1. Chapter 26 Lecture - Business Cycles, Unemployment, and Inflation

2. Business Cycles
Business Cycle: the pattern of real GDP rising and falling.
Recession (cookbook): real GDP declines for at least two consecutive quarters.
Recession (official): “a recurring period of decline in total output, income, employment and trade, usually lasting six months to a year and marked by contractions in many sectors of the economy.”
Recession (Contraction): two or more successive quarters of falling real GDP.
Depression: a severe, prolonged economic contraction. Usually involves unemployment rising to greater than 10% for years.

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

4. Causes of Business Cycles
Shocks and price stickiness
Supply and productivity shocks
Monetary shocks
Financial bursts and bubbles
Unexpected political events
Common link
Unexpected changes in spending
A National Bureau of Economic Research Panel picks peaks and troughs, often many months after the turning point. Forecasters have a good record of forecasting expansions because 4 out of 5 years since 1950 have been expansion years.

5. number in the Labor Force
Unemployment
The unemployment rate is the percentage of the labor force that is not working.
The U.S. Labor Department defines the labor force as being equal to:
All U.S. residents
16 years of age and over
Who are not institutionalized
Who are looking for work
Rate of Unemployment =
number unemployed
number in the Labor Force
Putting a number on the unemployment rate that can be considered full employment is a difficult process and will depend on factors such as the state of development of the economy and the method by which unemployment is calculated.

6. Interpreting the Unemployment Rate
Discouraged Workers are workers who have looked for work in the past year, but who have stopped looking because they believe no one will offer them a job.
Underemployment is the employment of workers in jobs that do not utilize their productive skills.

7. Types of Unemployment Seasonal Unemployment:
A product of regular, recurring changes in the hiring needs of certain industries on a monthly or seasonal basis.
For example, retail sales are higher during the holiday season therefore unemployment in this industry goes down during the months of November and December.
Frictional Unemployment
Usually short term, occurs because workers and employers have to find one another.
College graduates seeking employment are a good example of frictional unemployment.

8. Types of Unemployment Structural Unemployment
Reflects an imperfect match-up of employee skills and the skill requirements of the available jobs or a permanent reduction in demand for an industry’s output.
Advancements in technology have resulted in consistent declines in employment in the agriculture, forestry and fishing industries.
Cyclical Unemployment
A product of business cycle fluctuations. As a recession occurs, cyclical unemployment increases, and as growth occurs, cyclical unemployment decreases. .

9. Unemployment and Its Costs
Natural Rate of Unemployment The level of unemployment that results when the rate of unemployment is normal, considering both frictional and structural factors. Also called the NAIRU (Nonaccelerating Inflation Rate of Unemployment)
Potential Real GDP The level of output produced when nonlabor resources are fully utilized and unemployment is at its natural rate.
GDP gap = potential real GDP – actual GDP

10. Unemployment and Potential Output
To determine the effect changes in the unemployment rate will have on output, we use Okun's rule of thumb.
The rule states that a 1 percentage point change in unemployment will cause output to change in the opposite direction by 2 percent.

11. GDP GAP

12. http://www. reliableplant. com/article. aspx

13. The gap in unemployment rates between those with a bachelor’s degree and others is wider today than in 1967.
Percent unemployed
Note: 25 to 64 years for 1967 to 1997; 25 years or older for 2006.
Sources: Bureau of Labor Statistics, March Current Population Survey; and Wayne J. Howe, Monthly Labor Review (Jan. 1988).
© 2006 POPULATION REFERENCE BUREAU

15. Three Key Price Indexes
Inflation - Rise in the General
Level of Prices
Three Key Price Indexes
Consumer Price Index (CPI)
measures the impact of price changes on the cost of the typical bundle of goods and services purchased by households.
Producer Price Index (PPI)
A measure of the average prices received by producers for raw materials, intermediate, and final goods. The PPI used to be called the Wholesale Price Index (WPI).
GDP Deflator (GDP Price Index or GDPPI)
Is a broader price index than the CPI. It is designed to measure the change in the average price of all the goods and services included in GDP.

16. Price Indexes
The value of a price index in any particular year indicates how prices have changed relative to a base year.
The base year is the year against which all other years are compared.
The index is 100  the percent change in prices from the base year.
This type of index suffers from substitution bias as some buyers will change the mix of goods that they buy in response to price changes.

17. CPI = x Consumer Price Index 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
The next slides show how a CPI is calculated.

18. In order to properly measure the rate of inflation or deflation it is necessary establish a base year from which to make a comparison. Once the base is established, future (or past) price level changes can then be compared to this base.
The easiest way see this is to look at how the consumer price index or CPI is calculated. The formula for CPI is:
CPI =  P1Q0 x 100
 P0Q0
P0 is the price of the good in time period 0.
Q0 is the quantity of the good in time period 0.
P1 is the price of the good in time period 1.
Suppose your were given a shopping list of a number of different items (or a basket of items) and told to find out how much it would cost to purchase this basket at a given point in time.
In time period 0 you purchase a market basket which includes:
2 haircuts at 2.50 per haircut = 5.00
4 shirts at per shirt = 40.00
10 apples at .50 per apple =
______________________________________________
Total cost =

19. 2 haircuts at 3.50 per haircut = 7.00
One year late (time period 1) you go out and purchase the same market basket.
Time period 1
2 haircuts at 3.50 per haircut =
4 shirts at per shirt =
10 apples at .40 per apple =
__________________________________________
Total cost =
As shown, the market basket which cost in time period 0 costs in time period 1. It is important to note that the index looks at the price of a market basket of goods, not just one good's price.
In general form, to calculate the CPI in any given year, other than the base year which is always equal to 100, the following formula is used:
  CPI = Cost of Market Basket in given year X 100.
Cost of Market Basket in base year
Using a little bit of algebra,
  X 100 = X 100 = 112
Since the base is 100, the index, 112, can be interpreted as what costs 100 in time period 0 will cost 112 in time period 1.

20. BLS Home Page for CPI etc.
Over time, the price level can go up or down. The most common occurrence is INFLATION which is defined as a rise in the price level. There have been, however, periods in which the overall price level has declined. This phenomena is referred to as DEFLATION.
What is disinflation?
BLS Home Page for CPI etc.

22. Inflation Annual Inflation Rates in the United States, 1960-2007
Inflation Rate (percent)
Source: Bureau of Labor Statistics

23. Price Changes Over Time
To Print this Chart: When Printer dialog box appears be sure to switch to Landscape mode
         
Price Changes Over Time

24. Types of Inflation
Demand-pull inflation: increases in aggregate demand outpace increases in aggregate supply.
Cost-push inflation: increases in production costs cause firms to raise prices.
Hyperinflation: extremely high rate of inflation.

25. Problems with Inflation
Redistributive Effects
Nominal and real income
Growth in nominal income vs. inflation rate
Anticipated vs. unanticipated 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)
Debtors

26. Anticipated Inflation
Nominal Interest Rate
Real Interest Rate
Inflation Premium
11% 6% = + 5%
Inflation
Premium
Nominal
Interest
Rate
Real
Interest
Rate

27. 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

28. Economic Indicators Leading Indicators Coincident Indicators
A variable that fairly consistently changes before real GDP changes
Coincident Indicators
A variable that fairly consistently changes at the same time as real GDP changes
Lagging Indicators
A variable that fairly consistently changes after real GDP changes

29. Indicators of Business Cycle
Leading Indicators
New Building Permits
Manufacturers’
New Orders
Money Supply
Average Work Week
New plant and
equipment orders
Interest Rate Spread
Delivery Times
Unemployment Claims
Consumer Expectations
Stock Prices

30. Indicators of Business Cycle
Co-incident Indicators
Personal income
Payroll employment
Industrial production
Manufacturing
and trade sales

31. Indicators of Business Cycle
Lagging Indicators
Inventories to
sales ratio
Labor cost per
unit of output
Inflation rate
for services
Unemployment
duration
Outstanding
commercial loans
Prime interest rate
Consumer credit to
personal income ratio

32. Recent Unemployment Rates
Great Depression
Year
U.S. Unemployment Rate
1929
3.2%
1930
8.7%
1931
15.9%
1932
23.6%
1933
24.9% 
1939
17.2%