Economic Instability

Chapter 13 Vocab Outsourcing Technological unemployment Cyclical unemployment Seasonal unemployment GDP gap Misery index/ Discomfort index Inflation Deflation Price index Consumer price index Market basket Base year Creeping inflation Hyperinflation Stagflation Demand-pull inflation Cost-push inflation Civilian labor force Unemployed Unemployment rate Frictional unemployment Structural unemployment

Business Cycles vs. Business Fluctuations Business Cycles: regular increases and decreases in real GDP Business Fluctuations: irregular increases and decreases in real GDP They both can interrupt economic growth

First phase is recession, a period during which real GDP (GDP measured in constant prices) declines for at least 2 quarters in a row or 6 consecutive months.

The recession begins when the economy reaches a peak, the point where real GDP stops going up.

The recession ends when the economy reaches a trough, the turnaround point where real GDP stops going down.

As soon as the declining real GDP bottoms out, the economy moves into the second phase, expansion – a period of recovery until the economy reaches a new peak.

When it does, the current business cycle ends and a new one begins.

Trend line: growth path the economy would follow if it were not interrupted by alternating periods of recession and recovery

Causes of Changes in the Business Cycle Changes in investment spending: When the economy is expanding, businesses expect future sales to be high, so they invest heavily in capital goods. Innovation and Imitation: Come up with a new product or new way of doing things; copying what other companies may be doing Monetary Policy Decisions: Change of interest rates causing incentives to invest or not External Shocks: oil prices, wars, international conflict, natural disasters

What Happens if a recession becomes very severe? Depression: a state of the economy with large numbers of people out of work, acute shortages, and excess capacity in manufacturing plants.

The Great Depression Causes Effects Unequal distribution of income Easy Credit Global economic conditions GDP fell almost 50 percent Unemployment rose nearly 800 percent Average manufacturing wage fell from 55 cents an hour to 5 cents an hour Banks failed Money supply contracted

What’s the difference between inflation and deflation? Inflation: increase in the general level of prices of goods and services Deflation: decrease in the general level of prices for goods and services

Market Basket: commonly purchased goods and services Total of approx. 354 determined items

Constructing the Consumer Price Index Consumer Price Index (CPI): series used to measure prices changes for a representative sample of frequently used consumer items Select a Market Basket Find the average price of each item in the market basket. Then add up the total for the basket. Have a base year: a year that serves as a comparison for all other years Convert the dollar cost of a market basket to an index value so that it is easier to interpret.

(current year CPI – previous year CPI) Previous year CPI Measuring Inflation (current year CPI – previous year CPI) Previous year CPI

Types of Inflation Creeping Inflation: 1-3% inflation per year; not much of a problem Hyperinflation: 500% and above inflation per year; very very rare Stagflation: period of slow economic growth coupled with inflation

Causes of Inflation Causes of inflation include strong demand, rising costs, and wage-price spirals, along with a growing supply of money. Demand-pull inflation: prices rise because all sectors try to buy more goods and services than the economy can produce; cause shortages, which drive up prices Cost-push inflation: rising costs drive up prices of products

Consequences of Inflation Inflation can reduce purchasing power, distort spending, and affect the distribution of income. Reduce Purchasing Power: dollar buys less as prices rise Distort Spending Patterns: Encourage Speculation: Spend money on luxury items if the prices are expected to increase Distorted Distribution of Income:

Unemployment

Measuring Unemployment Civilian Labor Force: sum of all people age 16 and above who are either employed or actively seeking employment Who is classified as unemployed? People available to work who made a specific effort to find a job during the past month AND worked less than 1 hour for pay in a week Work 15 hours or less in a week in a family business for no pay

How to Calculate the Unemployment Rate Number of unemployed persons Civilian Labor Force 7,015,000 = 0.046 = 4.6% 150,991,000

Unemployment Rate Bedford Co. 10.8% Tennessee 9.5% All U.S. 9.2%

Limitations of the Unemployment Rate Doesn’t measure people too frustrated or discouraged to look for work People are considered employed even if they only have part-time jobs

Sources of Unemployment Frictional: workers are between jobs; short-term condition Structural: fundamental change in the economy; more serious type of unemployment, also includes Technological: workers are replaced by machines or automated systems Cyclical: related to changes in the business cycle, also includes Seasonal: annual changes in the weather or other conditions that reduce the demand for jobs