Chapter 9: Business Cycles, Unemployment, and Inflation

Expansion

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

Recession

A period of decline in total output, income, and employment.

The Business Cycle

Alternating increases and decreases in economic activity over time.

Unequal Burdens

An increase in the unemployment rate from 5 to, say, 9 or 10 percent might be more tolerable to society if every worker's hours of work and wage income were reduced proportionally. But this is not the case. Part of the burden of unemployment is that its cost is unequally distributed.

Peak

Business activity has reached temporary maximum.

Durable goods affected most

Capital goods and consumer durables.

Cyclical unemployment

Caused by the recession phase of the business cycle.

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.

Business cycle fluctuations

Demand shocks, supply shocks, prices are "sticky" downwards, economic response entails decreases in output and employment.

Types of Inflation

Demand-pull and Cost-push

Cost-push inflation

Due to a rise in per-unit input costs. Supply shocks.

Causes of business cycles

Economists cite several possible general sources of shocks that can cause business cycles: irregular innovation, productivity changes, monetary factors, political events, and financial instability.

Demand-pull inflation

Excess spending relative to output. Central bank issues too much money.

Hyperinflation

Extraordinarily rapid inflation, devastates an economy, business 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.

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".

Who is unaffected by inflation?

Flexible-income receivers: cost of living adjustments (COLAs), social security recipients, union members. Debtors: pay back the loan with "cheaper dollars".

Types of unemployment

Frictional, structural, and cyclical.

Economic cost of unemployment

GDP gap = Actual GDP - Potential GDP. Can be negative or positive. Loss of income is unequal.

Inflation

General rise in the price level. Inflation reduces the "purchasing power" of money. Consumer Price Index (CPI): The main measure in the US. CPI equals the price of the most recent market basket in the particular year divided by the price estimate of the market basket in 1982-1984, multiplied by 100.

Trough

In the trough of the recession or depression, output and employment "bottom out" at their lowest levels. This phase may be either short-lived or quite long.

Frictional unemployment

Individuals searching for jobs or waiting to take jobs soon.

Full employment

Is something less than 100 percent employment. Believed to occur when unemployment rate is less than 5 percent. Potential output.

Okun's Law

Macro-economist Arthur Okun was the first to quantify the relationship between the unemployment rate and the GDP gap. Okun's law indicates that for every 1 percentage point by which the actual unemployment rate exceeds the natural rate, a negative GDP gap of about 2 percentage occurs.

Redistribution Effects of Inflation

Nominal income, real income, and anticipated versus unanticipated inflation. Percentage change in real income equals percentage change in nominal income minus percentage change in price level.

Structural unemployment

Occurs due to changes in the structure of the demand for labor.

Phases of the business cycle

Peak, recession, trough, and expansion.

Anticipated Inflation

Real interest rate: rates adjusted for inflation. Nominal Interest rate: rates not adjusted for inflation.

Non-durable consumer goods affected less

Services, food, and clothing.

Core Inflation

The underlying inflation rate after volatile food and energy prices have been removed.

Unemployment

Unemployment rate equals the number of unemployed people divided by the labor force multiplied by 100.