Consequences of Business Fluctuations Chapter 14

Discussion Topics Fluctuations in business activity Consequences of business fluctuations Macroeconomic policy options

Nature of Business Fluctuations Expansionary phase Peak of business cycle Recessionary phase Trough of business cycle Page 338

Four Phases of a Business Cycle Length of cycles varies over time… Length of cycles varies over time…

Indicators of Economic Activity Coincident indicators: current production, current disposable income, current sales Lagging indicators: business inventories, duration of employment, average interest rate Leading indicators: new orders for goods, new building permits, new investment in plant and equipment, changes in the money supply Forecasting models: mathematical methods of forecasting future trends in the economy Pages

Page 340 Indicator index Indicator index Actual activity several months later… Actual activity several months later… A classical example of a leading indicator

Two Consequences of Business Fluctuations Fluctuations in the civilian unemployment rate and implications for policy Fluctuations in the rate of inflation and implications for policy Pages

Unemployment Rate

Calculation of Civilian Unemployment Rate Annual rate Number of civilians unemployed Size of total civilian labor force = where the size of the total civilian labor force is determined by subtracting those not seeking jobs (homemakers, students, etc.) from the total non- institutional population (those not in prison) over 16 years of age as well as those who are in military service. Pages 341

An Example Assume the following values: Total labor force million Members of armed services 1.7 million Employed persons million Annual rate – 1.7 – – 1.7 = =.0415 or 4.15 percent 1 The total labor force equals total population minus those not seeking employment over age 16 and those in institutions. Pages 341

Forms of Unemployment Frictional: changing jobs and currently unemployed Cyclical: associated with business cycles Seasonal: associated with seasonal business activity Structural: associated with technological change Pages 341

Page 342 Full employment barometer? Full employment barometer? Unemployment rate during the great depression was 25% Unemployment rate during the great depression was 25%

Inflation Rate

What is Inflation? Sustained rise in the general price level Not a change in the price of a single commodity Core rate of inflation excludes fuel and food price increases Deflation (prices falling) vs. disinflation (prices increasing at a slower rate) Pages 342 – 343

Measuring the CPI The consumer price index is a weighted average of the prices consumers pay for goods and services. It is measured by: CPI = Or: CPI = W FB (P FB ) + W H (P H ) + … + W OTHER (P OTHER ) = (P FB ) (P H ) + … (P OTHER ) Cost of market basket in current year Cost of market basket in base year × 100 See Table 14.3 on page 344 Page 342

Rate of Inflation The rate of inflation can be measured by the percent change in the CPI, or: Inflation rate = current CPI – previous CPI previous CPI If the CPI was in 1999 and in 2000, the annual rate of inflation in 2000 would be: Inflation rate = (172.3 – 166.6) ÷ =.0342 or 3.42% Pages 344

Inflation thought to be “under control” in this range Inflation thought to be “under control” in this range Brought about a major monetary policy action described in Chapter 13 Brought about a major monetary policy action described in Chapter 13 Page 345

Page 347 When describing growth in the economy on the nightly newscast, the newscaster will refer to the growth in real GDP after adjustments for inflation. In the above example, real GDP grew over the period, but not at the rate implied by comparisons in nominal terms. When describing growth in the economy on the nightly newscast, the newscaster will refer to the growth in real GDP after adjustments for inflation. In the above example, real GDP grew over the period, but not at the rate implied by comparisons in nominal terms.

Page 346 Some examples of annual rates of inflation around the world vs. U.S. Some examples of annual rates of inflation around the world vs. U.S.

Trade off between Inflation and Unemployment

Page 349 Phillips curve named after British economist A. W. Phillips… Phillips curve named after British economist A. W. Phillips…

Page 349 Policies that reduce unemployment may increase inflation in the short run, and vice versa… Policies that reduce unemployment may increase inflation in the short run, and vice versa…

Page 348 Demand oriented policies that shift the aggregate demand curve from AD 2 to AD 3 “pull up” the general price level from P 0 to P 1. This small increase in inflation may make sense since output increased from Y 2 to Y 3, which would lower unemployment. Demand oriented policies that shift the aggregate demand curve from AD 2 to AD 3 “pull up” the general price level from P 0 to P 1. This small increase in inflation may make sense since output increased from Y 2 to Y 3, which would lower unemployment.

Page 348 Demand oriented policies to maximize output at the economy’s potential or Y POT may bring about a substantial increase in the general price level (and hence rate of inflation) for a relatively small gain in output and employment. Demand oriented policies to maximize output at the economy’s potential or Y POT may bring about a substantial increase in the general price level (and hence rate of inflation) for a relatively small gain in output and employment.

Page 351 Both demand and supply oriented policies stimulate aggregate output. Both demand and supply oriented policies stimulate aggregate output.

Page 351 But demand expansion policy “pulls up” the general price level…. But demand expansion policy “pulls up” the general price level….

Page 351 …while supply oriented policies that enhance productivity reduce the general price level. …while supply oriented policies that enhance productivity reduce the general price level.

Page 351 In reality, both forms of policy are typically carried out at the same time.

Summary A business cycle has four phases: peak, recession, trough and expansion The two major consequences of business fluctuations are unemploy- ment and inflation Know how to calculate the civilian unemployment rate and the rate of inflation facing consumers Understand the nature of the index of leading economic indicators Understand the concept graphing of demand pull inflation Understand the Phillips curve and demand and supply policy impacts

Chapter 15 focuses on how macroeconomic policy affects agriculture….