CHAPTER 9

MACRO-POLICY AND
ISSUES
Instructor: OLIVER O. PRINCIPE
Learning Objective:
• differentiate the different phases of the business cycle,
• compare the rates of economic growth of various countries
• define unemployment, employment and inflation, and
• determine the causes and effects of unemployment and inflation
• The major concerns of every government policy makers
are high output growth, low unemployment and low
inflation. The first part describes the output growth
which explains the business cycles. The unemployment
rate is a key measure of how the economy is doing and
this follows output growth. The last topic considered is
inflation. The percentage change in the GDP deflator is
a measure of inflation. There are, however, other
measures of inflation but the most widely followed is
CPI.
OUTPUT GROWTH
• No economy can sustain growth and development over a long period
of time. This is because every business affected by various factors
classified as:
• Exogenous. These are forces outside economic system like natural
calamities, political crisis, wars or technological changes.
• Endogenous. These are forces within the economic system like
multiplier accelerator, monetary policies or innovations.
Business Cycle
• Economies tend to experience short-term ups and downs in their
performance instead of growing at an even rate at all times.
Fluctuations in business activities are natural phenomenon and it is
called business cycle. There are times where workers can find jobs
easily and money is plentiful. But this period does not last forever,
and it is followed by a downturn in business activities resulting to a
drop in demand for goods and services caused by massive lay-offs and
reduction in income.
Any economy, whether local national or international, follows the four phases of a business
cycle. These include:
• Prosperity/peak – phase where business activities are in its temporary maximum. The
economy at this phase is at full employment and the level of real output is at full capacity.
• Recession- decline in output, income, trade, and ultimate
employment. Therefore, during this phase unemployment is induced.
• Depression/trough– turning point of recession, or when activity is at
its lowest and unemployment is so severe.
• Expansion – recovery in the economy wherein income, trade, output,
interest rate, wage and employment are rising, meaning
unemployment is low.
EMPLOYMENT AND
UNEMPLOYMENT
• Employment rate is one indicator used in determining the phases of business cycle.
There is full employment when there is available job for every person who is willing and
able to work. This definition does not necessarily mean zero unemployment. Even about
6% of the labor force is unemployed; this can still be considered as full employment. On
the other hand, unemployment is a condition of people who are able and willing to work
but cannot find jobs.
• A person is considered unemployed if he/she is a member of the labor force but is not
engaged in work or business. The term “labor force” refers to people of a certain age (15
years and above in the case of the Philippines) who are:
a. Working or are engaged in business
b. Not working or engaged in business but are actively looking for work. This means is that
unemployment does not include those people who are either too young, too old, or are
not looking for work.
Unemployment is categorized as follows:
• Frictional unemployment. This is a situation where workers look for other jobs
or laid off due to some reasons like friction against co-workers, employers, or
environment.
• Structural unemployment. Innovations and technological changes render the
skills and talents of some workers obsolete. Hence, they were laid off.
• Cyclical unemployment. When economy starts to fall, more companies and
business close shop.
• Seasonal unemployment. Some sectors of the economy are affected by
seasonal changes. Like in agriculture and also in the industrial sector such as:
Christmas season, class opening, or summer or rainy seasons affects many
production and correspondingly, employment.
• Societal unemployment. People like ex-convict, disabled and ex-mental
patients have difficulty in looking for a job because society believes that they
are not worthy to be trusted.
There are two theories of employment:
• Classical theory of employment (Adam Smith). This theory is based on
the supply and demand principle. It says that there is more employment
at a lower wage rate. If wage hikes, employers will tend to lay off their
workers. The theory claims that there is widespread unemployment
because people do not want lower wage.

• Keynesian theory of employment (John Maynard Keynes). This is

considered the modern theory of employment. It explains that
employment is triggered by the aggregate demand for goods and
services. As demand get higher, production increases giving rise to more
employment. This theory further argues the contention of the classical
theorist regarding the unemployment due to stubborn acceptance of
lower wages. This is not true if there is depression. Even a meager income
will be accepted by anyone just to have employment during depression.
•Okun’s
  Law
This was developed by Arthur Okun who was a macroeconomist. He
developed the relationship between GDP and unemployment. As a
result of his findings, he concluded that for every 2-3% movement in
GDP, unemployment changes by 1% in both opposite directions.

INFLATION
Inflation is a sustained increase in the general price level/ prices as a
whole, or it is the rate of change of the consumer price index (CPI).
Mathematically it can be expressed as follows:
Consumer Price Index (CPI) – relates the prices urban consumers paid
for a fixed of approximately 40 goods to the prices paid for this same
basket during a base year.

Causes of inflation:
• Demand-pull inflation. “Too much spending chasing too few goods.” It
occurs when the level of spending in the economy exceeds the
amount firms are capable of producing.
• Cost push and supply shock inflation. Cost push inflation is the term
frequently used when labor unions demand for higher wages. Supply
shock inflation is more of recent theory. It occurs when a vital
resource becomes scarce, causing its price to rise and raising the cost
of production for firms.
Losers in inflation:
• Holders of securities. People who have investment both bonds and
stocks lose during the time of inflation.
• Pension holders
• Fixed income earners.

Winners of inflation
• Windfall to fixed asset owners. Land owners gain during inflation as
the value of land and other fixed assets appreciate.
• Producers.
• Deflation - a sustained decrease in the average price level

• Hyperinflation - refers to a period of time of extremely high inflation

reaching 100,000% and above.

• Stagflation - comes from two different words, stagnant and inflation.

The word “stagnant” is used to depict the dormancy of the economy
of the economy with the simultaneous occurrence of inflation. This
simply means that the economy is experiencing inflation and
unemployment at the same time.
CIRCULAR FLOW OF AN ECONOMIC
ACTIVITY
Economic model – simplification of economic reality.
• The economic model depicting the circular flow of goods and services
(output) and income is shown in (figure 9.2):

Equilibrium condition: Outflows = Inflow

Leakages = Injections
S+T+M = I+G+X
Where:
S = saving I = investment
T = net taxes G = government expenditures
M = import X = export
The economic model above can be expressed in mathematical form:
 
Y = C + I + G + (X-M)

Where: Y = national income

C = consumption expenditure
I = investment
G = government expenditures
X = export
M = import
References
• Bello, Amelia L. et al. 2009. Economics. C and E Publishing, Inc.
• Gabay, Bon Kristoffer G. et al. 2007. 1st edition. Economics: Its
Concepts and Principles (with Agrarian Reform and Taxation). Rex
Book Store.
• Case, Karl E., Fair, Ray C. and Oster, Sharon. 2009. Principles of
Economics. 9TH Edition. Pearson Education, Inc.
• Mankiw, Gregory N. 1998. Principles of Macroeconomics. The Dryden
Press, Harcourt. Brace College Publishers.