Business Cycles, Unemployment, and Inflation Chapter 26 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

26-2 Chapter Objectives The business cycle and its phases Measuring unemployment and inflation The types and impacts of unemployment and inflation

26-3 The Business Cycle Level of Real Output Time Peak Recession Expansion Trough Growth Trend Durable and nondurable industries affected differently

26-4 Causes of Business Cycles Shocks and price stickiness –Change in output instead of price Supply and productivity shocks –innovation Monetary shocks Financial bursts and bubbles Unexpected political events Common link –Unexpected changes in spending

26-5 Unemployment Twin problems of the business cycle –Unemployment –Inflation Measurement of unemployment –Who’s in the labor force Problems with the unemployment rate –Part-time employment –Discouraged workers Unemployment Rate Unemployed Labor Force = x 100

26-6 Unemployment Under 16 And/or Institutionalized (71.8 Million) 2007 data Total Population (303.6 Million) Not in Labor Force (78.7 Million) Employed (146.0 Million) Labor Force (153.1 Million) Unemployed (7.1 Million) Source: Bureau of Labor Statistics

26-7 Unemployment Types of unemployment –Frictional (search and wait) –Structural (occupational and geographical) –Cyclical Full employment redefined –No cyclical unemployment Natural rate of unemployment Full employment rate

26-8 Unemployment Natural rate of unemployment –1980’s 6% –Today 4-5% Aging labor force Temp agencies and the internetinternet New welfare laws and work requirements Prison population has doubled

26-9 Cost of Unemployment Foregone output Potential output GDP gap –(Actual output – potential output) –Negative or positive Okun’s Law –Each 1% above NRU creates negative 2% output gap

26-10 Unemployment The GDP Gap 12,000 11,000 10,000 9,000 8,000 7,000 6,000 5,000 GDP (billions of 1996 dollars) The Unemployment Rate Unemployment (percent of civilian Labor force) Source: Congressional Budget Office & Bureau of Economic Analysis GDP gap (positive) GDP gap (negative) Potential GDP Actual GDP

26-11 Unemployment Unequal burdens –Occupation –Age –Race and ethnicity –Gender –Education –Duration Noneconomic costs –Psychological, social, political

26-12 Unemployment Source: Bureau of Labor Statistics Unemployment Rates in Five Industrial Nations,

26-13 Inflation Rise in general level of prices Consumer price index (CPI) –Market basket –300 goods and services –Typical urban consumer –2 year updates CPI Price of the Most Recent Market Basket in the Particular Year Price estimate of the Market Basket in = x 100

Rate of Inflation Rate of inflation This year index – last year index last year index 26-14

26-15 Inflation Annual Inflation Rates in the United States, Inflation Rate (percent) Source: Bureau of Labor Statistics

26-16 Inflation Source: Bureau of Labor Statistics Inflation Rates in Five Industrial Nations,

26-17 Inflation Types of Inflation –Demand pull: resources fully employed, cant meet demand, higher prices –Cost-push: rise in ATC, lower output, higher prices – often due to supply shocks –Complex dynamic, often hard to diagnose Redistributive Effects –Nominal (just dollars) and real (nominal/price index) income –Growth in nominal income vs. inflation rate –Anticipated vs. unanticipated inflation

26-18 Inflation Who is hurt by inflation? –Fixed-income receivers –Savers –Creditors Who is unaffected or not hurt by inflation? –Flexible-income receivers Cost-of-living adjustments (COLAs) Demand-pull beneficiaries –Debtors

26-19 Anticipated Inflation –Nominal Interest Rate –Real Interest Rate –Inflation Premium Nominal Interest Rate Real Interest Rate Inflation Premium 11% 5% 6% =+

26-20 Other Inflation Issues Deflation Mixed effects - diversified Arbitrariness – whammy… Cost-push inflation and real output –“Stagflation” Demand-pull inflation and real output –Efficiency loss? –A little inflation as a trade-off for more productivity? Hyperinflation –No stability - chaos

26-21 The Stock Market Stock prices and macro instability The market for stocks Volatile stock prices Wealth effect Investment effect Little impact on macroeconomy Stock market bubbles do have an impact Index of Leading Indicators

26-22 Key Terms business cycle peak recession trough expansion labor force unemployment rate discouraged workers frictional unemployment structural unemployment cyclical unemployment full-employment rate of unemployment natural rate of unemployment (NRU) potential output GDP gap Okun’s law inflation Consumer Price Index (CPI) demand-pull inflation cost-push inflation per-unit production costs nominal income real income anticipated inflation unanticipated inflation cost-of-living adjustments (COLAs) real interest rate nominal interest rate deflation hyperinflation

26-23 Next Chapter Preview… Basic Macroeconomic Relationships