Transcript Economic Fluctuations, Unemployment, and Inflation

Chapter 8
Economic Fluctuations,
Unemployment, and Inflation
Slides to Accompany “Economics: Public and Private Choice 9th ed.”
James Gwartney, Richard Stroup, and Russell Sobel
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1. Swings in the
Economic Pendulum
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A Hypothetical Business Cycle

The phases of the business cycle are:
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Expansion,
Peak (or boom),
Contraction, and,
Recessionary trough.
The duration of business cycles is irregular and the
magnitude of the swings in economic activity
varies.
Annual Rate of Growth
in Real GDP
8
Long-run
Growth Rate
6
(approx.. 3%)
4
2
0
-2
-4
1960
1965
1970
1975
1980
1985
1990
1995
2000
Year
Source: Economic Report of the President, various issues.
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The Business Cycle
Real GDP
Business
Peak
Trend line
Business
Peak
Recessionary
Trough
Recessionary
Trough
Time

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In the past, ups and downs have often characterized aggregate
business activity.
Despite these fluctuations, there has been an upward trend in
real GDP in the United States and other industrial nations.
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2. Economic
Fluctuations and
the Labor Market
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Economic Fluctuations
and the Labor Market

The noninstitutional civilian adult population is
grouped into two broad categories:
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
Persons not in the labor force, and,
persons in the labor force.
Labor Force
Participation Rate
=
# in the Labor Force
Civilian Population (16+)
Recall the Labor Force = Employed + Unemployed

In order to be classified as unemployed, one must
either be on layoff or actively seeking work.
Rate of
Unemployment
=
# Unemployed
# in the Labor Force
Recall the Labor Force = Employed + Unemployed
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U.S. Population, Employment,
and Unemployment: 1998
205.2 Million
Civilian population
16 and over
137.7 Million
67.5 Million
Civilian
Labor Force
Not in the
Labor Force
• Household workers
• Students
• Retirees
• Disabled
131.5 Million
6.2 Million
Employed
Unemployed
• Employees
• Self-employed
workers
• New entrants
• Reentrants
• Lost last job
• Quit last job
• Laid off
Civilian Labor Force
Rate of Labor =
Force Participation Civilian Population (16+)
= 67.1%
Number Employed
Employment / =
= 64.1%
Population Ratio
Civilian Population (16+)
Number Unemployed
Rate of
=
Civilian Labor Force
Unemployment
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= 4.5%
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U.S. Labor Force Participation
of Men and Women: 1998
Labor Force
Participation Rate
100
87.0
83.3
77.9
80
76.8
60.4
60
46.3
40
32.7
37.7
20
0
1948
1960
1975
1998
1948
Men
1960
1975
1998
Women
Source: Monthly Labor Review April 1999..
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As the chart illustrates, the labor force participation rate
for women has been steadily increasing for several decades.
The rate for men has been declining during the same period.
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Composition of the
Unemployed by Reason
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There are various reasons why
persons were unemployed in
1998.
Only one third (31.5 %) of the
unemployed were terminated
from their previous jobs.
More than two fifths (42.7 %)
of the unemployed were either
new entrants or reentrants into
the labor force.
Job
Leavers
(11.8%)
Dismissed from
Previous Jobs
(31.5%)
New
Entrants
(8.4%)
Reentrants
(34.3%)
On
Layoff
(13.9%)
Source: Monthly Labor Review, April 1999.
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3. Three Types of
Unemployment
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Three Types of Unemployment
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Frictional Unemployment:
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Structural Unemployment:
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Caused by imperfect information in a world of
dynamic change.
Occurs because:
 employers are not fully aware of all available
workers and their job qualifications, and,
 available workers are not fully aware of the
jobs being offered by employers.
Reflects an imperfect match-up of employee skills
and the skill requirements of the available jobs.
Also reflects structural and demographic
characteristics of the labor market.
Cyclical Unemployment:
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
Reflects business cycle conditions
When there is a general downturn in business
activity, cyclical unemployment increases.
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4. Employment
Fluctuations
-- The Historical Record
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Unemployment and Output Are Closely
Linked Over the Business Cycle
% of Labor Force
Unemployed
Actual rate of
unemployment
10
8
6
4
Natural rate of
unemployment
2
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
Sources: Economic Report of the President, 1998; & Robert J. Gordon, Macroeconomics (Boston: Little Brown, 1990).

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Here we illustrate the rate of unemployment during the
1960-1998 period.
As expected, unemployment rose rapidly during each of the
six recessions (the shaded years indicate periods of recession).
In contrast, soon after each recession ended, the
unemployment rate began to decline as the economy moved
into an expansionary phase of the business cycle. Note that
the actual rate of unemployment was greater than the natural
rate during and immediately following the recession.
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The Concept of Full Employment
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Full Employment:
The level of employment that results when the
rate of unemployment is normal, considering
both frictional and structural factors.
The concept of full employment is closely related
to concept of the natural rate of unemployment.
Natural Rate of Unemployment:
The level of unemployment that reflects “job
shopping” in an economy filled with imperfect
information and dynamic change.
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The Concept of Full Employment
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The natural rate of unemployment is neither a
temporary high nor a temporary low; it is a rate that
is both achievable and sustainable into the future.
It is the rate of unemployment accompanying the
economy’s "maximum sustainable rate of output.”
The natural rate of unemployment is influenced
by both demographic factors (e. g. youthful workers
as a share of the labor force) and public policy
(e. g. generous unemployment benefits).
The actual rate rises above the natural rate
during a recession and falls below the natural
rate during an economic boom.
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5. Unemployment and
Measurement Problems
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Unemployment and
Measurement Problems

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The definition of unemployed involves
some subjectivity.
Some economists argue that the
employment/population ratio
-- the number employed divided by
population 16 years old and over --
is a better indicator of job availability than
the unemployment rate.
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Questions for Thought:
1. Classify each of the following as employed, unemployed, or
not in the labor force:
a. Brown is not working; she applied for a job at Wal-Mart last week
and is awaiting the result of her application.
b. Smith is vacationing in Florida during a layoff at a GM plant due to a
model changeover, but he expects to be recalled in a couple of weeks.
c. Green was laid off as a carpenter when a construction project is
completed. He is looking for work but has not found anything except
an $8 per hr job, which he turned down.
d. West works 50 to 60 hours per week as a homemaker for her family
of nine.
e. Carson, a 17-year-old, works six hours per week as a route person for
the local newspaper.
f. Johnson has worked three hours in the mornings at a clinic and for
the last two weeks and spent the afternoons looking for a full-time job.
2. What is full employment? How are full employment and
the natural rate of unemployment related? Indicate several
factors that would cause the natural rate of unemployment
to change. Is the actual rate of unemployment currently
greater or less than the natural rate of unemployment?
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6. Actual and
Potential GDP
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Actual and Potential GDP
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Potential output :
Maximum sustainable output level
consistent with the economy’s resource base,
given its institutional arrangements.
Actual and potential output will be equal
when the economy is at full employment.
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Actual and Potential GDP: 1960-1998
Real GDP
(Billions of 1987 $)
6,000
Actual
GDP
Potential
GDP
1990–1991
Recession
4,000
1980
Recession
1970
Recession
1982
Recession
1974–1975
Recession
2,000
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
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Here we illustrate both actual and potential GDP.
Note the gap (shaded area) between actual and
potential GDP during periods of recession.
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7. Effects of Inflation:
-- An Overview
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Effects of Inflation:
-- An Overview

The Rate of Inflation is calculated as:
Inflation
Rate
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=
This Year’s
Last Year’s
Price Index
Price Index
Last Year’s
Price Index
-
* 100
Inflation is a rise in the general level of
prices.

High rates of inflation are almost always
associated with substantial year-to-year
swings in the inflation rate.
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The Inflation Rate: 1953-1998
1973–1981 average
inflation rate = 9.2%
15
1983–1998 average
inflation rate = 3.3%
10
5
1953–1965 average
inflation rate = 1.3%
0
-5
Year
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
Sources: Derived from computerized data supplied by FAME ECONOMICS. Also see Economic Report of the President (annual).
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Here we present the annual rate of inflation for the last 45 years.
Between 1953 and 1965, prices increased at an annual rate of
only 1.3%.
In contrast, the inflation rate averaged 9.2% during the 19731981 era, reaching double-digit rates during several years.
Since 1982, the rate of inflation has been lower (the average
annual rate was about 3.3% from 1983-1998) and more stable.
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Effects of Inflation:
-- An Overview
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Anticipated and Unanticipated Inflation:
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Unanticipated inflation:
An increase in the price level that comes
as a surprise, at least to most individuals.
Anticipated inflation:
A change in the price level that is widely
expected.
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Effects of Inflation:
-- An Overview
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There are harmful effects of high and variable
rates of inflation.
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Because unanticipated inflation alters the
outcomes of long-term projects like the purchase
of a machine or operation of a business, it will
increase the risks and retard the level of such
productive activities.
Inflation distorts information delivered by prices.
People will respond to high and variable rates of
inflation by spending less time producing and
more time trying to protect their wealth and
income from uncertainty created by the inflation.
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What Causes Inflation?

Nearly all economists believe that rapid
expansion in the supply of money is the
cause of inflation.
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Questions for Thought:
1. Indicate how an unanticipated 5 percent jump in the
inflation rate will influence the wealth of the following:
a. A person whose major asset is a house with a 30-year
mortgage at a fixed interest rate.
b. A family holding most of its wealth in long-term fixed
yield bonds.
c. A retiree drawing a monthly pension.
d. A heavily indebted small-business owner.
e. The owner of an apartment complex with substantial
outstanding debt at a fixed interest rate.
f. A worker whose wages are determined by a three-year
union contract ratified three months ago.
2. Suppose that the consumer price index at year-end 1998
was 150 and by year-end 1999 had risen to 155. What
was the inflation rate during 1999?
3. What is the difference between anticipated and
unanticipated inflation?
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End
Chapter 8
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