1. 5 Business Cycle

2. 5.1 Business Cycle Definition
Fluctuations in Real GDP from year to year (quarter to quarter) is the Business Cycle
On average over the past 70 years the U.S. economy has grown 2-3 percent per year.
A recession is 2 consecutive quarters of real GDP contraction, reducing incomes & causing (cyclical) unemployment. A depression is an ‘extended’ recession.
Economies expand and peak; then decline and bottom; then expand.

3. 5.2 Unemployment & the Natural Rate
The natural rate of unemployment is unemployment considered any given time
Un* is the amount of unemployment that the economy experiences when there is no business cycle; also, is the opposite of ‘Full Employment’
Full employment is associated w ‘Potential Output’ (ie the PPF). Alternatively, full-employment is the lowest rate of unemployment compatible with price stability.

4. 5.3 Measurement
Unemployment is measured by the Bureau of Labor Statistics (BLS)
BLS surveys 60,000 randomly selected households every month. The survey is called the Current Population Survey
Employed; Unemployed; Not in the labor force
The BLS considers a person an adult if he or she is over 16 years old
A person is considered employed if he or she has spent most of the previous week working at a paid job ‘Most of the week’ is 15+ hours (ie part-time).

5. 5.3 Measurement
A person is unemployed if he or she does not possess a job but is looking (searching) for one.
A person who is neither employed nor searching is not in the labor force (eg full-time student, homemaker, or retiree, Discouraged workers).
Discouraged workers are those desiring work but not searching, ie they have given-up.

6. 5.3 Measurement
The BLS defines the labor force as the sum of the employed & the unemployed.
The unemployment rate is calculated as the percentage of the labor force that is unemployed:
Un rate = Un / (Un + E)
The labor-force participation rate is the percentage of the adult population that is in the labor force (apprx 0.5).

7. 5.4 Types of Unemployment
Cyclical unemployment refers to the year-to-year fluctuations in unemployment around the natural rate. Cyclical unemployment results during business cycles.
Frictional unemployment (Job Search Unemployment) refers to the unemployment that results from the time that it takes to match workers with jobs. In other words, it takes time for workers to search for the jobs that are best suited for them.
Job search is the process by which workers find appropriate jobs given their tastes & skills. Job search unemployment results from the fact that it takes time for qualified individuals to be matched with appropriate jobs.
Frictional unemployment is largely voluntary (eg the PhD engineer spending ‘working time’ searching for an engineering job rather than being McDonalds).

8. 5.4 Types of Unemployment
Structural unemployment occurs when the quantity of labor supplied exceeds quantity- demanded (classical labor surplus)
Structural unemployment is often thought to explain longer spells of unemployment, associated with ‘declining industries’
In an ideal labor market, wages would adjust immediately to balance the supply & demand, ensuring that all workers would be fully employed.
Un rate = Un/(Un + E) = (FU + SU + CU)/LF
Natural Un rate = U* = (U – CU)/LF

9. 5.5 Measurement Biases
Employment is overstated (unemployment understated) by
Inclusion of underemployed workers (eg a Phd engineer McDonalds).
Low hourly requirement.
Low age rquirement.
Exclusion of Discouraged workers.

10. 5.6 Inflation
Most people associate inflation with price increases of specific goods & services.
Inflation is an increase in the average level of prices, not a change in any specific price.
The average price is determined by finding the average price of all output, then looking for changes. If the average price rises it is called inflation; if the average price falls it is called deflation.
Over the past 70 years in the US, prices have risen on average about 3-5 percent per year. Deflation (decreasing average prices) last occurred in the U.S. in the nineteenth century.
In the 1970s prices rose by 7 percent per year. During the 1990s, prices rose at an average rate of 2 percent per year.
Hyperinflation refers to high rates (double-triple digit) of inflation such as Germany experienced in the 1920s.

11. 5.6 Inflation Relative Prices vs. The Price Level
Because inflation & deflation are measured in terms of average price levels, it is possible for individual prices to rise or fall continuously without changing the average price level.
A relative price is the price of one good in comparison with the price of other goods.
Relative price changes are an essential ingredient of the market mechanism resulting in a reallocation of resources in the economy (Law of Demand).
The price/cost to buyers is income(s) to sellers. If prices are rising, incomes (of owners) must be rising too, c.p.
Inflation has macroeconomic effects on income & wealth distribution. Inflation can alter the rate & mixes of output by changing consumption, work, saving, investment & trade behavior.

12. 5.6 Inflation Menu/Shoe-leather costs Bracket Creep
M-SL costs are the costs of adjusting prices.
During inflationary times, it is necessary to update price lists & other posted prices & increase trips to banks.
These are resource-consuming processes (ie opportunity costs) that take away from productive activities.
Bracket Creep
Another reason why savings, investment, & work effort decline when prices rise is that taxes go up as well.
Bracket creep is the movement of taxpayers into higher tax brackets (rates) as nominal incomes grow.
Inflation tends to increase everyone’s income pushing them into a higher tax bracket.
In recent years bracket creep has been limited by the inflation indexing of personal income tax rates & a reduction in the number of tax brackets as well as a levelling of inflation itself since the 1970s.

13. 5.6 Inflation Redistribution of Wealth
Periods of inflation cause wealth to be redistributed from Loaners to Borrowers
These redistributions occur because many loans in the economy are specified in terms of the unit of account – money.
Unexpected inflation redistributes wealth among the population in a way that has nothing to do with either merit or need.
Money Illusion & Money Neutrality
Nominal variables are variables measured in monetary units. Real variables are variables measured in physical units.
The use of nominal dollars rather than real dollars to gauge one’s economic condition is called money illusion. Money Illusion is perceived relative-price changes.
If money illusion is present, real variables will change, eg, firms will increase output, workers will supply more labor

14. 5.6 Inflation Hyperinflation
Hyperinflation is inflation that exceeds 50 percent per month (200/y; 100/y)
Hyperinflation occurs in some countries because the government prints too much money to pay for its spending.
When the government raises revenue by printing money, it is said to levy an inflation tax on everyone who holds money.
The inflation ends when the government institutes fiscal reforms such as cuts in government spending.