1. Economic Fluctuations, Unemployment, and Inflation
Macro Chapter 8
Economic Fluctuations, Unemployment, and Inflation

2. 5 Learning Goals Characterize fluctuations in economic growth.
Relate fluctuations in GDP to employment and the demand for labor.
Classify unemployment into three categories.
Distinguish the difference between full employment and the natural rate of unemployment and correlate both to potential GDP.
Determine inflation’s effect on the economy.

3. Swings in the Economic Pendulum

4. The Business Cycle
See Exhibit 1 on p. 171 and Exhibit 2 on p. 172

5. Annual growth rate of real GDP
6/15/2018
Annual growth rate of real GDP
Long-run growth rate (approx. 3%) 6 8 4 2
- 2
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2009
Source: Economic Report of the President, various issues.

6. The Hypothetical Business Cycle
6/15/2018
The Hypothetical Business Cycle
Real GDP
Business
peak
Trend line
Business
peak
Recessionary
trough
Expansion
Contraction
Recessionary
trough
Time
The four phases of the business cycle are expansion, peak, contraction, and recessionary trough.

7. Key Points: The business cycle varies and is unpredictable
The average annual growth rate is 3%

8. Economic Fluctuations and the Labor Market

9. This section describes the categories of people
Total population divided into two categories:
(1) Under age 16 & institutionalized people
(2) Over age 16
Over age 16 divided into two categories:
(1) Not in labor force – students, retirees, disabled
(2) In labor force
In labor force divided into two categories:
(1) Employed
(2) Unemployed, but want to be employed

10. Definition of unemployed:
A person not currently employed but (1) actively seeking a job, or (2) waiting to begin or return to a job
See BLS FAQs

11. U.S. Population, Employment, and Unemployment
6/15/2018
U.S. Population, Employment,
and Unemployment
Civilian population
16 and over
Not in the
labor force
Household workers
Students
Retirees
Disabled
Civilian
labor force
Employed
Employees
Self-employed
workers
Unemployed
New entrants
Reentrants
Lost last job
Quit last job
Laid off
Labor Force Participation Rate =
Civilian labor force
Civilian population (16+)
Employment / Population Ratio =
Number employed
Civilian population (16+)
Rate of Unemployment =
Number unemployed
Civilian labor force

12. See Current Population Survey

13. Two calculations to know
Labor force participation rate = (employed + unemployed) / civilian pop. over age 16
Unemployment rate = unemployed / (employed + unemployed) OR unemployed / labor force

14. Three Types of Unemployment

15. 3 general reasons why people are unemployed:
(1) Frictional – imperfect information
(2) Structural – workers don’t possess desired skills
(3) Cyclical – result of business cycle

16. Employment Fluctuations- The Historical Record

17. Some unemployment is unavoidable and arguably desirable
Natural rate of unemployment: “normal” frictional and structural unemployment
The natural rate occurs when the economy is operating at a sustainable rate
Full employment is when the natural rate of unemployment exists
Natural rate equals about 5%

18. Actual and Potential GDP

19. Potential output is the economy’s maximum sustainable output; occurs when the natural rate of unemployment exists; occurs when full employment exists
Potential output is perhaps best thought of as the 3% growth rate discussed earlier
Actual output can be greater than or less than potential; again, think about the actual growth rate

20. Trend line = maximum sustainable rate Business Cycle = actual output
Real GDP
Business
peak
Trend line
Business
peak
Recessionary
trough
Expansion
Contraction
Recessionary
trough
Time
Trend line = maximum sustainable rate
Business Cycle = actual output

21. Another way to think about these:
When you read the BEA report about quarterly GDP, if the reported (actual) growth rate is near 3%, then the economy is at it’s potential output.
At 3% actual growth, the unemployment rate will likely be around 5% (i.e. full employment is 95%)
The economy can never eliminate frictional and structural unemployment for an extended period.

22. The Effects of Inflation

23. See BLS CPI release

24. Inflation is a persistent increase in the general level of prices

25. Why is inflation “bad”?
It reduces investment: long-term projects are more risky
It distorts information delivered by prices: relative prices are skewed because some prices adjust more quickly than others
It results in less productive use of resources: people will spend more time trying to combat the effects of inflation rather than engaging in productive activity