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Chapter 10
ECONOMIC FLUCTUATIONS,
UNEMPLOYMENT, AND INFLATION
Chapter 10
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objectives
After reading this chapter you should be able to:
1.
2.
3.
4.
5.
6.
7.
8.
Analyze the business cycle.
List and discuss various business cycle theories.
Understand economic forecasting.
Calculate the unemployment rate.
List and identify the types of unemployment.
Construct a consumer price index.
Name and explain the theories of inflation.
Compute the misery index.
10-2
Business Cycle
 Business cycles: alternating increases and
decreases in the level of business activity of varying
amplitude and length.
 How do we measure “increases and decreases in
business activity?”

Percent change in real GDP.
 Why do we say “varying amplitude and length?”
 Some downturns are mild and some are severe
 Some are short (a few months) and some are long (over a year)
 Do not confuse with seasonal fluctuations!
10-3
Real GDP 1964-2012, in 2005 dollars
 Note downward slope on graph indicating that real
GDP is decreasing during recession years.
Source: U.S. Dept. of Commerce, Business Cycle Indicators, March 2010.
10-4
Three-Phase Business Cycle
 Recession: economic downturn from peak to trough.
 Recovery: expansion from trough to previous peak, marked by rising
real GDP.
 Prosperity: expansion beyond previous peak.
Note: Measure a full business cycle from peak to peak or from trough to trough.
10-5
Fluctuations in Real GDP: 1860 – 2010
10-6
Recession
 What is a recession?
 Two or more consecutive quarters of declining real GDP
 Who decides when we are in a recession?
 National Bureau of Economic Research
•

NBER is a private research organization, not a federal agency.
NBER’s Business Cycle Dating Committee used 4 barometers:
•
•
•
•
Employment
Industrial production
Personal income minus government transfer payments
Manufacturing and trade revenue
10-7
Post-World War II Recessions
Note: These recessions were of varying duration and severity.
10-8
Another Look at Expansions and Recessions
Can you find a pattern? Neither can economists! That’s why
recessions are hard to predict.
10-9
Business Cycle Theories
 Endogenous theories:





Innovation theory: innovation leads to saturation
Psychological theory: alternating optimism and pessimism
Inventory cycle theory: inventory and demand not in sync
Monetary theory: changes in money supply by Federal Reserve
Under-consumption theory: or overproduction
 Exogenous theories:



The external demand shock theory: effect of foreign economies
War theory: war stimulates economy; peace leads to recession
The price shock theory: fluctuations in oil prices
10-10
Business Cycle Forecasting
The Ten Leading Economic Indicators










Average workweek of production workers in manufacturing
Average initial weekly claims for state unemployment insurance
New orders for consumer goods and materials
Vendors performance (companies receiving slower deliveries from
suppliers)
New orders for capital goods
New building permits issued
Index of stock prices
Money supply
Spread between rates on 10-year Treasury bonds and Federal funds
Index of consumer expectations
10-11
Unemployment
 Unemployment: when people in the labor force are
willing and able to work, but are not working.
 Statistics compiled monthly by Bureau of Labor Statistics
(BLS)



A person who worked one day last month is counted as employed.
Someone who works part-time but who wants to work full-time is
counted as employed.
Retirees and others not looking for work are “not in the labor force.”
 Unemployment rate: the percent of the labor force
that is unemployed

Number of unemployed/Labor Force
10-12
The Unemployment Rate, 1948-2012
 Unemployment trended upward between 1969 and 1982, and trended
downward after that.
 After going above 10 percent in late 2009, it is very unlikely that our
unemployment will get down again to 5 percent before late in this
decade.
10-13
How Accurate is the Unemployment Rate?
 Liberals think unemployment is underestimated.
 BLS does not count discouraged workers as part of the labor
force.
•
•

Discouraged workers: those who have given up looking for
work and dropped out of the labor force.
To be unemployed, one must be actively seeking work.
BLS counts as people as employed if they are involuntarily
part-time, that is, they want full-time jobs but cannot find
them.
10-14
How Accurate is the Unemployment Rate?
• Conservatives think unemployment is
overestimated.
o Some people who respond that they are actively
seeking work may be going through the motions
while collecting unemployment compensation, or
other entitlements.
o The BLS misses people who work in the
underground economy, including illegal
immigrants
10-15
Unemployment Rate for Selected Groups of
American Workers, March 2013
Teenagers, African Americans, and Latinos have much higher
unemployment rates than the average for all workers.
What is the impact of a college degree on the likelihood you will be
unemployed?
10-16
Unemployment Rates for Workers Under 25
in 2013
10-17
Unemployment as a Lagging Indicator
 The unemployment rate usually peaks well after a
recession ends.
 Examples:


The 1990-91 recession ended in March 1991, but the
unemployment rate did not peak until June.
The 2001 recession ended in November 2001, but the
unemployment rate peaked in June 2003.
10-18
Questions for Thought and Discussion
 Why might the official unemployment rate be
understating the unemployment problem?

Which groups do liberals think are missed by our current approach
to collecting the data?
 Why might the official unemployment rate be overstating
the unemployment problem?

Which groups do conservatives think are counted as unemployed,
even though they shouldn’t be?
 Who do you agree with?
 Which business cycle theory best explains the origins of
the Great Recession?
10-19
Types of Unemployment
 Frictional Unemployment (not problematic)

People who are between jobs or just entering or reentering the
labor market.
 Structural Unemployment

People who are out of work for a relatively long period of time (due
to technological or economic displacement or lack of skills).
 Cyclical Unemployment

People who are out of work due to downturn in business cycle.
 Seasonal Unemployment (not problematic)
 Unemployment rate never reaches zero, due to frictional
and structural unemployment.
10-20
Natural Unemployment Rate
 Natural unemployment rate is lowest non-
inflationary rate. It serves as a “floor” for policy
makers.

It has fallen since the 1980s due to the aging of the population,
the rise of the prison population, the expanding temporaryhelp industry, and the increase in worker insecurity due to
downsizing and off-shoring.
10-21
Is the Natural Unemployment Rate Falling?
 The “natural” unemployment rate changes in
response to economic and social trends.
 The natural rate has fallen since the 1980s. Why?





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There are fewer youths in labor force.
There are more males in prison.
The fear of corporate downsizing and off-shoring.
The expansion of temporary work force.
It is easier for disabled to qualify for Social Security, so they
are not in the labor force.
The labor force (denominator) is bigger, due to influx of
workers (immigrants, women leaving welfare).
10-22
Inflation
 Inflation: a sustained rise in the average price level
over a period of years.
o
U.S. inflation has been persistent since World War II.
 When the overall price level is rising, the prices of
some goods and services are going down. Some items
where prices have been falling are:
o
o
o
o
o
LCD TVs
DVD players
Laser printers
Digital cameras
Contact lenses
10-23
Consumer Price Index (CPI) and Inflation Rate
 The most common indicator used to measure inflation is
the Consumer Price Index (CPI).

CPI measures changes in our cost of living.
 CPI is also based on data collected by the Bureau of
Labor Statistics (BLS).
 The CPI is based on what it costs an average family to
live.




BLS employees check prices of 80,000 items every month.
Compare prices with prices in base year.
Use this information to calculate percent increase or decrease in
overall prices.
Inflation rate is percent change in the CPI.
10-24
Consumer Price Index, 1915–2012 (1967=100)
Source: U.S. Bureau of Labor Statistics, http://stats.bls.gov.
Note: Each year is compared with 1967, the base year.
10-25
Annual Percentage Change in CPI, 1946-2013
Source: Economic Report of the President, 2013.
Since World War II, we have had two periods of price stability—from
1952 through 1965, and from 1991 to the present.
10-26
A Magic Number
 The CPI is set at 100 for a base year.
 The number 100 is magic! It lends itself to
calculating percentage changes.
 Suppose we want to find out by what percentage
prices have risen since the base year?
 If the CPI today is 136.4, by what percentage did
prices rise since the base year?
136.4 – 100 = 36.4%
10-27
Finding Percentage Change in the Price Level
Year
CPI
1972
125.3
1982
289.1
Original Number
By what percentage did
the cost of living rise?
Change = 163.8
Change
Percentage change = ---------------------------- X 100
Original Number
163.8
Percentage change = ---------------------------- X 100
125.3
Percentage change = 1.307 X 100
Percentage change = 130.7
10-28
Deflation
 Deflation is a decline in the general level of prices
for a period of years.


This is the OPPOSITE of inflation.
This last occurred between 1929–1933 during the Great
Depression.
 Some economists and policy makers, including
members of the Federal Reserve, have expressed
concerns that deflation could return to the U.S.
 Why is deflation bad for the economy?


Businesses have inventories that decline in value.
Wages fall, leading to a deflationary spiral.
10-29
Disinflation
 Disinflation occurs when the RATE OF INFLATION
declines.
Year
CPI
Inflation Rate
1980
82.4
13.5%
1981
90.9
10.3%
1982
96.5
6.2%
1983
99.6
3.2%
1984
103.9
4.3%
From 1981–1983 the rate
of inflation declined, but
prices continued to
increase . . . just at a
lower rate.
10-30
Hypothetical Illustration
Note that deflation occurs only when the rate falls below zero (negative).
10-31
Why has inflation remained low since 1992?
 Imported goods are competing with American-made




goods and driving down prices.
Rise of huge discount stores.
E-commerce has increased competition.
Wave of technical innovations has lowered prices of
electronics and other goods and increased worker
productivity.
Firms have become “lean and mean” by downsizing
and holding down wage increases.
10-32
Questions for Thought and Discussion
 Explain the difference between inflation, deflation,
and disinflation.

Which one is usually good news for the economy?
 Inflation devalues money. The same amount of
money will buy less in the future. Who is hurt by
inflation? Who is helped?



What about debtors (people who owe money to be paid back in
the future)?
What about creditors (lenders)?
What happens to retirees on fixed incomes?
10-33
Theories of the Causes of Inflation
 Demand-Pull Inflation
 Caused by excessive demand for goods and services.
 The economy is already operating at full capacity.
 Is often summed up as “too many dollars chasing too few
goods.”
 Cost-Push inflation
 Wage-price spiral
 Profit-push inflation
 Supply-side cost shocks ( like oil prices increasing)
10-34
Inflation vs. Price Stability
 Inflation is relative concept. When are regular price
increases a policy problem?


Creeping inflation: small, predictable increases
Hyperinflation: sudden, large price increases
 Inflation as a Psychological Process:
 If people believe prices will rise, they will act in a way that
keeps them rising.
 This can trigger hyperinflation spiral.
10-35
Stagflation
 Stagflation is the contraction of the words
stagnation and inflation.

This word got a lot of use in the recessions of 1973–1975, 1980
and 1981–1982 when we experienced the worst of both worlds,
declining output and inflation.
 Stagflation is measured by the Misery Index.
 The Misery Index is calculated by adding the unemployment
rate and the inflation rate.
 The Misery Index was unusually low in the 1990s until the
Great Recession.
10-36
The Misery Index, 1948 - 2012
You’ll note that this combined rate of unemployment and
inflation rose to a peak in 1979 and has declined substantially
since then.
10-37
Three Goals, Three Problems, Three Indicators
 Goal = Economic Growth
 Problem = Recession
 Indicator = real GDP
 Goal = Full Employment
 Problem = Unemployment
 Indicator = Unemployment Rate
 Goal = Price Stability
 Problem = Inflation (or Deflation)
 Indicator = Consumer Price Index
10-38
Questions for Thought and Discussion
 Where are all the jobs?
 To keep up with growth in labor force, there is a need of
150,000 new jobs per month.
 During the administration of Bill Clinton, we added an average
of 230,000 jobs per month.
 During George W. Bush’s administration, we averaged a gain
of less than 70,000 jobs per month.
 What are some of the reasons for slower job growth even
before the Great Recession?
10-39