Lecture 8 Business Cycle Unemploment Inflation

Business Cycle Overview

• The business cycle refers to the fluctuations in economic activity over time, marked by periods of expansion (growth) and contraction (recession).

• Measured by the rise and fall in real GDP, it reflects changes in overall economic performance.

Phases of the Business Cycle

• Peak: Maximum level of economic activity, characterized by high consumer and business confidence, full employment, and potential for inflation due to high demand.

• Recession: Defined by two consecutive quarters of declining real GDP, leading to decreased business and consumer spending, rising unemployment, and potentially falling prices.

• Trough: Lowest point in the business cycle, characterized by widespread unemployment and low economic confidence.

• Expansion: Recovery phase where spending increases, businesses ramp up production, and employment rises, although inflation may begin to increase again.

Components of Business Cycle

• Peak: High spending and production with full employment; inflation is likely.

• Recession: Spending and production decline; businesses cut back on hiring; unemployment rises.

• Trough: Very low spending and production; consumer and business confidence is low.

• Expansion: Economic activity resumes growth; businesses begin hiring again; inflationary pressures can resurface.

Leading Indicators of the Business Cycle

• The Composite Leading Index (CLI) is used to predict periods of economic expansion or recession.

• CLI provides early signals about the health of the economy.

Business Cycle and Unemployment

• Typically, unemployment rates rise during economic downturns as demand decreases, leading to less consumer spending.

• GDP is influenced by total spending in the economy, and lower spending results in reduced production and increased unemployment.

Understanding Unemployment

• Labour Force: Comprises individuals who are employed or actively seeking employment.

• Unemployment Types:

  • Frictional Unemployment: Short-term; arises as workers transition between jobs or enter the labor market.

  • Structural Unemployment: Occurs when skills are mismatched with job demands, often due to technological changes.

  • Cyclical Unemployment: Related to the business cycle; increases during recessions.

  • Seasonal Unemployment: Linked to seasonal demand fluctuations for labor.

Measuring Unemployment

• Unemployment Rate: Percentage of unemployed individuals within the labor force.

  • Calculated as Unemployed / Labour Force.

• Labour Force Participation Rate: Proportion of the working-age population that is part of the labor force.

Economics of Unemployment

• Unemployment has multiple impacts:

  • Economic costs due to lost output.

  • Social costs, like increased poverty and crime.

  • Leads to skill obsolescence and lower self-esteem among jobless workers.

Policies for Reducing Unemployment

• For Frictional Unemployment: Improve job matching and information dissemination.

• For Structural Unemployment: Provide training and education for skills development.

• For Cyclical Unemployment: Increase government spending and investment to stimulate the economy.

• For Seasonal Unemployment: Offer alternative job opportunities during low demand periods.

Inflation and Deflation

• Inflation: A sustained increase in the general price level.

• Deflation: A sustained decrease in the general price level.

• Measurement indices include the Consumer Price Index (CPI) and Producer Price Index (PPI).

Inflation Measurement and Effects

• CPI measures the average price of a basket of goods over time.

• Inflation leads to:

  • Loss of purchasing power.

  • Positive effects for producers but negative for fixed income earners, savers, and creditors.

Causes of Inflation

• Demand-Pull Inflation: Occurs when strong demand outpaces supply.

• Cost-Push Inflation: Results from rising production costs.

• Imported Inflation: Caused by price increases in imported goods.

Consequences of Deflation

• Deflation can lead to decreased consumer spending, impacting economic growth negatively.

• It redistributes income and wealth, often hurting borrowers while benefiting savers.

Hyperinflation

• Defined as an extremely rapid and sustained rise in prices, typically exceeding 50% per month.

• Often results from excessive growth in the money supply, leading to economic instability.