the rate of change in the price level asmeasured by the CPI.

• Terms used to describe the severity of inflation are creeping inflation, galloping inflation, andhyperinflation.

• Generous credit conditions and excessive growth ofthe money supply allow demand-pull, deficit spend-ing, cost-push, and wage-price spiral inflation to takeplace.

• Inflation erodes the value of the dollar, makes lifedifficult for people on fixed incomes, changes thespending habits of consumers and businesses, andalters the distribution of income in favor of debtors.

S e c t i o n 4

Poverty and the Distribution ofIncome (pages 394–400)

• The distribution of income is measured by rankingfamily incomes from lowest to highest and thendividing the ranking into quintiles. The incomeearned by each quintile is then compared to otherquintiles.

• The Lorenz curve shows that incomes are not evenlydistributed, and that they are becoming less equal.

• Factors accounting for the unequal distribution ofincome include educational levels, wealth, discrimi-nation, ability, and monopoly power.

• Poverty is determined by comparing the amount ofincome earned by families to measures called thepoverty guidelines.

• The growing income gap is due to the increasedimportance of the service industry, the wideningworkers’ skills gap, the decline of union influence,and the changing composition of the Americanfamily.


Identifying Key TermsWrite the letter of the key term that best matches each definition below.

a. trend lineb. cyclical unemploymentc. unemployedd. food stampse. frictional unemploymentf. peakg. troughh. inflationi. Lorenz curvej. poverty guidelinesk. price levell. seasonal unemploymentm. structural unemploymentn. technological unemploymento. recessionp. workfare

1. marks the beginning of a recession

2. an example of a welfare program

3. annual benchmark used to evaluate the moneyincome that families receive

4. caused by a shift in demand or a change in the waythe economy operates

5. caused by annual changes in weather and holidayseasons

6. caused by periodic swings in business activity

7. caused by workers who are “between jobs” forshort periods

8. describes the requirement that welfare recipientsexchange labor for benefits

9. happens when workers face the threat ofautomation

10. growth path in absence of recession or expansion

11. measured by changes in the CPI

12. lowest point of the business cycle

13. measured by the CPI

14. shows how much the actual distribution of incomediffers from an equal distribution

15. real GDP declines two consecutive quarters

16. works less than one hour per week for pay or profit

Reviewing the FactsSection 1 (pages 375–380)

1. Describe the Great Depression.

2. Distinguish between depressions and recessions.

3. Analyze two methods economists use to predictbusiness cycles.

Section 2 (pages 382–387)

4. Describe how the unemployment rate is computed.

5. Identify the major types of unemployment.

6. Analyze what is meant by full employment.


7. Compare the difference between the price leveland inflation.

8. Identify the five causes of inflation.

9. List four destabilizing effects of inflation.

Self-Check Quiz Visit the Economics: Principlesand Practices Web site at epp.glencoe.com andclick on Chapter 14—Self-Check Quizzes to pre-pare for the chapter test.




10. Explain what is meant by the distribution ofincome.

11. Identify five major reasons for inequality in thedistribution of income.

12. Explain how the Lorenz curve is used to showthe inequality of income distribution.

13. Name seven antipoverty programs.

Thinking Critically1. Analyzing Information Why is it important to

understand the impact of business cycles?

2. Drawing Conclusions Why might a governmentstatistic about the number of employed people bemisleading?

3. Understanding Cause and Effect Explain theeffect that inflation has on the financial positionsof borrowers and lenders. Use a chart similar tothe one below to help you organize your answer.If you managed a bank, what interest rate wouldyou charge to overcome the disadvantage of long-term inflation?

Applying Economic Concepts1. Unemployment rate If we were to enter a period

of recession, what would likely happen to the unem-ployment rate? The inflation rate? The poverty rate?

2. Inflation Explain why inflation cannot take placewithout an expansion of the money supply.

3. Lorenz curve Suppose that a new governmentprogram reduced the level of poverty in the coun-try. How would this affect the Lorenz curve?

Math PracticeUse the following information to determine realGDP per capita for each of the following years.

Thinking Like an Economist Why is an economist likely to prefer a program likenegative income tax over other welfare programs?

Technology SkillSending E-Mail Write a topic sentence aboutincome to research. Examples include: “Is incomerising above or below the rate of inflation?” “Isthere an income gap between men’s and women’swages? And if so, “Is the income gap widening?”

Then browse the Internet or call the government toobtain the E-mail address of a federal agency con-cerned with this issue. E-mail the federal agency,sharing your topic and requesting information.

1960197019801990

179,323,000203,302,000226,542,000248,710,000

$2,263$3,398$4,615$6,136

Year Population Real GDP in $billion

Effect:Cause:Inflation

Using the Internet Search for information ontrends in inflation and unemployment ratesfrom the following sites on the Internet: theCensus Bureau, the Bureau of Labor Statistics,and the Economic Statistics Briefing Room.

Search for recent articles discussing unem-ployment, inflation, or poverty. Download atleast two recent press releases from each ofthe above sites. Summarize the articles andshare your findings with other members ofthe class.



Issues in FreeIssues in FreeIssues in FreeIssues in Free

Issues in FreeIssues in Free

The Gap isWidening

Income inequality has been worsening in theUnited States since the early 1970s. Before 1973,all groups enjoyed healthy income gains, particu-larly the middle class. However, since 1979, therich have gained far more than the middle class,while the income of the poor has fallen inabsolute terms. A recent study found that therichest one percent of families (average annualincome: $800,000 for a family of four)captured 70 percent of the total rise infamily income in the United Statesbetween 1977 and 1989.

America has always been considereda land of opportunity, where parentsbelieve in the possibility of a “betterlife” for their children. Does upwardmobility mean growing inequality is

unimportant, since, with effort and a bit of luck,those at the bottom can still move toward the top?

Not exactly. First of all, we know that historicallyhigh rates of mobility in the United States resultedfrom fast economic growth that was shared acrossthe board. Today, growth benefits the wealthy farmore than the middle class, let alone the poor.

P R O

IS INCOME INEQUALITY REALLY A PROBLEM?

Not everyone in the United States makes the same amount of money. Some people make agreat deal, some make very little, and most make something in between. Economists call thissituation, quite simply, income or wage inequality. Others call it the income gap.

An income gap is inevitable in a free market economy. First, the market gives different valuesto different activities, and second, some people work more than others. So the existence ofsome income inequality, in and of itself, doesn’t generally cause concern.

But some analysts express concern that, if the gap widens, it will be more and more difficultto close. In other words, the rich will get richer and the poor will get poorer.

As you read the selections, ask yourself: Is the income gap aserious economic problem, or are fears about it overblown?


EnterpriseEnterprise

EnterpriseSecond, although many families do move from

one income category to another over time, indi-viduals have suffered larger downward, and smallerupward, income changes since the 1970s—with theexception of the rich, whose earnings have jumpeddramatically.

Third, though education has always been seenas the great leveler, it now reinforces initial advan-tages instead of compensating for initial handi-caps. [Schools] no longer effectively make up fordeep inequalities among children. . . .

So, if America is to remain the land of oppor-tunity, elementary and secondary education mustwork for the poor. Otherwise, inequality ofincome will come to reflect not just differences inmotivation, work effort, and sheer luck amongplayers in a fair game, but different rules for richand poor.

—Nancy Birdsall, Executive Vice-President, Inter-American Development Bank

The Problem isExaggerated

That we are rapidly becoming richer is clear.People who deny that equality is increasing arefixated on the recent small increase in incomeinequality. That increase, the subject of anunceasing journalistic drumbeat, is, [ChrisDeMuth, president of American EnterpriseInstitute] argues, a small incongruity in the long-term “leveling of material circumstances” thathas been underway for three centuries and isaccelerating.

Since 1700, the average life span in Westernsocieties has doubled. Today material necessities—food, shelter—are so universally available that theproblem of poverty, understood as materialscarcity, has been solved. Poverty, DeMuth notes,

now is a problem of individual behavior, socialorganization and policy, not of society’s materialscarcities.

Two centuries ago land was the essentialsource of wealth. One century ago, physical cap-ital was. Today, human capital—knowledge, cog-nitive skill—is, and such capital is widelydistributed by nature and is augmented by uni-versal education. Furthermore, sexual equalityhas advanced so far that young men and womenof comparable education and training now earnessentially equal incomes.

As societies become more wealthy, DeMuthargues, money income becomes a less informa-tive measure of individual welfare, as is demon-strated by this fact: Western democracies havebecome so wealthy that, for the first time in his-tory, “voluntary reduction in time spent at paidemployment has become a major social and eco-nomic phenomenon.” This reduction appears inexpanded education of the young and, evenmore, in longer retirement of the elderly. . . .

The modern age’s expansion of individualautonomy . . . frees individuals for admirable andimproving pursuits—and for unworthy and self-destructive behavior. With the growth of wealth,freedom and equality has come an equallyastounding explosion of social pathologies, fromfamily disintegration and illegitimacy to drugabuse and vulgar popular entertainment. . . .

Citizens are turning their attention, as indi-viduals and as members of civic and religiousgroups, to the question: What is freedom for?The question is itself among the luxuries of awealthy, free and equal society.

—George F. Will, Washington Post Writers Group

Analyzing the Issue 1. Summarize Birdsall’s argument.

2. What does Will mean by calling income inequality(quoting DeMuth) “a small incongruity”?

3. Will calls America “a wealthy, free and equalsociety.” Considering Birdsall’s argument, do youagree? Explain.

C O N

UNIT 4 MACROECONOMICS: POLICIES 405

Chap14 Fundamental Economic Concepts

Education

Transcript of Chap14 Fundamental Economic Concepts