1. Business Cycles, Unemployment, and Inflation 26 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. The Business Cycle Alternating increases and decreases in economic activity over time Phases of the business cycle Peak Recession Trough Expansion LO1 26-2

3. The Business Cycle Level of real output Time Peak Recession Expansion Trough Growth Trend LO1 26-3

4. The Business Cycle U.S. Recessions since 1950 Period Duration, Months Depth (Decline in Real Output) 1953-5410 -2.6% 1957-588-3.7 1960-6110-1.1 1969-7011-0.2 1973-7516-3.2 19806-2.2 1981-8216-2.9 1990-918-1.4 20018-0.4 2007-0918-3.7 Source: National Bureau of Economic Research, http://www.nber.org and Minneapolis Federal Reserve Bank, http://www.minneapolisfed.org/ Output data are in 2000 dollarshttp://www.nber.orghttp://www.minneapolisfed.org/ LO1 26-4

5. Causation: A First Glance Business cycle fluctuations Economic shocks Prices are “sticky” downwards Economic response entails decreases in output and employment LO1 26-5

6. Causation: A First Glance Causes of shocks Irregular innovation Productivity changes Monetary factors Political events Financial instability Recession of 2007 LO1 26-6

7. Cyclical Impact Durable goods affected most Capital goods Consumer durables Nondurable consumer goods affected less Services Food and clothing LO1 26-7

8. Unemployment Under 16 and/or Institutionalized (71.4 million) Not in labor force (81.7 million) Employed (139.9 million) Unemployed (14.3 million) Total population (307.3 million) Labor force (154.2 million) Unemployment rate = 14,265,000 154,142,000 X 100 = 9.3% Unemployment rate = # of unemployed labor force X 100 LO2 26-8

9. Unemployment Criticisms of unemployment Involuntary part-time workers counted as if full-time Discouraged workers are not counted as unemployed LO2 26-9

10. Types of Unemployment Frictional unemployment Individuals searching for jobs or 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 LO3 26-10

11. Definition of Full Employment Natural Rate of Unemployment (NRU) Full employment level of unemployment Can vary over time Demographic changes Changing job search methods Public policy changes Actual unemployment can be above or fall below the NRU LO3 26-11

12. Economic Cost of Unemployment GDP Gap GDP gap = actual GDP – potential GDP Can be negative or positive Okun’s Law Every 1% of cyclical unemployment creates a 2% GDP gap LO3 26-12

13. Economic Cost of Unemployment LO3 Economic Cost of Unemployment 26-13

14. Economic Cost of Unemployment LO3 26-14

15. Unequal Burdens Occupation Age Race and ethnicity Gender Education Duration LO3 26-15

16. Unequal Burdens Unemployment Rates by Demographic Group: Full Employment Year (2007) and Recession Year (2009)* Demographic Group Unemployment Rate 20072009 Overall4.6%9.3% Occupation: Managerial and professional Construction and extraction 2.1 4.6 7.619.7 Age: 16-19 African American, 16-19 White, 16-19 Male, 20+ Female, 20+ 15.724.3 29.439.5 13.921.8 4.19.6 4.07.5 Race and ethnicity: African American Hispanic White 8.314.8 5.612.1 4.18.5 Gender: Women Men 4.58.1 4.710.3 Education: ** Less than high school diploma High school diploma only College degree or more 7.114.6 4.49.7 2.04.6 Duration: 15 or more weeks 1.54.7 LO3 26-16

17. Noneconomic Costs LO3 Loss of skills and loss of self-respect Plummeting morale Family disintegration Poverty and reduced hope Heightened racial and ethnic tensions Suicide, homicide, fatal heart attacks, mental illness Can lead to violent social and political change 26-17

18. Global Perspective LO3 26-18

19. Inflation General rise in the price level Inflation reduces the “purchasing power” of money Consumer Price Index (CPI) LO2 CPI Price of the Most Recent Market Basket in the Particular Year Price estimate of the Market Basket in 1982-1984 = x 100 CPI 207.3 - 201.6 201.6 = x 100 = 2.8% 26-19

20. Inflation LO2 Inflation Rates in Five Industrial Nations 26-20

21. Inflation LO2 26-21

22. Types of Inflation Demand-Pull inflation Excess spending relative to output Central bank issues too much money Cost-Push inflation Due to a rise in per-unit input costs Supply shocks LO3 26-22

23. Inflation Difficult to distinguish inflation types Types differ in sustainability Demand-pull continues as long as the excess spending continues Cost-push ends in a recession Core inflation Without food and energy goods Focuses on more stable prices LO3 26-23

24. Redistribution Effects of Inflation Nominal income Unadjusted for inflation Real income Nominal income adjusted for inflation Anticipated vs. unanticipated income Percentage change in real income = Percentage change in nominal income Percentage change in price level LO3  26-24

25. 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” LO3 26-25

26. Who is Unaffected by Inflation? Flexible-income receivers COLAs Social Security recipients Union members Debtors Pay back the loan with “cheaper dollars” LO3 26-26

27. Anticipated Inflation Real interest rate Rates adjusted for inflation Nominal interest rate Rates not adjusted for inflation LO3 26-27

28. Anticipated Inflation Nominal Interest Rate Real Interest Rate Inflation Premium 11% 5% 6% =+ LO3 26-28

29. Other Redistribution Issues Deflation Mixed effects Incomes may rise Fixed assets values may fall For fixed-rate mortgages, real debt declines Arbitrariness LO3 26-29

30. 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 LO3 26-30

31. Hyperinflation 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 LO3 26-31

32. The Stock Market and the Economy Stock prices changing Wealth effect Investment effect Typical changes lead to weak effects Stock market bubbles Huge unwarranted rises in stock prices Excessive optimism and frenzied buying Can be detrimental to an economy 26-32