Business Cycles, Unemployment, and Inflation · PDF file•Natural Rate of Unemployment (NRU) •Full employment level of unemployment •Can vary over time •Demographic changes

Business Cycles, Unemployment, and Inflation

26

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

AGENDA: Tues 2/9

• Team Teaching: CH 26

–P3: Abbey, Blake, Itzel, Savanah

–P5: Eric, Evan, Daniel, Lainey

• On Deck: CH 27

–P3: Austin, Jeremy, Luis, T-Flex

–P5: Blake, Chris, Henry, Matt

• HW: Read pp 547-554 Q#1-4

–CH 26 & 27 Assessment Th 2/18

LO1 26-2

The Business Cycle

• Alternating increases and decreases

in economic activity over time

• Phases of the business cycle

• Peak

• Recession

• Trough

• Expansion

LO1 26-3

The Business Cycle L

evel

of

real

ou

tpu

t

Time

Peak

Peak

Peak

Trough

Trough

LO1 26-4

The Business Cycle

U.S. Recessions since 1950

Period

Duration,

Months

Depth

(Decline in Real

Output)

1953-54 10 -2.6%

1957-58 8 -3.7

1960-61 10 -1.1

1969-70 11 -0.2

1973-75 16 -3.2

1980 6 -2.2

1981-82 16 -2.9

1990-91 8 -1.4

2001 8 -0.4

2007-09 18 -3.7

Source: National Bureau of Economic Research, http://www.nber.org and Minneapolis Federal Reserve

Bank, http://www.minneapolisfed.org Output data are in 2000 dollars

LO1 26-5

Causation: A First Glance

• Business cycle fluctuations

• Economic shocks

• Prices are “sticky” downwards

• Economic response entails

decreases in output and

employment

LO1 26-6

Causation: A First Glance

• Causes of shocks

• Irregular innovation

• Productivity changes

• Monetary factors

• Political events

• Financial instability

•Recession of 2007

LO1 26-7

Cyclical Impact

• Durable goods affected most

• Capital goods

• Consumer durables

• Nondurable consumer goods affected

less

• Services

• Food and clothing

LO1 26-8

Unemployment

Under 16

and/or

Institutionalized

(71.4 million)

Not in

labor

force

(81.7 million)

Employed

(139.9 million)

Unemployed

(14.3 million)

Total

population

(307.3

million)

Labor

force

(154.2

million)

Unemployment rate =

14,265,000

154,142,000 X 100 = 9.3%

Unemployment rate =

# of unemployed

labor force X 100

LO2 26-9

Unemployment

• Criticisms of unemployment

• Involuntary part-time workers

counted as if full-time

• Discouraged workers are not

counted as unemployed

LO2 26-10

Types of Unemployment

• Frictional unemployment

• Individuals searching for jobs or

waiting to take jobs soon

• Structural unemployment

• Occurs due to changes in the

structure of the demand for labor

• Cyclical unemployment

• Caused by the recession phase of

the business cycle LO3 26-11

Definition of Full Employment

• Natural Rate of Unemployment (NRU)

• Full employment level of

unemployment

• Can vary over time

•Demographic changes

•Changing job search methods

•Public policy changes

• Actual unemployment can be above

or fall below the NRU LO3 26-12

Economic Cost of Unemployment

• GDP Gap

• GDP gap = actual GDP – potential

GDP

• Can be negative or positive

• Okun’s Law

• Every 1% of cyclical unemployment

creates a 2% GDP gap

LO3 26-13

Economic Cost of Unemployment

LO3

Economic Cost of Unemployment

26-14

Economic Cost of Unemployment

LO3 26-15

Unequal Burdens

• Occupation

• Age

• Race and ethnicity

• Gender

• Education

• Duration

LO3 26-16

Unequal Burdens Unemployment Rates by Demographic Group: Full Employment Year (2007) and Recession Year (2009)*

Demographic Group

Unemployment Rate

2007 2009

Overall 4.6% 9.3%

Occupation:

Managerial and professional

Construction and extraction

2.1 4.6

7.6 19.7

Age:

16-19

African American, 16-19

White, 16-19

Male, 20+

Female, 20+

15.7 24.3

29.4 39.5

13.9 21.8

4.1 9.6

4.0 7.5

Race and ethnicity:

African American

Hispanic

White

8.3 14.8

5.6 12.1

4.1 8.5

Gender:

Women

Men

4.5 8.1

4.7 10.3

Education:** Less than high school diploma

High school diploma only

College degree or more

7.1 14.6

4.4 9.7

2.0 4.6

Duration:

15 or more weeks 1.5 4.7

LO3 26-17

Noneconomic Costs

LO3

• Loss of skills and loss of self-respect

• Plummeting morale

• Family disintegration

• Poverty and reduced hope

• Heightened racial and ethnic tensions

• Suicide, homicide, fatal heart attacks,

mental illness

• Can lead to violent social and political

change 26-18

Global Perspective

LO3 26-19

Inflation

• General rise in the price level

• Inflation reduces the “purchasing

power” of money

• Consumer Price Index (CPI)

LO2

CPI

Price of the Most Recent Market

Basket in the Particular Year

Price estimate of the Market

Basket in 1982-1984

= x 100

CPI 207.3 - 201.6

201.6 = x 100 = 2.8%

26-20

Inflation

LO2

Inflation Rates in Five Industrial Nations

26-21

Inflation

LO2 26-22

Types of Inflation

• Demand-Pull inflation

• Excess spending relative to output

• Central bank issues too much

money

• Cost-Push inflation

• Due to a rise in per-unit input costs

• Supply shocks

LO3 26-23

Inflation

• Difficult to distinguish inflation types

• Types differ in sustainability

• Demand-pull continues as long as

the excess spending continues

• Cost-push ends in a recession

• Core inflation

• Without food and energy goods

• Focuses on more stable prices

LO3 26-24

Redistribution Effects of Inflation

• Nominal income

• Unadjusted for inflation

• Real income

• Nominal income adjusted for

inflation

• Anticipated vs. unanticipated income

Percentage

change in

real income =

Percentage

change in

nominal income

Percentage

change in

price level

LO3

26-25

Who is Hurt by Inflation?

• Fixed-income receivers

• Real incomes fall

• Savers

• Value of accumulated savings

deteriorates

• Creditors

• Lenders get paid back in “cheaper

dollars”

LO3 26-26

Who is Unaffected by Inflation?

• Flexible-income receivers

• COLAs

• Social Security recipients

• Union members

• Debtors

• Pay back the loan with “cheaper

dollars”

LO3 26-27

Anticipated Inflation

• Real interest rate

• Rates adjusted for inflation

• Nominal interest rate

• Rates not adjusted for inflation

LO3 26-28

Anticipated Inflation

Nominal Interest

Rate

Real Interest

Rate

Inflation Premium

11%

5%

6%

= +

LO3 26-29

Other Redistribution Issues

• Deflation

• Mixed effects

• Incomes may rise

• Fixed assets values may fall

• For fixed-rate mortgages, real debt

declines

• Arbitrariness

LO3 26-30

Does Inflation Affect Output?

• Cost-Push inflation

• Reduces real output

• Redistributes a decreased level of

real income

• Demand-Pull inflation

• One view is that zero inflation is

best

• Another view is that mild inflation is

best LO3 26-31

Hyperinflation

• Extraordinarily rapid inflation

• Devastates an economy

• Businesses don’t know what to charge

• Consumers don’t know what to pay

• Money becomes worthless

• Zimbabwe’s 14.9 billion percent

inflation in 2008

LO3 26-32

The Stock Market and the Economy

• Stock prices changing

• Wealth effect

• Investment effect

• Typical changes lead to weak effects

• Stock market bubbles

• Huge unwarranted rises in stock prices

• Excessive optimism and frenzied buying

• Can be detrimental to an economy

26-33