Lecture Essentials of economics (3/e): Chapter 11 - Brue, McConnell, Flynn

Chapter 11 - Business cycles, unemployment, and inflation. This chapter previews the business cycle, unemployment, and inflation. It is an important chapter as it sets the stage for the analytical presentation in later chapters.

Chapter 11 Business Cycles, Unemployment, and Inflation McGraw­Hill/Irwin         Copyright © 2013 by The McGraw­Hill Companies, Inc. All rights reserved Copyright © 2014 by The McGraw­Hill Companies, Inc. All rights reserved 1­1 The Business Cycle • Alternating increases and decreases • in economic activity over time Phases of the business cycle • Peak • Recession • Trough • Expansion 11­2 The Business Cycle Peak Rec ess io an si on h t w o Gr n Re ces sio n Ex pa Peak ns i on d Tren Trough Ex p Level of real output Peak Trough Time LO1 11­3 The Business Cycle U.S Recessions since 1950 Period 1953–54 Duration, Months 10 Depth (Decline in Real Output) -2.6% 1957–58 -3.7 1960–61 10 -1.1 1969–70 11 -0.2 1973–75 16 -3.2 1980 -2.2 1981–82 16 -2.9 1990–91 -1.4 2001 -0.4 2007–09 18 -3.7 Source: National Bureau of Economic Research, www.nber.org, and Minneapolis Federal Reserve Bank, www.minneapolisfed.org Output data are in 2000 dollars LO1 11­4 Causes of Business Cycles • Business cycle fluctuations • Demand shocks • Supply shocks • Prices are “sticky” downwards • Economic response entails decreases in output and employment LO1 11­5 Cyclical Impact • Durable goods affected most • Capital goods • Consumer durables • Nondurable consumer goods affected less • Services • Food and clothing LO1 11­6 Causes of Business Cycles • Causes of shocks • Irregular innovation • Productivity changes • Monetary factors • Political events • Financial instability • Recession of 2007 LO1 11­7 Unemployment Unemployment rate = Under 16 and/or Institutionalized (70.9 million) Total population (308.7 million) # of unemployed Labor force Not in labor force (83.9 million) Employed (139.1 million) × 100 Unemployment rate = Labor force (153.9 million) 14,855,000 153,889,000 × 100 = 9.6% Unemployed (14.8 million) LO2 11­8 Types of Unemployment • Frictional unemployment • Individuals searching for jobs or • • LO3 waiting to take jobs soon Structural unemployment • Occurs due to changes in the structure of the demand for labor Cyclical unemployment • Caused by the recession phase of the business cycle 11­9 Definition of Full Employment • Full employment is something less • • LO3 than 100 percent employment Believed to occur when unemployment rate is less than percent Potential output 11­10 Economic Cost of  Unemployment • GDP gap • GDP gap = Actual GDP – Potential • LO3 GDP • Can be negative or positive Loss of income is unequal 11­11 Unemployment Rates LO3 11­12 Inflation • • • General rise in the price level Inflation reduces the “purchasing power” of money Consumer Price Index (CPI) CPI = CPI = LO2 Price of the most recent market basket in the particular year Price estimate of the market basket in 1982–1984 218.1 - 214.5 214.5 × 100 × 100 = 1.6% 11­13 Inflation Inflation Rates in Five Industrial Nations LO2 11­14 Inflation Annual Inflation Rates in the United States, 1960-2010 LO2 11­15 Types of Inflation • Demand-pull inflation • Excess spending relative to output • Central bank issues too much • LO3 money Cost-push inflation • Due to a rise in per-unit input costs • Supply shocks 11­16 Redistribution Effects of  Inflation • • • Nominal income • Unadjusted for inflation Real income • Nominal income adjusted for inflation Anticipated versus unanticipated income Percentage change in real income LO3 = Percentage change in nominal income Percentage change in price level 11­17 Who Is Hurt by Inflation? • Fixed-income receivers • Real incomes fall • Savers • Value of accumulated savings • LO3 deteriorates Creditors • Lenders get paid back in “cheaper dollars” 11­18 Who Is Unaffected by Inflation? • Flexible-income receivers • COLAs • Social Security recipients • Union members • Debtors • Pay back the loan with “cheaper dollars” LO3 11­19 Anticipated Inflation • Real interest rate • Rates adjusted for inflation • Nominal interest rate • Rates not adjusted for inflation LO3 11­20 Anticipated Inflation 6% 11% = + 5% Nominal interest rate LO3 Inflation premium Real interest rate 11­21 Does Inflation Affect Output? • Cost-push inflation • Reduces real output • Redistributes a decreased level of real • LO3 income Demand-pull inflation • One view is that zero inflation is best • Another view is that mild inflation is best 11­22 Hyperinflation • • • • • • LO3 Extraordinarily rapid inflation Devastates an economy Businesses 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 11­23 ... LO1 11 3 The Business Cycle U.S Recessions since 1950 Period 1953–54 Duration, Months 10 Depth (Decline in Real Output) -2 .6% 1957–58 -3 .7 1960–61 10 -1 .1 1969–70 11 -0 .2 1973–75 16 -3 .2 1980 -2 .2... output 11 10 Economic Cost of Unemployment • GDP gap • GDP gap = Actual GDP – Potential • LO3 GDP • Can be negative or positive Loss of income is unequal 11 11 Unemployment Rates LO3 11 12 Inflation... 100 = 1.6% 11 13 Inflation Inflation Rates in Five Industrial Nations LO2 11 14 Inflation Annual Inflation Rates in the United States, 196 0-2 010 LO2 11 15 Types of Inflation • Demand-pull inflation