Chapter 27: The Business Cycle

Deflation

A decrease in the general level of prices, a decrease in the CPI.

Real Income

A measure of the amount of goods and services nominal income can buy; the purchasing power of nominal income, or income adjusted for inflation.

Expansion

A period in which real GDP, income, and employment rise.

Recession

A period of decline in total output, income, and employment. Lasts six months or more and is marked by the widespread contraction of business activity in many sectors of the economy.

Redistribution Effects of Inflation: Mixed Effects

A person who is simultaneously an income earner, a holder of financial assets, and a debtor will probably find that the redistribution impact of unanticipated inflation is cushioned. They are simultaneously hurt and helped by inflation.

Inflation

A rise in the general level of prices.

Cost-Push Inflation and Real Output

Abrupt and unexpected rises in key resource prices sufficiently drive up overall production costs to cause cost-push inflation. As prices rise, the quantity demanded of goods and services falls. So firms responded by producing less output, and unemployment goes up.

GDP Gap

Actual GDP - Potential GDP.

Business Cycle

Alternating rises and declines in the level of economic activity, sometimes over several years. Individual cycles vary substantially in duration and intensity.

Percentage Change in Real Income

Approximately equals: percentage change in nominal income - percentage change in price level.

Labor Force

Consists of people who are willing and able to work. Includes both those who are employed and those who ate unemployed but actively seeking work.

Demand-Pull Inflation and Real Output

Economists do not fully agree on the effects of mild inflation (less than 3 percent) unreal output. One perspective is that even low levels of inflation reduce real output because inflation diverts time and effort toward activities designed to hedge against inflation. In contrast, other economist's point out that full employment and economic growth depend on strong levels of total spending. Such spending creates high profits, strong demand for labor, and a powerful incentive for firms to expand their plant and equipment. Moreover, a little inflation may have positive effect because it makes it easier for firms to adjust real wages downward when the demands for their product fall. With mild inflation, Forbes can reduce real wages by holding nominal wages study. With zero inflation firms would need to cut in on the way just to reduce real wages. Such cuts and nominal wages are highly visible and may cause considerable worker resistance and labor strife.

Hyperinflation

Extraordinarily rapid inflation, which can have a devastating impact on real output and employment. As prices shoot up sharply and unevenly, people begin to anticipate even more rapid inflation and normal economic relationships are disrupted. Business owners do not know what to charge for their products. Consumers do not know what to pay. Resource suppliers want to be paid with actual output, rather than with rapidly depreciating money. Money eventually becomes almost worthless and ceases to do its job as a medium of exchange. The net result is economic collapse and, often, political chaos.

Cyclical Impact on Goods and Services

Firms and industries producing capital goods and consumer durables are affected most by the business cycle. Service industries and industries that produce non-durable consumer goods are somewhat insulated from the most severe effects of recession.

Okun's Law

For every one percentage point by which the actual unemployment rate exceeds the natural rate, a negative GDP Gap of about 2 percent occurs.

Cost-of-Living Adjustments (COLAs)

Given to some union workers, increasing their pay when the CPI rises. However, such increases rarely equal the full percentage rise in inflation.

Unequal Burdens of Unemployment: Gender

In recent recessions, the unemployment rates for men significantly exceed that for women.

Causes of the Business Cycle

Irregular innovation, productivity changes, monetary factors, political events, and financial instability.

Redistribution Effects of Anticipated Inflation

Less severe than the redistribution effects of unanticipated inflation. For example, lenders and borrowers can put into place an inflation premium (with or without the existing interest rate), therefore adjusting the amount owed in accordance with increases in the CPI.

Unequal Burdens of Unemployment: Education

Less-educated workers, on average, have higher unemployment rates than workers with more education. Less education outs usually associated with lower-skilled, less-permanent jobs, more time between jobs, and jobs that are more vulnerable to cyclical layoff.

Noneconomic Costs of Unemployment

Loss of skills, loss of self-respect, plummeting morale, family disintegration, and socio-political unrest. Increase in poverty, heightened racial and ethnic tensions, increase in violence, increase in mental and physical problems, and lessening of hope for material advancement.

Consumer Price Index (CPI)

Main measure of inflation in the US.

Discouraged Workers

Many workers, after unsuccessfully seeking employment for a time, become discouraged and drop out of the labor force. By not counting these people as unemployed, real unemployment is understated.

Full Employment

Occurs when an economy is experiencing only frictional and structural unemployment.

Peak

Occurs when business activity has reached a temporary maximum. Here the economy is near or at full employment and the level of real output is at or very close to the economy's capacity.

Demand-Pull Inflation

Occurs when excess demand bids up the prices of limited output (excess of total spending beyond the economy's capacity to produce), the most common type of inflation.

Trough

Occurs when output and employment are at their lowest levels in a business cycle.

Cost-Push Inflation

Occurs when per-unit production costs squeeze profits and reduce the amount of output firms are willing to supply at the existing price level. As a result, the economy supply of goods and services declines and the price level rises.

Part-Time Employment

Part-time workers who want to work full time and cannot find suitable full-time work or work fewer hours because of a temporary slack in consumer demand are, in effect, partially employed and partially unemployed. By counting these people as fully employed, the actual unemployment rate is understated.

Flexible-Income Receivers and Inflation

People who have flexible incomes may escape inflation's harm or even benefit from it. For example, individuals who derive their incomes solely from Social Security are largely unaffected by inflation because Social Security payments are indexed to the CPI. Benefits automatically increase when the CPI increases, preventing erosion of benefits from inflation. Also applies to those receiving COLAs.

Fixed-Income Receivers and Inflation

People whose incomes are fixed see their real incomes fall when inflation occurs.

Nominal Interest Rate Equation

Real interest rate + inflation premium (the expected rate of inflation).

Business Cycle: Irregular Innovation

Significant new products or production methods can rapidly spread through the economy, sparking sizable increases in investment, consumption, output, and employment. After the economy has largely absorbed the new innovation, the economy may for a time slow down or possibly decline.

Unequal Burdens of Unemployment: Age

Teenagers have much higher unemployment rates than adults. Teenagers have lower skill levels, quit their jobs more frequently, and have less geographic mobility than adults.

Redistribution Effects of Inflation: Deflation

The effects of unanticipated deflation (declines in the price level) are the reverse of those of inflation.

Nominal Income

The number of dollars received as wages, rent, interest, or profit.

Unequal Burdens of Unemployment: Duration

The number of persons unemployed for long periods (15 weeks or more) as a percentage of the labor force is much lower than the overall unemployment rate.

Nominal Interest Rate

The percentage increase in money that the borrower party's the lender, including that resulting from the built-in expectation of inflation.

Real Interest Rate

The percentage increase in purchasing power that the borrower pays the lender.

Unemployment Rate

The percentage of the labor force unemployed. (Unemployed / labor force) * 100.

Redistribution Effects of Inflation: Arbitrariness

The redistribution effects of inflation occur regardless of society's goals and values. Inflation lacks a social conscience and takes from some and gives to others, whether they are rich, poor, young, old, healthy, or infirm.

Core Inflation

The underlying increases in the price level (CPI) after volatile food and energy prices are removed.

Natural Rate of Unemployment

The unemployment rate that is consistent with full employment. This rate can vary over time as demographic factors, job-search methods, and public policies change. An economy can operate at this rate, below it, or above it.

Unequal Burdens of Unemployment: Race and ethnicity

The unemployment rates for African Americans and Hispanics are higher than that for whites. The causes of the higher rates include lower rates of educational attainment, greater concentration in lower-skilled occupations, and discrimination in the labor market.

Unequal Burdens of Unemployment

There is large variance in unemployment rates for different groups, including groups by occupation, age, read and ethnicity, gender, education, and duration.

Per-Unit Production Cost

Total input cost / units of output.

Debtors (Borrowers) and Inflation

Unanticipated inflation benefits debtors (borrowers). Because of inflation, the purchasing power of the dollar goes down, so a borrower pays back less-valuable dollars than those received from the lender.

Creditors (Lenders) and Inflation

Unanticipated inflation harms creditors (lenders). As prices go up, the purchasing potter of the dollar goes down, so a borrower pays back less-valuable dollars than those received from the lender.

Savers and Inflation

Unanticipated inflation hurts savers. As prices rise, the real value, or purchasing power, of am accumulation of savings deteriorates.

Divisions of Population in Terms of Employment

Under 16 and/or institutionalized, not in the labor force, employed, and unemployed (the later two make up the labor force).

Frictional Unemployment

Unemployed workers who are either searching for jobs or waiting to take jobs in the near future.

Cyclical Unemployment

Unemployment that is caused by a decline in total spending (insufficient demand for goods and services). Typically begins in the recession phase of the business cycle.

Structural Unemployment

Unemployment that occurs when workers' skills or geographical locations do not match the jobs that are available.

Business Cycle: Financial Instability

Unexpected Financial bubbles or bursts can spill over to the general economy by expanding or contracting lending, and boosting or eroding the confidence of consumers and businesses.

Business Cycle: Political Events

Unexpected political events, such as peace treaties or wars, can create economic opportunities or strains.

Business Cycle: Monetary Factors

When a nation's central bank shocks the economy by creating more money than people were expecting, an inflationary boom occurs. By contrast, printing less money than people were expecting triggers and output decline and, eventually, a price-level fall.

Redistribution Effects of Inflation

When inflation occurs, not everyone's nominal income Rises at the same Pace as the price level. Therein lies the potential for redistribution of real income from some to others. If the change in the price level differs from the change in a person's national income, his or her real income will be affected.

Business Cycle: Productivity Changes

When productivity unexpectedly increases, the economy booms; one productivity unexpectedly decreases, the economy recedes. Such changes in productivity can result from unexpected changes and resource availability or from unexpected changes in the general rate of technological advance.

Unequal Burdens of Unemployment: Occupation

Workers in lower-skilled occupations have higher unemployment rates than workers in higher-skilled occupations.