Business Cycles and Fluctuations. Chapter 14.

UNEMPLOYMENT Unequal Burdens of Unemployment Occupation Age Race and Ethnicity Gender Education

Unemployment Rates for Various Groups

Full Employment  Occurs only if there is no cyclical unemployment  Occurs when the only unemployment is frictional, structural, or seasonal  Does not mean zero unemployment  Frictional, seasonal, and structural unemployment can still occur  Occurs when from 4% to 6% of the labor force is unemployed

UNEMPLOYMENT Measurement of Unemployment, 2002 Employed Not in labor force Under 16 and/or institutionalized Total Population 288,600,000 Labor force 142,500,000 74,700,000 71,400,000 Unemployed 8,300, ,200,000

The U.S. Unemployment Rate Since 1900

INFLATION Defined and Measurement A rising general level of prices Rate of inflation calculated using index numbers Consumer Price Index = Price of the same market basket in x 100 CPI Price of most recent market basket in the particular year The most widely reported measure of inflation for cost of living

CPI= /43.47 x 100 CPI = Rate of Inflation: /100 x 100 Or =13.18

Inflation. Creeping or normal inflation. 1-3 percent a year. Why must we have some inflation for a healthy economy? Galloping inflation percent per year. Hyperinflation or 500 percent a year.

CPI Since 1913 – Annual Percentage Change

Inflation Across Countries Inflation Rates in Major Economies Have Trended Lower Over the Past Two Decades

Is it Good or Bad? Inflation is not bad if it occurs at a low predictable rate; acceptable is 2-3% If wages increase at a rate that maintains purchasing power, then it is also not bad. Older people are more sensitive to inflation. Hyperinflation is bad. Deflation can also be either.

Inflation  Inflation: a sustained increase in the average price level  Hyperinflation: extremely high inflation  Deflation: a sustained decline in the average price level  Disinflation: a reduction in the rate of inflation

REDISTRIBUTIVE EFFECTS OF INFLATION Who is Hurt by Inflation? Fixed-Income Receivers Savers Creditors Want to be home owners.

Who is less hurt or helped by Inflation? Flexible-Income earners. Cost of Living Adjustments (COLAs) Debtors Tangible asset holders.

Causes of Inflation Labor costs rising faster than productivity Rising raw-material costs Depreciation of the dollar Increased money supply Low interest rates. Increased consumer spending. Increased gov ’ t spending.

Causes of Inflation? “TOO much money chasing TOO few goods and services.”

Causes of Inflation: Demand-pull inflation is inflation initiated by an increase in aggregate demand. Cost-push, or supply-side, inflation is inflation caused by an increase in costs.

Demand pull : Increase in AD can be due to a fiscal or monetary policy, thus increasing prices

Cost push: Upward shift of the AS will be due to increase in costs due to increase in price of inputs.

Combination of both:

Exhibit 6a: Inflation Caused by Shifts of AD and AS Curves 25 Increase in the AD curve pulls up the price level. To generate continuous demand-pull inflation, the AD curve must keep shifting outward along a given AS curve Increase in costs of production push up the price level. To generate continuous cost-push inflation, the AS curve must keep shifting to the left along a given AD curve.

Stagflation: Stagflation occurs when output is falling at the same time that prices are rising. One possible cause of stagflation is an increase in costs.

Countering inflation: Demand -pull Reduce demand by higher taxation, lower govt. expenditure, lower govt borrowing, higher interest rates Cost pushTake steps to reduce production costs by deregulating labour markets, encouraging greater productivity, apply control over wages and prices Import factorsreduce quantity of imports or their prices via trade policies.

Controlling inflation (cont) Excessive growth on money supply Reduce money supply by cutting down on public sector borrowing Funding Govt borrowing from non bank Reduce bank lending Maintain interest rates Expectations of inflation Pursue policies which indicate Govt’s determination to reduce inflation

Anticipated versus Unanticipated Inflation  Unanticipated inflation creates more problems for the economy than does anticipated inflation  To the extent that inflation is higher or lower than anticipated, it arbitrarily creates winners and losers  If it is higher than expected, the winners are all those who had contracted to pay a price that anticipates lower inflation  The losers are all those who agreed to sell at that price  If inflation is lower is lower than expected, the situation is reversed 29

Inflation Across Metropolitan Areas  Inflation rates differ across regions mostly because of differences in housing prices, which grow faster in some places than in others  Federal government tracks separate CPIs for each of 26 metropolitan areas. 30

Exhibit 8: Average Annual Inflation from 1994 to 2004 Differed Across U.S. Metropolitan Areas 31

Why is Inflation Unpopular?  Problems with unanticipated inflation  Hits those whose incomes are fixed in nominal terms  Arbitrarily redistributes income and wealth from one group to another  Reduces the ability to make long-term plans  Forces buyers and sellers to pay more attention to prices - less time for production - overall productivity of economy falls 32

Homework Read pages Complete #2, 4,5, and 6