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.

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