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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