CHAPTER 7 Business Cycles, Unemployment, and Inflation 1 Slides prepared by Bruno Fullone, George Brown College © 2010 McGraw-Hill Ryerson Limited PART 2: GDP, GROWTH, AND FLUCTUATIONS

Learning Objective 7.1: The nature and cause of the business cycle Learning Objective 7.2 : The nature of unemployment and how it is measured Learning Objective 7.3 : The definition of inflation and how it is measured Learning Objective 7.4 : About the redistribution effects of inflation Learning Objective 7.5: About the output effects of inflation 2 In This Chapter You Will Learn:

3LO6.1 Business cycle refers to alternating rises and declines in the level of economic activity, sometime over several years 7.1 The Business Cycle

LO7.14 Level of real output Time Figure 7-1 PEAK PEAK Phases of the Business Cycle

LO7.15 Level of real output Time Figure 7-1 Trough Trough Phases of the Business Cycle

LO7.16 GROWTHTRENDGROWTHTREND Time Level of real output Figure 7-1 Phases of the Business Cycle

7LO7.1 Year Depth (decline in real GDP, %) 1930–33 – – – – – – –09* – 2.2 Source: Statistics Canada. Updates at: Accessed May 7, * Fourth quarter 2008 and first quarter 2009 Table 7-1 Canadian Recessions since 1930

8LO7.1 Table 7-2 Percentage Change in Real GDP for Provinces and Territories, 2008

9LO7.1 Causation: a First Glance o innovation: railroads, automobile, microchip etc have great impact on investment and consumption (occur irregularly) o changes in productivity: increase lead to booms and vice versa o money supply changes: expansions leads to booms and vice versa o total spending changes The Business Cycle

Cyclical Impact: Durables and Nondurables o affects different segments in different ways and to different degrees o Firms producing capital goods and consumer durables affected most because these purchases can be postponed o Service industries and nondurable consumer industries are somewhat insulated from the business cycle

11LO Unemployment

12LO7.2 Unemployment rate = unemployed x 100 labour force Thus in 2008 the unemployment rate was 1,119,300 x 100 = 6.1% 18,245,100 In ,613,700 labour force and 1,489,700 unemployed, unemployment rate = 8.0% Measurement of Unemployment: The Unemployment Rate:

13LO7.2 How the unemployment rate is understated: o Part-Time Employment Statistics – no distinction in the stats for full-time and part- time employment o Discouraged Workers – not counted. If in the survey your are not looking for a job, you are not in the labour force Measurement of Unemployment

LO7.214 Frictional Unemployment – people in between jobs; inevitable in free societies Structural Unemployment – those who don’t have skills required by available positions or not willing to move where skills are in demand; requires retraining Cyclical Unemployment – due to deficient demand Seasonal Unemployment – temporary unemployment due to weather Types of Unemployment

LO7.215 Natural rate of unemployment (NRU) NOT zero unemployment Occurs when there is no cyclical unemployment Not automatic Varies over time Definition of ‘Full’ Employment

LO7.216 GDP Gap & Okun’s Law The amount by which actual GDP falls short of potential GDP GDP gap = actual GDP – potential GDP Okun’s Law: o For every 1% unemployment exceeds the natural rate (full employment rate).… o A GDP Gap of about 2% occurs Economic Cost of Unemployment

17LO 7.2 Figure 7-3 Actual and Potential GDP and the Unemployment Rate

LO7.218 Given for 1992: o unemployment rate is 11.3% o natural rate is 7.5% o potential GDP is $770 billion What is the GDP gap? o 11.3%  7.5% = 3.8%  above full employment (gap in % terms) o 3.8% X 2 = 7.6% (apply Okun’s Law) o 7.6% of $770 billion = $59 billion Economic Cost of Unemployment

LO7.219 Unequal Burdens o Occupation – lower skilled occupations have higher unemployment o Age – teenagers have high unemployment rate (due to lack of marketable skills) o Gender – females used to have higher unemployment rate, but not any longer o Education – less educated workers have higher unemployment Economic Cost of Unemployment

20LO7.2 Unemployment means idleness, loss of output Increases poverty, heightens racial and ethnic tensions, and reduces hope for material advancement Severe unemployment can lead to rapid and violent social and political change Higher unemployment linked to increases in suicide, homicide, and physical and mental illness Non-Economic Costs of Unemployment

21LO6.3 LABOUR AND PRODUCTIVITY labour productivity: The average product of labour; output per worker per hour Real GDP = worker-hours x labour productivity Or, % change in GDP = % change in worker-hours + % change in productivity Production Possibilities Analysis

LO7.222 Table 7-4 Regional Variations

23LO7.2 International Comparisons

LO7.324 Meaning of Inflation o a rise in the general level of prices Measurement of Inflation o Consumer Price Index Example: Rate of Inflation (2008) 7.3 Inflation

LO7.325 Figure 7-4 Annual Inflation Rates in Canada,

LO Global Perspective Inflation Rates in Five Industrial Nations,

LO7.327 Demand-Pull Inflation o Excess aggregate demand Cost-Push Inflation o Per-unit production costs rises, pushing up prices o Supply shocks (example: abrupt increase in natural resource prices) Complexities o Often difficult to distinguish between demand pull and cost push Types of Inflation

LO7.428 Nominal Income and Real Income Real income = 7.4 Redistribution Effects of Inflation

LO7.429 Unanticipated inflation Anticipated inflation Expectations

LO7.430 Assuming Unanticipated Inflation o Those with fixed-incomes – elderly people o Savers – the real value of their purchasing power falls o Creditors – lenders are hurt because they will get paid in money that has less purchasing power Who is hurt by inflation?

LO7.431 Assuming unanticipated inflation o Flexible-Income receivers – those whose income is indexed to inflation o Debtors – can pay back loans with funds that have much less purchasing power Who is unaffected or helped by Inflation?

LO7.432 Effects are lessened to the extent inflation is correctly anticipated o COLA clauses – cost of living allowance clauses o inflation premium on loans – those that loan out money will ask for a premium that take into consideration the expected inflation rate Anticipated Inflation

Figure 7-5 The Inflation Premium, and Nominal and Real Interest Rates o Nominal Interest Rate o Real Interest Rate o Inflation Premium Nominal Interest Rate Real Interest Rate Inflation Premium 11% 5% 6% =+

LO7.434 Deflation – effects of unanticipated deflation are reverse of unanticipated inflation; those on fixed income will benefit; creditors will benefit at expense of debtors Mixed Effects Arbitrariness Other Redistribution Issues

LO7.535 Cost-Push Inflation and Real Output – will put upward pressure on wages and inputs and thus will reduce output and employment Demand-Pull Inflation and Real Output – disagreements whether inflation < 3% can actually help economy Business costs of changing prices – “menu costs” Time and effort spent obtaining information – changing prices requires consumers to spend time getting price information People limit money that they carry Hyperinflation – devastating effects on output (Zimbabwe as an example 2006ish: prices change for food as you eat!) 7.5 Effects of Inflation on Output

The Last Word: The Stock Market and the Economy 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

The Last Word Changes in stock prices and stock market wealth do cause instability but usually the effect is weak Wealth effect: consumer spending rises as asset values rise and vice versa if stock prices decline greatly Investment effect: rising share prices = more capital goods investment and vice versa for falling share prices

7.1 The Business Cycle 7.2 Unemployment 7.3 Inflation 7.4 Redistribution Effects of Inflation 7.5 Effects of Inflation on Output Chapter 738 Chapter 7 Summary