Economic Fluctuations, Unemployment, and Inflation Macro Chapter 8 Economic Fluctuations, Unemployment, and Inflation

“Prosperity is when the prices of things that you sell are rising; inflation is when the prices of things that you buy are rising. Recession is when other people are unemployed; depression is when you are unemployed.” Anonymous quote

5 Learning Goals Characterize fluctuations in economic growth. Relate fluctuations in GDP to employment and the demand for labor. Classify unemployment into three categories. Distinguish the difference between full employment and the natural rate of unemployment and correlate both to potential GDP. Determine inflation’s effect on the economy.

Swings in the Economic Pendulum

Instability in the Growth of Real GDP Annual Rate of Growth in Real GDP (long-run growth rate approximately 3%) Although real GDP in the United States has grown at an average rate of approximately 3%, the growth has been characterized by economic ups-and-downs. Note: periods of recession are indicated with shading. 8% 6% 4% 2% 0% -2% -4% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: Economic Report of the President, various issues.

The Hypothetical Business Cycle 4/14/2017 The Hypothetical Business Cycle Real GDP Business peak Trend line Business peak Recessionary trough Expansion Contraction Recessionary trough Time The four phases of the business cycle are expansion, peak, contraction, and recessionary trough.

Key Points: The business cycle varies and is unpredictable The average annual growth rate is 3%

Economic Fluctuations and the Labor Market

Q8.1 A person not working is considered unemployed. True False

This section describes the categories of people Total population divided into two categories: (1) Under age 16 & institutionalized people (2) Over age 16 Over age 16 divided into two categories: (1) Not in labor force – students, retirees, disabled (2) In labor force In labor force divided into two categories: (1) Employed (2) Unemployed, but want to be employed

Definition of unemployed: A person not currently employed but (1) actively seeking a job, or (2) waiting to begin or return to a job See BLS FAQs (BLS_FAQS.pdf)

U.S. Population, Employment, and Unemployment 4/14/2017 U.S. Population, Employment, and Unemployment Civilian population 16 and over Not in the labor force Household workers Students Retirees Disabled Civilian labor force Employed Employees Self-employed workers Unemployed New entrants Reentrants Lost last job Quit last job Laid off Labor Force Participation Rate = Civilian labor force Civilian population (16+) Employment / Population Ratio = Number employed Civilian population (16+) Rate of Unemployment = Number unemployed Civilian labor force

See Current Population Survey (CPS_Aug_2012.pdf)

Q8.2 Mary is a homemaker. Last week, she was busy with her normal household chores. She is a member of the civilian labor force who is employed. a member of the civilian labor force who is unemployed. a member of the civilian labor force who is underemployed. a discouraged worker who is not a member of the labor force. not a member of the labor force.

Two calculations to know Labor force participation rate = (employed + unemployed) / civilian pop. over age 16 Unemployment rate = unemployed / (employed + unemployed) OR unemployed / labor force

Q8.3 Which of the following would be officially classified as unemployed? a school administrator who has been working as a substitute teacher one day per week while looking for a full-time job in administration a mathematician who returned to graduate school after failing to find a job the last four months a 60-year-old former steel worker who would like to work but has given up actively seeking employment a laid-off construction worker waiting to return to a previous job

Please see article “15 Statistics about the jobs market Please see article “15 Statistics about the jobs market.pdf” (the data are a little old, but still informative)

The unemployment rate climbed to 8. 3% in February, 2009 The unemployment rate climbed to 8.3% in February, 2009. It’s stayed over 8% since (that’s 43 months). The unemployment rate climbed to 9.4% in May, 2009. It stayed over 9% until September, 2011 (except for March, 2011 at 8.9%). That’s 28 out of 29 months. The previous longest streak above 8% was 27 months, from 1981 to 1984.

Three Types of Unemployment

3 general reasons why people are unemployed: (1) Frictional – imperfect information (2) Structural – workers don’t possess desired skills (3) Cyclical – result of business cycle

Watch Video: Stossel-unemployment and labor mobility

Employment Fluctuations- The Historical Record

Example of workers moving to a new industry: Watch video- Treycycle employs NASA engineers

Q8.4 Which of the following is a positive effect of job search and the unemployment that often accompanies it? It keeps wages and income levels low. It permits individuals to better match their skills and preferences with the requirements of a job. It reduces the wage gap between high skill workers and those with few skills. It creates political pressure for an increase in the minimum wage, which will reduce the rate of unemployment in the long run.

Some unemployment is unavoidable and arguably desirable Natural rate of unemployment: “normal” frictional and structural unemployment The natural rate occurs when the economy is operating at a sustainable rate Full employment is when the natural rate of unemployment exists Natural rate equals about 5%

Q8.5 Full employment is the situation in which the economy operates at an unemployment rate equal to the sum of structural and frictional unemployment. cyclical and frictional unemployment. structural and cyclical unemployment. structural, frictional, and cyclical unemployment.

Actual and Potential GDP

Potential output is the economy’s maximum sustainable output; occurs when the natural rate of unemployment exists; occurs when full employment exists Potential output is perhaps best thought of as the 3% growth rate discussed earlier Actual output can be greater than or less than potential; again, think about the actual growth rate

Trend line = maximum sustainable rate Business Cycle = actual output Real GDP Business peak Trend line Business peak Recessionary trough Expansion Contraction Recessionary trough Time Trend line = maximum sustainable rate Business Cycle = actual output

Actual & Potential GDP, 1960-2011 Real GDP (billions of 2000 $) 14,000 Potential GDP Actual GDP 12,000 2008-10 recession Here we illustrate both actual GDP and potential GDP. Note the gap (shaded area) between actual and potential GDP during periods of recession. 1990-91 recession 2001 recession 10,000 1970 recession 8,000 1960 recession 6,000 1980 recession 1982 recession 4,000 1974-75 recession 2,000 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2011

Another way to think about these: When you read the BEA report about quarterly GDP, if the reported (actual) growth rate is near 3%, then the economy is at it’s potential output. At 3% actual growth, the unemployment rate will likely be around 5% (i.e. full employment is 95%) The economy can never eliminate frictional and structural unemployment for an extended period.

Q8.6 Actual GDP will be below potential GDP when the economy is at full employment. during an economic boom. when resources are fully utilized. during a recession.

The Effects of Inflation

Actual & Potential GDP, 1960-2011 1956-1965 average inflation rate = 1.6 % Between 1956 and 1965, the general price level increased at an average annual rate of only 1.6%. In contrast, the inflation rate averaged 9.2% from 1973 to 1981, reaching double-digits during several years. Since 1982, the average rate of inflation has been lower (2.9% from 1983-2011) and more stable. 1973-1981 average inflation rate = 9.2 % 15% 1983-2011 average inflation rate = 2.9 % 10% 5% 0% -5% 1956 1960 1965 1970 1975 1985 1990 1995 2000 2005 2011 2011

See BLS CPI release (CPI_August_2012.pdf)

Q8. 7 Suppose you received a 3 percent increase in your nominal wage Q8.7 Suppose you received a 3 percent increase in your nominal wage. Over the year, inflation ran about 6 percent. Which of the following is true? Your real wage fell. Your nominal wage fell. Both your nominal and real wages decreased. Although your nominal wage fell, your real wage increased. Both nominal and real wages increased.

Inflation is a persistent increase in the general level of prices

Case Study: Zimbabwe In February, 2008 a loaf of bread was 200,000 Zimbabwe dollars In August, 2008, that same loaf of bread was 1.6 trillion dollars That’s 11.2 million percent!

Watch Video: Ducktales-inflation (just for fun)

Why is inflation “bad”? It reduces investment: long-term projects are more risky It distorts information delivered by prices: relative prices are skewed because some prices adjust more quickly than others It results in less productive use of resources: people will spend more time trying to combat the effects of inflation rather than engaging in productive activity

Question Answers 8.1 = 2 8.2 = 5 8.3 = 4 8.4 = 2 8.5 = 1 8.6 = 4 8.7 = 1