Chapter 13: Economic Instability

What are business fluctuations?

rise & fall of real GDP (GDP adjusted for inflation) over time in an irregular manner

What are business cycles marked by?

alternating periods of expansion and recession

What is a recession?

period in which real GDP declines for 2 consecutive quarters (6 months)

What is a depression?

continuous recession over consecutive quarters (Great Depression)

What is an expansion?

period of recovery from a recession

What are causes of business cycles?

1. changes in investment spending

2. innovation and imitation

3. monetary policy

4. external shocks

What are changes in investment spending (a cause of business cycle)?

spending more on expansion, capital goods, updating equipment, etc.; when expansion ends, layoffs could occur

What are innovation & imitation (a cause of business cycle)?

gaining an edge over your competitors; copying your competitors to stay competitive; slowing down of economic activity

What is monetary policy (a cause of business cycle)?

Federal Reserve sets interest rates, making it easier/harder to borrow & invest money; rising interest rates discourages potential investors

What are external shocks (a cause of business cycle)?

increase in oil prices, wars, international conflict, etc.

How do economists try to forecast business cycles?

use of econometric model to describe how economy behaves

What is a formula used by economists to describe how the economy behaves?

GDP = C + I + G + (X-M)

• C = consumption expenditures

• I = investment spending

• G = government expenditures

• X = exports

• M = imports

• X – M = net exports

What can the formula be used for (forecasting business cycles)?

can be used to forecast for up to 9 months into the future; each month the numbers are updated to reflect any changes

What is inflation?

rise in the general level of prices

What is deflation?

decline in general level of prices

How do economists measure inflation?

they use the Consumer Price Index (CPI)

What is the Consumer Price Index (CPI)?

tracks monthly changes in prices paid by consumers for a “basket” of goods/services

What is in the Consumer Price Index (CPI)?

“market basket,” average price and base year

How is index value determined in the Consumer Price Index (CPI)?

divide current market basket cost by base year market basket cost

How is percent change of inflation found?

divide change in CPI by beginning value of CPI

What is creeping inflation?

1-3% per year

What is hyperinflation?

100 % per year (usually, a sign of impending economic collapse, especially during war)

What is stagflation?

stagnant economy & inflation (1970s as an example)

What are the causes of inflation?

1. demand pull inflation

2. cost push inflation

3. wage price spiral

4. excessive monetary growth

What is demand pull inflation?

prices rise because all sectors of economy (consumers, businesses, government) try to buy more goods/services than economy can produce

• Shortages occur, driving up prices due to excessive demand

What is a consequence of demand pull inflation?

using credit cards & going into debt to buy something you otherwise couldn’t afford

What is cost push inflation?

rising input costs (energy, organized labor), drive up cost of products for manufacturers, causing inflation

What are examples of cost push inflation?

• oil prices go up, raising price of other goods that rely on oil

• union wins large wage increase, causing producers to raise prices

What is wage price spiral?

self-perpetuating spiral of wages & prices becomes difficult to stop

• higher prices force workers to demand higher wages so producers raise prices (and so on)

What is excessive monetary growth?

money supply grows faster than real GDP

• any extra money or credit increases someone’s purchasing power; when they spend that money, it creates a demand-pull effect, raising prices

What are consequences of inflation?

• reduced purchasing power

• distorted spending patterns

• encouraged speculation

• distorted distribution of income

What does reduced purchasing power mean (consequences of inflation)?

dollar buys less as prices rise, losing value over time

What does distorted spending patterns mean (consequences of inflation)?

people’s spending habits can be drastically affected

What does encouraged speculation mean (consequences of inflation)?

people tempted to buy exotic items that may increase in value later

What does distorted distribution of income mean (consequences of inflation)?

loans can be repaid but dollar value may have dropped

What is the labor force?

all people 16 or older who are either employed or actively seeking employment

What does the labor force exclude?

military members, people in jail, residents of mental health facilities

What is unemployed?

people available for work who made a specific effort to find a job in past month and who, during the past week, worked less than one hour for pay/profit

How is the unemployment rate calculated?

divide number of unemployed people by labor force

What is underemployment?

people working less than full-time, but are considered employed; part-time work is considered to be employed

What are the sources of unemployment?

1. frictional unemployment

2. structural unemployment

3. technological unemployment

4. cyclical unemployment

5. seasonal unemployment

What is frictional unemployment?

people between jobs

What is structural unemployment?

change in economic progress causes a change in demand for workers

• change in consumer tastes, outsourcing, new government  regulations, etc.

What is technological unemployment?

workers replaced by machines

What is cyclical unemployment?

changes in business cycle

What is seasonal unemployment?

seasonal changes in weather, holidays, etc.