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micro economics chapter 09

9
Business Cycles, Unemployment,
and Inflation

McGraw-Hill/Irwin

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


The Business Cycle
• Alternating increases and decreases in



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economic activity (GDP, employment, income)
over time
Vary in duration and magnitude
Phases of the business cycle
• Peak

• Recession – 6 months or more
• Trough
• Expansion


The Business Cycle
Peak

Rec
ess
io

n

ns
io
n

Trough

Time

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Re
ces
sio

n

ns
io

h
t
w
o
Gr

Ex


pa

Peak

n

d
Tren

Ex
pa

Level of real output

Peak

Trough


The Business Cycle
TABLE 26.1 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, www.nber.org, and Minneapolis Federal Reserve Bank,
www.minneapolisfed.gov. Output data are in 2000 dollars
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Cyclical Impact

• Durable & capital goods affected


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most during recessions
• Postponability
Nondurable consumer goods affected
less


Unemployment
Under 16
and/or
Institutionalized
(69.5 million)

Total
population
(321.4
million)

Not in
labor
force
(94.1 million)

Employed
(149.9 million)

Unemployed
(7.9 million)
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Labor force
(157.8
million)


Unemployment
Unemployed

• Unemployment Rate = Labor Force x 100
• Criticisms
• Involuntary part-time workers counted
as if full-time
• Discouraged workers are not counted
as unemployed
• http://www.youtube.com/watch?v=Ul
u3SCAmeBA
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Types of Unemployment

• Frictional unemployment
• Individuals searching/waiting for jobs
• Shorter term
• Structural unemployment
• Occurs due to changes in the
structure of the demand for labor
• Longer term

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Types of Unemployment

• Frictional and structural


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unemployment are unavoidable and
beneficial
Cyclical unemployment
• Caused by a recession – decrease
in total spending


Definition of Full Employment

• Natural Rate of Unemployment (NRU)
• Full employment level of


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unemployment
• Zero cyclical unemployment
• Can vary over time
• Actual unemployment can be above
or fall below the NRU
Potential GDP is GDP associated with
NRU


Economic Cost of Unemployment

• Irretrievable loss of goods and services
• GDP Gap
• Amount of goods and services
sacrificed due to cyclical
unemployment
• GDP gap = actual GDP – potential
GDP

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Economic Cost of Unemployment

• Negative GDP gap occurs because


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there is cyclical unemployment;
potential GDP exceeds actual GDP
Positive GDP occurs because the
actual unemployment rate is less than
the NRU; actual GDP is greater than
potential GDP.


Economic Cost of Unemployment

• Okun’s Law
• Every 1% of cyclical unemployment
creates a 2% GDP gap

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Economic Cost of Unemployment

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Global Perspective

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Inflation

• General rise in the price level
• Consumer Price Index (CPI) is used
• Can use the “rule of 70”

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Inflation

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Inflation

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Types of Inflation

• Demand-Pull inflation
• “Too much spending chasing too
few goods”
• Central bank issues too much
money
• More likely to occur the closer the
economy is to full-employment

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Types of Inflation

• Cost-Push inflation
• Due to a rise in per-unit input costs
• Supply shocks

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Inflation

• Core inflation
• Excludes volatile food and energy
goods
• Focuses on more stable prices

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Redistribution Effects of Inflation

• Nominal income
• Unadjusted for inflation
• Real income
• Nominal income adjusted for inflation
• Real income can fall if nominal income
increases by less than inflation
• Income is redistributed

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Who is Hurt by Inflation?

• Fixed-income receivers
• Real incomes fall
• Savers
• Value of accumulated savings


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deteriorates
Creditors
• Lenders get paid back in “cheaper
dollars”


Who is Unaffected by Inflation?

• Flexible-income receivers
• COLAs
• Social Security recipients
• Union members
• Debtors
• Pay back the loan with “cheaper
dollars”
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