Transcript Unemployed

Chapter 13: Business
Cycles, Unemployment,
and Inflation
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved
Business Cycles
 Economic growth is interrupted by the periods of
economic instability associated with business cycles.
 Two main phases of business cycles are recessions
(declines) and expansions (increases) with turning
points called peaks and troughs.
Business cycles are recurring increases and decreases in the
level of economic activity over periods of time.
Recession is a period of declining real GDP, accompanied by
lower income and higher unemployment.
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The Business Cycle
Peak
Level of Real Output
Peak
Peak
Trough
Trough
Time
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Causes of Business Cycles
 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.
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Unemployment
 Unemployment increases during recessions.
 To determine the unemployment rate, the U.S. Bureau of
Labor Statistics surveys some 60,000 households each
month.
Unemployment Rate
=
Unemployed
Labor Force
x 100
Labor force includes all persons 16 years and older who are not in
institutions and who are either employed or unemployed and
seeking work.
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Labor Force, Employment,
and Unemployment in 2007
Under 16
And/or
Institutionalized
(71.8 Million)
Not in
Labor Force
(78.7 Million)
Total
Population
(303.6 Million)
(7.1 mil./153.1 mil.) x
100% =
4.6%
Employed
(146.0 Million)
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Unemployment rate:
Labor
Force
(153.1 Million)
Unemployed
(7.1 Million)
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Three Types
of Unemployment
Frictional
Unemployment
People searching for
jobs or waiting to
take jobs in the near
future.
 search unemployment

wait unemployment
Structural
Unemployment
Unemployment
that occurs due to
mismatch between
available jobs and
the skills or
locations of those
unemployed.
Cyclical
Unemployment
Unemployment
that is associated
with the
recessionary
phase of the
business cycle.
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Full Employment and
Potential Output
 Because of frictional and structural unemployment, full
employment occurs at less than 100 percent
employment of the labor force.
 Economy is fully employed when there is only frictional
and structural unemployment and no cyclical
unemployment.
 Today, full employment is believed to occur when the
unemployment rate is below 5 percent.
 The level of GDP that occurs at full employment is called
potential output.
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Economic Costs of
Unemployment
 Forgone output is the basic economic cost
of unemployment.
 If actual GDP is above or below potential
GDP, the result is a GDP gap.
 When actual GDP is less than potential GDP,
there is a negative GDP gap accompanied by a
higher unemployment rate and foregone income.
GDP gap = actual GDP – potential GDP
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Unemployment and
GDP Gap
GDP gap
(positive)
Potential GDP
GDP gap
(negative)
Actual GDP
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Source: Congressional Budget Office & Bureau of Economic Analysis
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Inflation
 Inflation is a rise in the general level of prices in
an economy.
 When there is inflation, each dollar of income buys fewer
goods and services; the purchasing power of money
declines.
 On average, the prices of goods and services are
rising; however, not all prices go up—the prices of
some products remain fairly constant or decrease.
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Measuring Inflation
 The main measure of inflation in the U.S. is the consumer price
index (CPI).
 The CPI includes some 300 products.
 The composition of the market basket is updated every two years.
CPI =
Price of the Most Recent Market
Basket in the Particular Year
Price of the Same Market
Basket in 1982-1984
x
100
Consumer price index (CPI) is an index that compares the price of a
market basket of goods and services in one period with the price of the same
(or highly similar) market basket in a base period, currently 1982-1984.
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Inflation Rate
 The rate of inflation for a certain year is found
by comparing, in percentage terms, that year’s
index with the index in the previous year.
 For example, the CPI rose from 201.6 in 2006 to
207.3 in 2007.
 Rate of inflation =
(207.3-201.6)/201.6 x 100% = 2.8%
 So the rate of inflation for 2007 was 2.8 percent.
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Types of Inflation
 Demand-pull inflation occurs due to increases in the
price level caused by excessive spending beyond the
economy’s capacity to produce.
 Excess demand from expanding output bids up the
prices of the limited output.
 Cost-push inflation occurs due to increases in the price
level caused by sharp rises in the cost of key resources.
 Supply shocks are the main source of cost-push
inflation.
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Redistribution Effects of
Inflation
 Inflation redistributes real income from some people to others:
 Fixed-income receivers, savers and creditors are hurt by
unanticipated inflation.
 Flexible-income receivers are either unaffected or helped by
inflation.
 As inflation reduces the value of the dollar, debtors (or
borrowers) are helped by inflation.
Nominal income is the number
of dollars received as wages,
rent, interest, and profits.
Real income is the purchasing power
of nominal income, that is, a measure
of the amount of goods and services
nominal income can buy.
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Anticipated Inflation is
Reflected in Interest Rates
 Nominal Interest Rate
 Real Interest Rate
 Inflation Premium
6%
11%
=
+
5%
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Nominal
Interest
Rate
Inflation
Premium
Real
Interest
Rate
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Inflation and Output
 Inflation may affect a nation’s level of real output
and real income.
 The direction and significance of this effect on
output depends on the type of inflation and its
severity.
 Cost-push inflation reduces real output.
 Demand-pull inflation causing mild inflation may
reduce real output, according to some economists,
but can increase real output and lead to economic
growth according to others.
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