Chapter 8 Unemployment and Inflation. Business Cycles Business Cycle: the pattern of real GDP rising and falling. Recession (Contraction): two or.

Chapter 8

Unemployment and InflationUnemployment and Inflation

Business CyclesBusiness Cycles

Business CycleBusiness Cycle: the pattern of real GDP : the pattern of real GDP rising and falling.rising and falling.

RecessionRecession (Contraction): two or more (Contraction): two or more successive quarters of falling real GDP.successive quarters of falling real GDP.

DepressionDepression: a severe, prolonged : a severe, prolonged economic contraction. Usually involves economic contraction. Usually involves unemployment rising to greater than 10% unemployment rising to greater than 10% for years.for years.

U.S. Real U.S. Real GDPGDP(Recessions (Recessions Shaded)Shaded)

Changes in Real GDPChanges in Real GDP

Source: National Economic TrendsFederal Reserve Bank of St. LouisUpdated March 5, 2004

Figure 2: The Business Figure 2: The Business CycleCycle

Are we in a recession?Are we in a recession?

Source: National Economic TrendsFederal Reserve Bank of St. LouisUpdated March 5, 2004

Great DepressionGreat Depression

YearYear U.S. Unemployment RateU.S. Unemployment Rate

19291929 3.2%3.2%

19301930 8.7%8.7%

19311931 15.9%15.9%

19321932 23.6%23.6%

19331933 24.9%24.9%

19391939 17.2%17.2%

Economic IndicatorsEconomic Indicators

Leading IndicatorsLeading Indicators A variable that fairly consistently changes before A variable that fairly consistently changes before

real GDP changesreal GDP changes

Coincident IndicatorsCoincident Indicators A variable that fairly consistently changes at the A variable that fairly consistently changes at the

same time as real GDP changessame time as real GDP changes

Lagging IndicatorsLagging Indicators A variable that fairly consistently changes after A variable that fairly consistently changes after

real GDP changesreal GDP changes

The IndicatorsThe Indicators

UnemploymentUnemployment

Rate ofUnemploymen

t

= number unemployednumber in the Labor Force

The unemployment rate is the percentage of the labor force that is not working.

The U.S. Labor Department defines the labor force as being equal to:

• All U.S. residents• Over the age of 16• Who are not institutionalized• Who are looking for work

Interpreting the Interpreting the Unemployment RateUnemployment Rate Discouraged WorkersDiscouraged Workers are workers who are workers who

have looked for work in the past year, have looked for work in the past year, but who have stopped looking because but who have stopped looking because they believe no one will offer them a job.they believe no one will offer them a job.

UnderemploymentUnderemployment is the employment of is the employment of workers in jobs that do not utilize their workers in jobs that do not utilize their productive skills.productive skills.

Types of Types of UnemploymentUnemployment

Seasonal UnemploymentSeasonal Unemployment A product of regular, recurring changes in the hiring needs

of certain industries on a monthly or seasonal basis. Frictional UnemploymentFrictional Unemployment

Occurs because workers and employers have to find one another.

A product of the short-term movement of workers between jobs, and of those just entering the labor force.

Structural UnemploymentStructural Unemployment Reflects an imperfect match-up of employee skills and the

skill requirements of the available jobs. A product of technological change and other changes in the

structure of the economy. Cyclical UnemploymentCyclical Unemployment

A product of business cycle fluctuations. When there is a general downturn in business activity,

cyclical unemployment increases.

Unemployment and Its Unemployment and Its CostsCosts Natural Rate of UnemploymentNatural Rate of Unemployment

The level of unemployment that results when the rate of The level of unemployment that results when the rate of unemployment is normal, considering both unemployment is normal, considering both frictionalfrictional and and structuralstructural factors. Also called the factors. Also called the NAIRUNAIRU (Nonaccelerating Inflation Rate of Unemployment)(Nonaccelerating Inflation Rate of Unemployment)

Potential Real GDPPotential Real GDPThe level of output produced when nonlabor resources The level of output produced when nonlabor resources are fully utilized and unemployment is at its natural rate.are fully utilized and unemployment is at its natural rate.

GDP gap = potential real GDP – actual GDPGDP gap = potential real GDP – actual GDP

NormsNorms

In most years, the unemployment rate In most years, the unemployment rate for women is higher than for men.for women is higher than for men.

Teenagers have the highest Teenagers have the highest unemployment rate.unemployment rate.

Whites have lower unemployment rates Whites have lower unemployment rates than nonwhites.than nonwhites.

Interest RatesInterest Rates

Nominal Interest Rate (i):Nominal Interest Rate (i): the observed the observed interest rate in the market.interest rate in the market.

Real Interest Rate (r):Real Interest Rate (r): nominal rate nominal rate adjusted for adjusted for inflation (inflation ())..

r = i - r = i -

Types of InflationTypes of Inflation

Demand-pull inflationDemand-pull inflation: caused by increases in : caused by increases in aggregate demand outpacing increases in aggregate demand outpacing increases in aggregate supply.aggregate supply.

Cost-push inflationCost-push inflation: caused by increases in : caused by increases in production costs cause firms to raise prices.production costs cause firms to raise prices.

HyperinflationHyperinflation: extremely high rate of inflation.: extremely high rate of inflation.

Recent HyperinflationsRecent Hyperinflations