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#6 Business Cycles, Unemployment, and Inflation McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. The Business Cycle • Alternating increases and decreases • LO1 in economic activity over time Phases of the business cycle • Peak • Recession • Trough • Expansion 6-2 The Business Cycle Peak Level of real output Peak Peak Trough Trough Time LO1 6-3 The Business Cycle U.S. Recessions since 1950 Period Duration, Months Depth (Decline in Real Output) 1953–54 10 -2.6% 1957–58 8 -3.7 1960–61 10 -1.1 1969–70 11 -0.2 1973–75 16 -3.2 1980 6 -2.2 1981–82 16 -2.9 1990–91 8 -1.4 2001 8 -0.4 2007–09 18 -3.7 Source: National Bureau of Economic Research, www.nber.org, and Minneapolis Federal Reserve Bank, www.minneapolisfed.gov. Output data are in 2000 dollars. LO1 6-4 Causes of Business Cycles • Business cycle fluctuations • Demand shocks • Supply shocks • Prices are “sticky” downwards • Economic response entails decreases in output and employment LO1 6-5 Cyclical Impact • Durable goods affected most • Capital goods • Consumer durables • Nondurable consumer goods affected less • Services • Food and clothing LO1 6-6 Causes of Business Cycles • Causes of shocks • Irregular innovation • Productivity changes • Monetary factors • Political events • Financial instability • Recession of 2007 LO1 6-7 Unemployment Under 16 and/or Institutionalized (70.9 million) Total population (308.7 million) Unemployment rate = # of unemployed × 100 Labor force Not in labor force (83.9 million) Employed (139.1 million) Unemployment rate = 14,855,000 × 100 = 9.6% 153,889,000 Labor force (153.9 million) Unemployed (14.8 million) LO2 6-8 Types of Unemployment • Frictional unemployment • Individuals searching for jobs or • • LO3 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 6-9 Definition of Full Employment • Full employment is something less than • • LO3 100 percent employment Believed to occur when unemployment rate is less than 5 percent Potential output 6-10 Economic Cost of Unemployment • GDP gap • GDP gap = Actual GDP – Potential • LO3 GDP • Can be negative or positive Loss of income is unequal 6-11 Unemployment Rates LO3 6-12 Inflation • General rise in the price level • Inflation reduces the “purchasing • power” of money Consumer Price Index (CPI) CPI = CPI = LO2 Price of the most recent market basket in the particular year Price estimate of the market basket in 1982–1984 218.1 - 214.5 ×100 ×100 = 1.6% 214.5 6-13 Inflation Inflation Rates in Five Industrial Nations LO2 6-14 Inflation Annual Inflation Rates in the United States, 1960-2010 LO2 6-15 Types of Inflation • Demand-pull inflation • Excess spending relative to output • Central bank issues too much • LO3 money Cost-push inflation • Due to a rise in per-unit input costs • Supply shocks 6-16 Redistribution Effects of Inflation • Nominal income • Unadjusted for inflation • Real income • Nominal income adjusted for • inflation Anticipated versus unanticipated income Percentage change in real income LO3 = Percentage change in nominal income Percentage change in price level 6-17 Who Is Hurt by Inflation? • Fixed-income receivers • Real incomes fall • Savers • Value of accumulated savings • LO3 deteriorates Creditors • Lenders get paid back in “cheaper dollars” 6-18 Who Is Unaffected by Inflation? • Flexible-income receivers • COLAs • Social Security recipients • Union members • Debtors • Pay back the loan with “cheaper dollars” LO3 6-19 Anticipated Inflation • Real interest rate • Rates adjusted for inflation • Nominal interest rate • Rates not adjusted for inflation LO3 6-20 Anticipated Inflation 6% 11% = + 5% Nominal interest rate LO3 Inflation premium Real interest rate 6-21 Does Inflation Affect Output? • Cost-push inflation • Reduces real output • Redistributes a decreased level of • LO3 real income Demand-pull inflation • One view is that zero inflation is best • Another view is that mild inflation is best 6-22 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 6-23