Chapter 26 - Business cycles, unemployment, and inflation. After studying this chapter you will be able to understand: Describe the business cycle and its primary phases, illustrate how unemployment and inflation are measured, explain the types of unemployment and inflation and their various economic impacts.
Chapter 26 Business Cycles, Unemployment, and Inflation McGrawHill/Irwin Copyright © 2009 by The McGrawHill Companies, Inc. All rights reserved Chapter Objectives • The business cycle and its phases • Measuring unemployment and inflation • The types and impacts of unemployment and inflation 26-2 The Business Cycle Peak si Rec ess io n Re ces sio n Ex pa ns i on on th w o r G an Peak d Tren Trough Ex p Level of Real Output Peak Trough Time Durable and nondurable industries affected differently 26-3 Causes of Business Cycles • • • • • • Shocks and price stickiness Supply and productivity shocks Monetary shocks Financial bursts and bubbles Unexpected political events Common link – Unexpected changes in spending 26-4 Unemployment • Twin problems of the business cycle – Unemployment – Inflation • Measurement of unemployment – Who’s in the labor force • Problems with the unemployment rate – Part-time employment – Discouraged workers Unemployment Rate = Unemployed Labor Force x 100 26-5 Unemployment 2007 data Under 16 And/or Institutionalized (71.8 Million) Not in Labor Force (78.7 Million) Total Population (303.6 Million) Employed (146.0 Million) Unemployed (7.1 Million) Labor Force (153.1 Million) Source: Bureau of Labor Statistics 26-6 Unemployment • Types of unemployment – Frictional – Structural – Cyclical • Full employment defined – No cyclical unemployment • Natural rate of unemployment • Full employment rate 26-7 Unemployment • Natural rate of unemployment – 1980’s 6% – Today 4-5% • Aging labor force • Temp agencies and the internet • New welfare laws and work requirements • Prison population has doubled 26-8 Cost of Unemployment • Foregone output • Potential output • GDP gap – (Actual output – potential output) • Okun’s Law – Each 1% above NRU creates negative 2% output gap 26-9 GDP (billions of 1996 dollars) Unemployment 12,000 12,000 The GDP Gap 11,000 11,000 GDP gap (positive) 10,000 10,000 9,000 9,000 Potential GDP 8,000 8,000 GDP gap (negative) 7,000 7,000 6,000 6,000 Actual GDP 5,000 5,000 1985 1987 Unemployment (percent of civilian Labor force) 1985 10 10 8 6 4 2 0 1987 1989 1991 1989 1991 1993 1993 1995 1995 1997 1997 1999 1999 2001 2001 2003 2003 2005 2005 The Unemployment Rate 1985 1985 1987 1987 1989 1989 1991 1991 19931993 19951995 1997 1997 1999 1999 2001 2001 2003 2003 2005 2005 Source: Congressional Budget Office & Bureau of Economic Analysis 26-10 Unemployment • Unequal burdens – Occupation – Age – Race and ethnicity – Gender – Education – Duration • Noneconomic costs 26-11 Unemployment Unemployment Rates in Five Industrial Nations,1995-2005 Source: Bureau of Labor Statistics 26-12 Inflation • Rise in general level of prices • Consumer price index (CPI) – Market basket – 300 goods and services – Typical urban consumer – year updates CPI = Price of the Most Recent Market Basket in the Particular Year Price estimate of the Market Basket in 1982-1984 x 100 26-13 Inflation Annual Inflation Rates in the United States, 1960-2007 Inflation Rate (percent) 15 10 1960 1970 1980 1990 2000 Source: Bureau of Labor Statistics 26-14 Inflation Inflation Rates in Five Industrial Nations, 1995-2005 Source: Bureau of Labor Statistics 26-15 Inflation • Types of Inflation – Demand pull – Cost-push • Redistributive Effects – Nominal and real income – Growth in nominal income vs inflation rate – Anticipated vs unanticipated inflation 26-16 Inflation • Who is hurt by inflation? – Fixed-income receivers – Savers – Creditors • Who is unaffected or not hurt by inflation? – Flexible-income receivers • Cost-of-living adjustments (COLAs) – Debtors 26-17 Anticipated Inflation – Nominal Interest Rate – Real Interest Rate – Inflation Premium 6% 11% = + 5% Nominal Interest Rate Inflation Premium Real Interest Rate 26-18 Other Inflation Issues • • • • Deflation Mixed effects Arbitrariness Cost-push inflation and real output • Demand-pull inflation and real output • Hyperinflation 26-19 The Stock Market • • • • • • • Stock prices and macro instability The market for stocks Volatile stock prices Wealth effect Investment effect Little impact on macroeconomy Stock market bubbles have an impact • Index of Leading Indicators 26-20 Key Terms • • • • • • • • • • • • business cycle peak recession trough expansion labor force unemployment rate discouraged workers frictional unemployment structural unemployment cyclical unemployment full-employment rate of unemployment • natural rate of unemployment (NRU) • potential output • GDP gap • • • • • • • • • • • • • • • Okun’s law inflation Consumer Price Index (CPI) demand-pull inflation cost-push inflation per-unit production costs nominal income real income anticipated inflation unanticipated inflation cost-of-living adjustments (COLAs) real interest rate nominal interest rate deflation hyperinflation 26-21 Next Chapter Preview… Basic Macroeconomic Relationships 26-22 ... in 198 2-1 984 x 100 2 6- 13 Inflation Annual Inflation Rates in the United States, 196 0-2 007 Inflation Rate (percent) 15 10 1960 1970 1980 1990 2000 Source: Bureau of Labor Statistics 2 6- 14 Inflation... inflation 2 6- 16 Inflation • Who is hurt by inflation? – Fixed-income receivers – Savers – Creditors • Who is unaffected or not hurt by inflation? – Flexible-income receivers • Cost-of-living adjustments... real interest rate nominal interest rate deflation hyperinflation 2 6- 21 Next Chapter Preview… Basic Macroeconomic Relationships 2 6- 22