1. Business Cycles, Unemployment, and Inflation 9 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. The Business Cycle (Fluctuations) Alternating increases and decreases in economic activity (GDP, employment, income) over time Vary in duration and magnitude Phases of the business cycle Peak Recession – 6 months or more Trough Expansion LO1

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

4. The Business Cycle TABLE 26.1 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 LO1

5. The Great Depression vs. The Great Recession The Great Depression – 27 percent decline in real GDP – Decade-long impact vs. The Great Recession – 4.3 percent decline in real GDP – 18 months LO1

6. Business cycle fluctuations Economic shocks – most caused by demand Prices are “sticky” downwards Economic response entails decreases in output and employment The Business Cycle LO1

7. Cyclical Impact Durable & capital goods affected most during recessions Postponability Nondurable consumer goods affected less LO1

8. Unemployment Under 16 and/or Institutionalized (71.6 million) Not in labor force (88.3 million) Employed (142.5 million) Unemployed (12.5 million) Total population (314.9 million) Labor force (155 million) LO2

9. Unemployment Unemployment Rate = Criticisms Involuntary part-time workers counted as if full-time Discouraged workers are not counted as unemployed http://www.youtube.com/watch?v=Ulu3SCAm eBA http://www.youtube.com/watch?v=Ulu3SCAm eBA LO2 Unemployed Labor Force x 100

10. Types of Unemployment Frictional unemployment Individuals searching/waiting for jobs Shorter term Structural unemployment Occurs due to changes in the structure of the demand for labor Longer term LO3

11. Types of Unemployment Frictional and structural unemployment are unavoidable and beneficial Cyclical unemployment Caused by a recession – decrease in total spending LO3

12. Definition of Full Employment Natural Rate of Unemployment (NRU) Full-employment rate of unemployment Economy producing its potential output Only frictional and structural unemployment Zero cyclical unemployment Cannot be avoided LO3

13. Definition of Full Employment Natural Rate of Unemployment (NRU) –Can vary over time Demographic changes Changing job search methods Public policy changes LO3

14. Definition of Full Employment Natural Rate of Unemployment (NRU) Actual unemployment can be above or fall below the NRU LO3

15. Potential GDP Measurement of what a country’s GDP would be if it were operating at full employment and utilizing all of its resources. Generally higher than actual GDP Potential GDP is GDP associated with NRU LO3

16. Economic Cost of Unemployment Irretrievable loss of goods and services GDP Gap Amount of goods and services sacrificed due to cyclical unemployment GDP gap = actual GDP – potential GDP LO3

17. Economic Cost of Unemployment Negative GDP gap occurs because there is cyclical unemployment; potential GDP exceeds actual GDP Positive GDP gap occurs because the actual unemployment rate is less than the NRU; actual GDP is greater than potential GDP. LO3

18. Economic Cost of Unemployment Okun’s Law Every 1% of cyclical unemployment creates a 2% GDP gap LO3

19. Economic Cost of Unemployment LO3

20. Global Perspective LO3

21. Inflation LO2

22. Inflation General rise in the price level over time Inflation reduces the “purchasing power” of money Consumer Price Index (CPI) is used to measure Can use the “rule of 70” LO2

23. Measuring the CPI and Inflation Rate LO2 CPI Price of the Most Recent Market Basket in the Particular Year Price estimate of the Market Basket in 1982-1984 = x 100 Rate of Inflation 207.3 - 201.6 201.6 = x 100 = 2.8% LO3

24. Inflation LO2

25. Inflation LO2

26. Types of Inflation Demand-Pull inflation Central bank issues too much money More likely to occur the closer the economy is to full-employment “Too much spending chasing too few goods” LO3

27. Types of Inflation Cost-Push inflation Due to a rise in per-unit input costs Supply shocks LO3 Per Unit Production Cost Total Input Cost Units of Output =

28. Inflation Difficult to distinguish inflation types Types differ in sustainability Demand-pull continues as long as the excess spending continues Cost-push ends in a recession LO3

29. Inflation Core inflation Excludes volatile food and energy goods Focuses on more stable prices LO3

30. Redistribution Effects of Inflation Nominal income Unadjusted for inflation Real income Nominal income adjusted for inflation Anticipated vs. unanticipated income Percentage change in real income = Percentage change in nominal income Percentage change in price level LO3  LO4

31. Redistribution Effects of Inflation Nominal income Unadjusted for inflation Real income Nominal income adjusted for inflation Real income can fall if nominal income increases by less than inflation Income is redistributed LO3

32. Inflation Real Income = Economy’s Total Purchasing Power LO3 Real Income Nominal Income CPI (in hundredths) =

33. 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

34. Who is Unaffected by Inflation? Flexible-income receivers Social Security recipients Union members (COLAs) Debtors Pay back the loan with “cheaper dollars” LO3