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Fluctuations in Economic Output, Unemployment, and Inflation The Business Cycle • The phases of the business cycle are: • • • • Recovery or Expansion, Peak or Boom (shaded green) Recession or Contraction trough or Depression (blue shaded areas). Real GDP Business peak Trend line Business peak Depression or trough Depression or trough Time The Business Cycle • Cycles are irregular •Annual growth rate of real GDP •8 •Long-run growth rate (approx. 3%) •6 •4 •2 •0 •- 2 •1960 •1965 •1970 •1975 •1980 •1985 •1990 •1995 •2000 •2005 •2009 •Source: Economic Report of the President, various issues. • Ups and downs characterize business activity. • There has been an upward trend in real GDP in the United States and other industrial nations. The Business Cycle • Cycles are irregular •Share of labor force unemployed •10 •Actual rate of unemployment •8 •6 •4 •2 •Natural rate of unemployment •1960 •1965 •1970 •1975 •1980 •1985 •1990 •1995 •2000 •2005 •2009 • Ups and downs characterize business activity. • There has been an upward trend in real GDP in the United States and other industrial nations. Actual and Potential GDP • Potential output : Maximum sustainable output level consistent with the economy’s resources, (on the production possibilities curve.) • Actual and potential output will be equal when the economy is at full employment. Actual & Potential GDP, 1960 - 2009 •Real GDP (billions of 2000 $) •12,000 •2001 recession •10,000 •8,000 •Potential GDP •Actual GDP •6,000 •4,000 •2,000 •2008-09 recession •1990-91 recession •1960 recession •1970 recession •1982 recession •1980 recession •1974-75 recession •1960 •1965 •1970 •1975 •1980 •1985 •1990 •1995 •2000 •2005 •2010 Note the gap (shaded area) between actual and potential GDP during periods of recession. Economic Fluctuations and the Labor Market 1. Employed – a person (16 years old or over) who is • working for pay at least one hour per week, • self employed, or, • working 15 hours or more each week without pay in a family-operated enterprise. 2. Unemployed – a person not currently employed who is either • actively seeking a job, or, • waiting to begin or return to a job. 3. Civilian Labor force – civilians (16 years and older) who are either employed or unemployed. 4. Not in the labor force – persons (16 years and older) who are neither employed nor unemployed (like retirees, 4 Labor Market Classifications students, homemakers, or disabled persons). Economic Fluctuations and the Labor Market • The non-institutional civilian adult population is grouped into two broad categories: • 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 • To be classified as unemployed, one must either be on layoff or actively seeking work. Rate of Unemployment = # Unemployed # in the Labor Force Unemployment and Measurement Problems • The definition of unemployed involves some subjectivity. • Some argue the employment/population ratio is a better indicator of job availability than the unemployment rate. Employment / Population Ratio = # employed Civilian population (16+) U.S. Population, Employment, and Unemployment: 2001 211.9 million Civilian population 16 and over 141.8 million 70.1 million Civilian labor force Not in the labor force • Household workers • Students • Retirees • Disabled 135.1 million Labor Force Participation Rate Employment / Population Ratio Rate of Unemployment Employed Unemployed • Employees • Self-employed workers • New entrants • Reentrants • Lost last job • Quit last job • Laid off = Civilian labor force Civilian population (16+) = 66.9% = Number employed Civilian population (16+) = 63.8% = 4.8% = 6.7 million Number unemployed Civilian labor force U.S. Population, Employment, and Unemployment: 2004 223.4 million Civilian population 16 and over 147.4 million 76.0 million Civilian labor force Not in the labor force • Household workers • Students • Retirees • Disabled 139.3 million Labor Force Participation Rate Employment / Population Ratio Rate of Unemployment = Civilian labor force Civilian population (16+) = Number employed Civilian population (16+) = Number unemployed Civilian labor force 8.1 million Employed Unemployed • Employees • Self-employed workers • New entrants • Reentrants • Lost last job • Quit last job • Laid off = 147.4 223.4 = 66.0% = 139.3 223.4 = 62.3% = 8.1 147.4 = 5.5% • U.S. Population, Employment, • and Unemployment: 2006 •228.6 million •77.4 million •Civilian population •16 and over •Civilian •labor force •Not in the •labor force • Household workers • Students • Retirees • Disabled •Employed •144.4 million •Rate of Unemployment • Employees • • Self-employed •workers •Civilian labor force =•Civilian •= population (16+) •151.8 •228.6 • =•66.4% •Number employed •= •= •Civilian population (16+) •144.4 •228.6 •= •63.2% •Labor Force • Participation Rate •Employment / Population Ratio •151.8 million •= •Number unemployed •Civilian labor force • = •7.0 • •151.8 = •4.6% •7.0 million •Unemployed • New entrants • Reentrants • Lost last job • Quit last job • Laid off •2001 Labor Force Participation Rate Employment / Population Ratio Rate of Unemployment = Civilian labor force Civilian population (16+) = Number employed Civilian population (16+) = Labor Force Participation Rate •2003 Employment / Population Ratio Rate of Unemployment = Civilian labor force Civilian population (16+) = Number employed Civilian population (16+) •Employment / Population Ratio •Rate of Unemployment = 66.9% = 135.1 211.9 = 63.8% = 6.7 141.8 = 4.8% = 147.4 223.4 = 66.0% = 139.3 223.4 = 62.3% = 8.1 147.4 = 5.5% •Civilian labor force =•Civilian •= population (16+) •151.8 •228.6 • =•66.4% •Number employed •= •= •Civilian population (16+) •144.4 •228.6 •= •63.2% = •Labor Force • Participation Rate •2006 Number unemployed Civilian labor force = 141.8 211.9 •= Number unemployed Civilian labor force •Number unemployed •Civilian labor force • = •7.0 • •151.8 = •4.6% Composition of the Unemployed by Reason • There are various reasons why persons were unemployed in 2006. • A little less than two-fifths (39.1%) of the unemployed were dismissed from their previous jobs. • 43.6% of the unemployed were either new entrants or reentrants into the labor force. •Source: www.bls.gov. •Job •leavers •12.5 % •New entrants 9.5% •Reentrants 34.1% •Dismissed from •previous jobs 39.1% •On •layoff •13.3% Classify each of the following as (a) employed, (b) unemployed, or (c) not in the labor force: a. a person who is not working but applied for a job at WalMart last week b. a person working part-time who is searching diligently for a full-time job c. an auto worker vacationing in Florida during a layoff at a General Motors plant who expects to be recalled in a couple of weeks d. a 17-year-old who works six hours per week as a route person for the local newspaper e. homemaker working 70 hours a week preparing meals and performing other household services f. a college student who spends between 50 and 60 hours per week attending classes and studying g. a retired Social Security recipient •a •b •c 2. The figures below (in millions) are for the U.S. during the year 2006. Population (age 16 and over) 299.8 Civilian pop. (age 16 and over) 228.6 Employed 144.4 Unemployed 7.0 a. Calculate the unemployment rate. •7.0 •7.0 • 144.4 b. Calculate the labor force participation rate. •7.0 • 144.4 •228.6 c. Calculate the employment/ population ratio • 144.4 •228.6 1. Frictional 2. Structural 3. Cyclical 4. Seasonal between jobs job replaced less business temporary job Deals with which type? 1. Frictional? 2. Structural? 3. Cyclical? • 1. A student who decides at midsemester to devote the rest of the term to studying quits her part-time job • 2. A graphic artist who is out of work because a computer now does her job. • 3. A waiter who quits his job and is applying for the same type of work in a restaurant where morale is better. • 4. The son of a local farmer who works 20-hour weeks without pay on the farm while waiting for a job at a nearby factory. • 5. A travel agent who is laid off because the economy is in a slump and vacation travel is at a minimum. • 6. A plumber who works 5 hours per week for his church (on a paid basis) until he can get a full-time job At full employment there will still be some: 1. Frictional 2. Structural but no Cyclical actual unemployment may only get as low as 4–5% • Inflation is an increase in the general level of prices. • The Rate of Inflation is calculated as: Inflation rate = This year’s price index - Last year’s price index Last year’s price index * 100 The Inflation Rate, 1956-2009 •Inflation rate •15 •10 •1973-1981 average inflation rate = 9.2 % •1956-1965 average inflation rate = 1.6 % •1983-2009 average inflation rate = 3.1 % •5 •0 •1956•1960 •1965 •1970 •1975 •1980 •1985 •1990 •1995 •2000 •2005 •2010 • Between 1956 and 1965, the general price level increased at an average annual rate of only 1.3%. • 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 (3.1% from 1983-2009) and more stable. There are 2 Kinds of Inflation 1. Anticipated inflation: A widely expected change in the price level. 2. Unanticipated inflation: An increase in the price level that comes as a surprise, at least for most individuals. 1. Hyperinflation 2. Money loses value 1. Savings Lose value 2. Loans Are easier to repay 3. Wealth May increase • Nearly all economists believe that rapid expansion in the money supply is the primary cause of inflation. 1. Demand-Pull 2. Cost-Push 1. Demand-Pull Price S1 New price and output P2 Orig. price and output P1 D2(increase in demand) D1 Q1 Q2 Quantity buyers demands greater than producers supply 2. Cost Push Price S2(new equilibrium) S1(initial equilibrium) P2 P1 D Q2 Q1 Quantity/time sellers’ costs are passed on to buyers • a slowing of the inflation rate • the aim of policies • usually phrased as “slowing inflation” •http://abcnews.go.com/Video/playerIndex?id=6484348 • 4. How would an unanticipated 5 percent jump in inflation impact the wealth of: • a. Joe, who has a 30-year home mortgage at a fixed interest rate • b. The McCoy's, who hold most of their wealth in long-term fixed yield bonds • c. Hanna, a retiree drawing a pension of a fixed dollar amount • d. Jose, a heavily indebted small-business owner. • e. Mike, the owner of an apartment complex with substantial debt at a fixed interest rate • f. Tina, a worker whose wages are determined by a 3-year union contract ratified three months ago •1. During this century, the growth rate of real GDP in the United States has averaged approximately 6% •a. 1 % •b. 3 % •c. •d. 10 % •2. Economists use the term “business cycle” to refer to •a. •b. •c. •d. the growth of small businesses into major corporations. changes in products that occur from improved technology. fluctuations in the level of real output and employment. periods of increases and decreases in the rate of inflation. •3. The labor force participation rate of women in the United States has been a. b. •c. •d. increasing for several decades. decreasing for the past several decades after increasing dramatically in the early 1900s. approximately constant during the last three decades. decreasing since the early 1900s. •4. Suppose there was a country with an adult (age 16 and over) population of 1,000, of which 100 were unemployed and 700 were employed. Which of the following is true? •a. The employment population ratio is 87.5 percent. •b. The labor force participation rate is 70 percent. •c. The unemployment rate is 12.5 percent. •d. There are 700 individuals in this country’s labor force. •5. The type of unemployment caused by changes in the business cycle is •b. natural •c. frictional •a. cyclical •d. structural. •6. Frictional unemployment is the result of •a. not enough jobs for everyone to be employed. •b. unemployed workers’ skills not matching those needed for the available jobs. •c. a decline in the demand for labor, such as during a recession. •d. imperfect information and temporary periods of unemployment while workers are changing jobs. •7. Which of the following individuals would be considered unemployed by the official government definition? • George, who returned to graduate school after failing to find a a. job • the last four months b. • Gwen, a medical student, who is still in college and is not working c. Morgan, who is employed part-time but desires a full-time job • •d. Ralph, an auto worker vacationing in Florida during a layoff at a General Motors plant. •8. Suppose that the consumer price index at year-end 2004 was 140 and by year-end 2005 had risen to 150. What was the inflation rate during 2005? •a. 7.1 % •b. 10 % •c. 14.2 % •d. 50 % •9. Which of the following is true? •a. Anticipated inflation is an increase in the price level that comes as a surprise, at least to most individuals •b. Unanticipated inflation is a change in the price level that is widely expected. •c. Decision makers are generally able to anticipate slow steady rates of inflation with a fairly high degree of accuracy. •d. Inflation will increase the prices of goods and services that households purchase but not the wage rates of workers