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Macro Chapter 8
Economic Fluctuations,
Unemployment, and Inflation
“Prosperity is when the prices of things
that you sell are rising; inflation is when
the prices of things that you buy are rising.
Recession is when other people are
unemployed; depression is when you are
unemployed.”
Anonymous quote
5 Learning Goals
1) Characterize fluctuations in economic growth.
2) Relate fluctuations in GDP to employment and
the demand for labor.
3) Classify unemployment into three categories.
4) Distinguish the difference between full
employment and the natural rate of
unemployment and correlate both to potential
GDP.
5) Determine inflation’s effect on the economy.
Swings in the Economic
Pendulum
Instability in the Growth of Real GDP
Annual Rate of Growth
in Real GDP
• Although real GDP in the United
States has grown at an average rate
of approximately 3%, the growth
has been characterized by economic
ups-and-downs.
Note: periods of recession are
indicated with shading.
(long-run growth rate approximately 3%)
8%
6%
4%
2%
0%
-2%
-4%
1960
1965
1970
1975
1980
1985
1990
Source: Economic Report of the President, various issues.
1995
2000
2005 2010
The Hypothetical Business Cycle
Real GDP
Business
Trend line
peak
Business
peak
Recessionary
trough
Recessionary
trough
Time
The four phases of the business cycle are expansion,
peak, contraction, and recessionary trough.
Key Points:
1) The business cycle varies and is
unpredictable
2) The average annual growth rate is 3%
Economic Fluctuations
and the Labor Market
Q8.1 A person not working is considered
unemployed.
1) True
2) False
This section describes the
categories of people
Total population divided into two categories:
– (1) Under age 16 & institutionalized people
– (2) Over age 16
Over age 16 divided into two categories:
– (1) Not in labor force – students, retirees, disabled
– (2) In labor force
In labor force divided into two categories:
– (1) Employed
– (2) Unemployed, but want to be employed
Definition of unemployed:
A person not currently employed but (1)
actively seeking a job, or (2) waiting to
begin or return to a job
See BLS FAQs (BLS_FAQS.pdf)
U.S. Population, Employment,
and Unemployment
Civilian population
16 and over
Not in the
labor force
• Household workers
• Students
• Retirees
• Disabled
Civilian labor force
Labor Force
Participation Rate
= Civilian population (16+)
Employment /
Population Ratio
Number employed
Civilian population (16+)
=
Number unemployed
Rate of
Unemployment = Civilian labor force
Civilian
labor force
Employed
• Employees
• Self-employed
workers
Unemployed
• New entrants
• Reentrants
• Lost last job
• Quit last job
• Laid off
See Current Population Survey
(CPS_Aug_2012.pdf)
Q8.2 Mary is a homemaker. Last week, she was
busy with her normal household chores. She is
1)
2)
3)
4)
a member of the civilian labor force who is employed.
a member of the civilian labor force who is unemployed.
a member of the civilian labor force who is underemployed.
a discouraged worker who is not a member of the labor
force.
5) not a member of the labor force.
Two calculations to know
1) Labor force participation rate = (employed
+ unemployed) / civilian pop. over age 16
2) Unemployment rate = unemployed /
(employed + unemployed) OR
unemployed / labor force
Q8.3 Which of the following would be officially
classified as unemployed?
1. a school administrator who has been working as a
substitute teacher one day per week while looking for a
full-time job in administration
2. a mathematician who returned to graduate school after
failing to find a job the last four months
3. a 60-year-old former steel worker who would like to work
but has given up actively seeking employment
4. a laid-off construction worker waiting to return to a
previous job
Please see article “15 Statistics about the
jobs market.pdf” (the data are a little old,
but still informative)
The unemployment rate climbed to 8.3%
in February, 2009. It’s stayed over 8%
since (that’s 43 months).
The unemployment rate climbed to 9.4%
in May, 2009. It stayed over 9% until
September, 2011 (except for March, 2011
at 8.9%). That’s 28 out of 29 months.
The previous longest streak above 8%
was 27 months, from 1981 to 1984.
Three Types of
Unemployment
3 general reasons why people are
unemployed:
(1) Frictional – imperfect information
(2) Structural – workers don’t possess
desired skills
(3) Cyclical – result of business cycle
Watch Video: Stossel-unemployment and
labor mobility
Employment
Fluctuations- The
Historical Record
Example of workers moving to a new
industry: Watch video- Treycycle employs
NASA engineers
Q8.4 Which of the following is a positive effect of
job search and the unemployment that often
accompanies it?
1. It keeps wages and income levels low.
2. It permits individuals to better match their skills and
preferences with the requirements of a job.
3. It reduces the wage gap between high skill workers and
those with few skills.
4. It creates political pressure for an increase in the
minimum wage, which will reduce the rate of
unemployment in the long run.
Some unemployment is unavoidable and
arguably desirable
Natural rate of unemployment: “normal”
frictional and structural unemployment
The natural rate occurs when the economy
is operating at a sustainable rate
Full employment is when the natural rate
of unemployment exists
Natural rate equals about 5%
Q8.5 Full employment is the situation in which the
economy operates at an unemployment rate equal
to the sum of
1. structural and frictional unemployment.
2. cyclical and frictional unemployment.
3. structural and cyclical unemployment.
4. structural, frictional, and cyclical
unemployment.
Actual and Potential GDP
Potential output is the economy’s
maximum sustainable output; occurs when
the natural rate of unemployment exists;
occurs when full employment exists
Potential output is perhaps best thought of
as the 3% growth rate discussed earlier
Actual output can be greater than or less
than potential; again, think about the
actual growth rate
Real GDP
Business
peak
Trend line
Business
peak
Recessionary
trough
Recessionary
trough
Trend line = maximum sustainable rate
Business Cycle = actual output
Time
Actual & Potential GDP, 1960-2011
Real GDP
(billions of 2000 $)
14,000
• Here we illustrate both actual GDP
and potential GDP.
• Note the gap (shaded area) between
actual and potential GDP during
periods of recession.
Actual
GDP
12,000
1990-91
recession
10,000
8,000
6,000
1970
recession
1960
recession
2008-10
recession
1982
recession
4,000
1974-75
recession
2,000
1960
2001
recession
Potential
GDP
1965
1970
1975
1980
1980
recession
1985
1990
1995
2000
2005
2011
Another way to think about these:
When you read the BEA report about
quarterly GDP, if the reported (actual)
growth rate is near 3%, then the economy
is at it’s potential output.
At 3% actual growth, the unemployment
rate will likely be around 5% (i.e. full
employment is 95%)
The economy can never eliminate
frictional and structural unemployment for
an extended period.
Q8.6 Actual GDP will be below potential
GDP
1.
2.
3.
4.
when the economy is at full employment.
during an economic boom.
when resources are fully utilized.
during a recession.
The Effects of Inflation
Actual & Potential GDP, 1960-2011
• Between 1956 and 1965, the general
price level increased at an average
annual rate of only 1.6%.
• In contrast, the inflation rate
averaged 9.2% from 1973 to 1981,
reaching double-digits during
several years.
• Since 1982, the average rate of
inflation has been lower (2.9%
from 1983-2011) and more stable.
1956-1965 average
inflation rate = 1.6 %
15%
10%
1973-1981 average
inflation rate = 9.2 %
1983-2011 average
inflation rate = 2.9 %
5%
0%
-5%
1956 1960 1965 1970 1975 1985 1990 1995 2000 2005 2011
2011
See BLS CPI release
(CPI_August_2012.pdf)
Q8.7 Suppose you received a 3 percent increase in
your nominal wage. Over the year, inflation ran about
6 percent. Which of the following is true?
1. Your real wage fell.
2. Your nominal wage fell.
3. Both your nominal and real wages decreased.
4. Although your nominal wage fell, your real wage
increased.
5. Both nominal and real wages increased.
Inflation is a persistent increase in the
general level of prices
Case Study: Zimbabwe
In February, 2008 a loaf of bread was
200,000 Zimbabwe dollars
In August, 2008, that same loaf of bread
was 1.6 trillion dollars
That’s 11.2 million percent!
Watch Video: Ducktales-inflation (just for
fun)
Why is inflation “bad”?
1) It reduces investment: long-term projects are
more risky
2) It distorts information delivered by prices:
relative prices are skewed because some
prices adjust more quickly than others
3) It results in less productive use of resources:
people will spend more time trying to combat
the effects of inflation rather than engaging in
productive activity
Question Answers
8.1 = 2
8.2 = 5
8.3 = 4
8.4 = 2
8.5 = 1
8.6 = 4
8.7 = 1