Chapter 29: Business Cycles, Unemployment, Inflation

business cycle

Recurring increases and decreases in the level of economic activity over periods of years; consists of peak, recession, trough, and expansion phases.

peak

The point in a business cycle at which business activity has reached a temporary maximum; the point at which an expansion ends and a recession begins. At the peak, the economy is near or at full employment and the level of real output is at or very close to the economy’s capacity.

recession

A period of declining real GDP, accompanied by lower real income and higher unemployment.

trough

The point in a business cycle at which business activity has reached a temporary minimum; the point at which a recession ends and an expansion (recovery) begins. At the trough, the economy experiences substantial unemployment and real GDP is less than potential output.

expansion

The phase of the business cycle in which real GDP, income, and employment rise.

inflation

A rise in the general level of prices in an economy; an increase in an economy’s price level.

reduced the purchasing power of money

what is the most prominent theory regarding the cause of business cycle fluctuations?

sticky prices

the idea that the prices of many goods and services are unable to adjust quickly to meet the quantity supplied and quantitiy demanded in the market in the weeks and months following an economic shock, thus resulting in a need to adjust output and employment rather than price

sources of supply and demand shocks

• political events (war, terrorism, peace treaties)

• financial instability (bubbles, bursts)

• irregular innovation (rapid spread then slow/decline)

• productivity changes (resulting from unexpected changes in resource availability or in the rate of technological advance)

• monetary factors

what do economists agree is the cause of most cyclical fluctuations?

unexpected changes in the level of total spending

who benefits the most from expansions and suffers the most from recessions?

firms producing capital goods and consumer durables

what industry is the most insulated from the effects of a recession?

the service industry and industries that produce nondurable goods

labor force

Persons 16 years of age and older who are not in institutions and who are employed or are unemployed and seeking work.

unemployment rate

The percentage of the labor force unemployed at any time.

= unemployed / labor force (x100)

criticisms of BLS surveys of unemployment rate

• counting part-time workers as full time

• discouraged workers

discouraged workers

Employees who have left the labor force because they have not been able to find employment.

types of unemployment

frictional, structural, cyclical

frictional unemployment

A type of unemployment caused by workers voluntarily changing jobs and by temporary layoffs; unemployed workers between jobs.

structural unemployment

Unemployment of workers whose skills are not demanded by employers, who lack sufficient skill to obtain employment, or who cannot easily move to locations where jobs are available.

change in demand and technology

cyclical unemployment

A type of unemployment caused by insufficient total spending (insufficient aggregate demand) and which typically begins in the recession phase of the business cycle.

full employment rate of unemployment

The unemployment rate at which there is no cyclical unemployment of the labor force; equal to around 4 percent (rather than zero percent) in the United States because frictional and structural unemployment are unavoidable.

natural rate of unemployment (NRU)

The full-employment rate of unemployment; the unemployment rate occurring when there is no cyclical unemployment and the economy is achieving its potential output; the unemployment rate at which actual inflation equals expected inflation.

potential output

The real output (GDP) an economy can produce when it fully employs its available resources.

GDP gap

Actual gross domestic product minus potential output; may be either a positive amount (a positive GDP gap) or a negative amount (a negative GDP gap).

what happens to the GDP gap when the unemployment rate falls below the NRU?

it will be positive since there is a larger quantity of labor being utilized that allows the economy to produce more than the full-employment level of output

Okun’s law

The generalization that any 1-percentage-point rise in the unemployment rate above the full-employment rate of unemployment is associated with a rise in the negative GDP gap by 2 percent of potential output (potential GDP).

consumer price index

An index that measures the prices of a fixed “market basket” of some 300 goods and services bought by a “typical” consumer.

=price of most recent market basket in a particular year / price estimate of the makret basket in 1982-1984 (x100)

deflation

A decline in the general level of prices in an economy; a decline in an economy’s price level.

demand pull inflation

Increases in the price level (inflation) resulting from increases in aggregate demand.

cost push inflation

Increases in the price level (inflation) resulting from an increase in resource costs (for example, raw-material prices) and hence in per-unit production costs; inflation caused by reductions in aggregate supply.

per unit production costs

The average production cost of a particular level of output; total input cost divided by units of output.

core inflation

The underlying increases in the price level after volatile food and energy prices are removed.

nominal income

The number of dollars received by an individual or group as wages, rent, interest, or profti during some period of time.

real income

The amount of goods and services that can be purchased with nominal income during some period of time; nominal income adjusted for inflation.

=nominal income / CPI (in hundredths)

unanticipated inflation

An increase of the price level (inflation) at a rate greater than expected.

hurts fixed income receivers, savers, and creditors

anticipated inflation

Increases in the price level (inflation) that occur at the expected rate.

cost of living adjustments

An automatic increase in the incomes (wages) of workers when inflation occurs; often included in collective bargaining agreements between firms and unions. Cost-of-living adjustments are also guaranteed by law for Social Security benefits and certain other government transfer payments.

real interest rate

The interest rate expressed in dollars of constant value (adjusted for inflation) and equal to the nominal interest rate less the expected rate of inflation.

nominal interest rate

The interest rate expressed in terms of annual amounts currently charged for interest and not adjusted for inflation.

hyperinflation

An extremely high rate of inflation, usually defined as an inflation rate in excess of 50 percent per month.