1. # McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Business Cycles, Unemployment, and Inflation 6

2. 6-2 The Business Cycle Alternating increases and decreases in economic activity over time Phases of the business cycle Peak Recession Trough Expansion LO1

3. 6-3 The Business Cycle Level of real output Time Peak Recession Expansion Trough Growth Trend LO1

4. 6-4 The Business Cycle Peak – the economy is at or near full employment and the level of real output is at or very close to the economy’s capacity. The price level is likely to rise at this level. Recession – period of decline in total output, income, and employment. The downturn, which lasts 6 months or more, is marked by widespread contraction of business activity in many industries. Significant increases in unemployment occur. Trough – output and employment bottom out at their lowest levels. The trough phase may be short or long. Expansion – period in which real GDP, income, and employment rise. The economy again approaches full employment. Spending may surpass production capacity and inflation will occur.

5. 6-5 The Business Cycle U.S. Recessions since 1950 Period Duration, Months Depth (Decline in Real Output) 1953–5410 -2.6% 1957–588-3.7 1960–6110-1.1 1969–7011-0.2 1973–7516-3.2 19806-2.2 1981–8216-2.9 1990–918-1.4 20018-0.4 2007–0918-3.7 Source: National Bureau of Economic Research, www.nber.org, and Minneapolis Federal Reserve Bank, www.minneapolisfed.gov. Output data are in 2000 dollars.www.nber.org www.minneapolisfed.gov LO1

6. 6-6 Economic fluctuations are driven by demand shocks and supply shocks, such as unexpected changes in technology, productivity, or spending by consumers, businesses, and the government. Firms cannot deal with shocks on their own because of sticky prices, prices that are slow to respond to changes in demand and supply. Demand shocks are unexpected changes in the demand for goods and services. Supply shocks are unexpected changes in the supply of goods and services. LO: 6-1 Causes of Business Cycles

7. 6-7 Causes of Business Cycles Business cycle fluctuations Economic response entails decreases in output and employment LO1

8. 6-8 Cyclical Impact Durable goods affected most Capital goods Consumer durables Nondurable consumer goods affected less Services Food and clothing LO1

9. 6-9 Causes of Business Cycles Causes of shocks Irregular innovation Productivity changes Monetary factors Political events Financial instability Recession of 2007 LO1

10. 6-10 Unemployment Under 16 and/or Institutionalized (70.9 million) Not in labor force (83.9 million) Employed (139.1 million) Unemployed (14.8 million) Total population (308.7 million) Labor force (153.9 million) Unemployment rate = 14,855,000 153,889,000 × 100 = 9.6% Unemployment rate = # of unemployed Labor force × 100 LO2

11. 6-11 11 Unemployment http://www.bls.gov/news.release/empsit.nr0.htm 4 problems with the measure (1) Some who work still not considered employed (“not in labor force”) Full-time housekeepers/childcare providers Children under 16 working for no pay Unemployment rate overstated (2) Some who do not work are counted as employed Illness, bad weather, labor disputes Unemployment rate understated

12. 6-12 12 (3) Part-time workers Considered fully employed Some want full-time work, but can’t find it Lack of consumer demand Partially unemployed Unemployment rate understated (4) Discouraged workers Some who seek work and can’t find it Unemployment rate understated Unemployment

13. 6-13 Types of Unemployment Frictional unemployment Individuals searching for jobs or waiting to take jobs soon Structural unemployment Occurs due to changes in the structure of the demand for labor Cyclical unemployment Caused by the recession phase of the business cycle LO3

14. 6-14 Definition of Full Employment Full employment is something less than 100 percent employment Believed to occur when unemployment rate is less than 5 percent Potential output LO3

15. 6-15 Economic Cost of Unemployment GDP gap GDP gap = Actual GDP – Potential GDP Can be negative or positive Loss of income is unequal LO3

16. 6-16 Unemployment and GDP gap Source: Congressional Budget Office & Bureau of Economic Analysis LO: 6-3 The Unemployment Rate GDP gap (positive) GDP gap (negative) Potential GDP Actual GDP 12,000 11,000 10,000 9,000 8,000 7,000 6,000 5,000 GDP (billions of 1996 dollars) 10 8 6 4 2 0 Unemployment (percent of civilian labor force)

17. 6-17 Unemployment Rates LO3

18. 6-18 Inflation General rise in the price level Inflation reduces the “purchasing power” of money Consumer Price Index (CPI) LO2 CPI Price of the most recent market basket in the particular year Price estimate of the market basket in 1982–1984 = × 100 CPI 218.1 - 214.5 214.5 = × 100 = 1.6%

19. 6-19 Inflation LO2 Inflation Rates in Five Industrial Nations

20. 6-20 Inflation LO2 Annual Inflation Rates in the United States, 1960-2010

21. 6-21 Types of Inflation Demand-pull inflation Excess spending relative to output Central bank issues too much money Cost-push inflation Due to a rise in per-unit input costs Supply shocks LO3

22. 6-22 Redistribution Effects of Inflation Nominal income Unadjusted for inflation Real income Nominal income adjusted for inflation Anticipated versus unanticipated income Percentage change in real income = Percentage change in nominal income Percentage change in price level LO3 

23. 6-23 Nominal Income vs. Real Income 5%3% 2% Redistribution Effects of Inflation

24. 6-24 Who Is Hurt by Inflation? Fixed-income receivers Real incomes fall Savers Value of accumulated savings deteriorates Creditors Lenders get paid back in “cheaper dollars” LO3

25. 6-25 Who Is Unaffected by Inflation? Flexible-income receivers COLAs Social Security recipients Union members Debtors Pay back the loan with “cheaper dollars” LO3

26. 6-26 Anticipated Inflation Real interest rate Rates adjusted for inflation Nominal interest rate Rates not adjusted for inflation LO3

27. 6-27 Anticipated Inflation Nominal interest rate Real interest rate Inflation premium 11% 5% 6% =+ LO3

28. 6-28 Does Inflation Affect Output? Cost-push inflation Reduces real output Redistributes a decreased level of real income Demand-pull inflation One view is that zero inflation is best Another view is that mild inflation is best LO3

29. 6-29 Hyperinflation Extraordinarily rapid inflation Devastates an economy Businesses don’t know what to charge Consumers don’t know what to pay Money becomes worthless Zimbabwe’s 14.9 billion percent inflation in 2008 LO3