Macroeconomics: Business Cycles, Unemployment, and Inflation

Chapter 9: Business Cycles, Unemployment, and Inflation

The Business Cycle

  • Definition: The business cycle refers to the alternating increases and decreases in economic activity over time.

  • Phases of the Business Cycle:

    • Peak: The highest point of economic expansion before a decline.

    • Recession: A period where economic activity slows, marked by declining output, employment, and investment.

    • Trough: The lowest point of the economic cycle, marking the end of a recession.

    • Expansion: A period of economic growth following a trough, where output, employment, and demand increase.

Visual Representation

  • Business Cycle Illustration: Represents the level of real output over time, highlighting the cyclical nature of economic activity from trough to peak.

U.S. Recessions Since 1950

  • Key Statistics:

    • Period: 1953–54, Duration: 10 Months, Depth: –2.6%

    • Period: 1957–58, Duration: 8 Months, Depth: –3.7%

    • Period: 1960–61, Duration: 10 Months, Depth: –1.1%

    • Period: 1969–70, Duration: 11 Months, Depth: –0.2%

    • Period: 1973–75, Duration: 16 Months, Depth: –3.2%

    • Period: 1980, Duration: 6 Months, Depth: –2.2%

    • Period: 1981–82, Duration: 16 Months, Depth: –2.9%

    • Period: 1990–91, Duration: 8 Months, Depth: –1.4%

    • Period: 2001, Duration: 8 Months, Depth: –0.4%

    • Period: 12/07–6/09, Duration: 18 Months, Depth: –4.3%

    • Period: 2020 (COVID), Duration: 2 Months, Depth: –10.1%

Business Cycle Fluctuations

  • Economic Shocks: Sudden, unexpected changes that affect the economy.

  • Price Stickiness: A term indicating that prices are generally resistant to decrease, leading to drops in output and employment in response to economic shocks.

Causes of Economic Shocks

  • Political Events: Major political decisions or instability can disrupt economic stability.

  • Financial Instability: Issues such as bank failures or stock market crashes can lead to decreased economic activity.

  • Irregular Innovation: Sudden changes in technology or productivity that can disrupt markets.

  • Productivity Changes: Changes in the efficiency of production can impact economic output.

  • Monetary Factors: Policies set by central banks can significantly affect economic stability.

Cyclical Impact of Economic Shocks

  • Durable Goods: Items that last long periods, such as capital goods and consumer durables, are affected more severely during economic downturns.

  • Nondurable Goods: Items consumed quickly, like services, food, and clothing, tend to be less impacted by economic fluctuations.

The U.S. Labor Force, Employment, and Unemployment (2021 Statistics)

  • Population Breakdown:

    • Under 16 and/or Institutionalized: 70.5 million

    • Not in labor force: 100.2 million

    • Employed: 152.6 million

    • Total Labor Force: 161.2 million

    • Unemployed Individuals: 8.6 million

    • Unemployment Rate Calculation:
      ext{Unemployment Rate} = rac{8,600,000}{161,200,000} imes 100 = 5.3 ext{%}

Criticisms of Unemployment Measurements

  • Involuntary Part-Time Workers: Often counted as full-time employees.

  • Discouraged Workers: Those who have stopped seeking employment are not counted as unemployed.

Types of Unemployment

  • Frictional Unemployment: Occurs when individuals are in between jobs or are searching for their first jobs.

  • Structural Unemployment: Resulting from changes in the economy that alters the demand for labor, often due to technological advancements.

  • Cyclical Unemployment: Occurs during economic recessions or downturns.

Full Employment Definition

  • Natural Rate of Unemployment (NRU):-

    • Description: Reflects the level of unemployment at which the economy is considered to be at full employment.

    • Potential Output: The maximum sustainable level of output the economy can produce without triggering inflation.

    • Variability: The NRU can be influenced by demographic shifts, changes in job search strategies, and public policies.

    • Notably, the actual unemployment rate might fluctuate above or below this rate.

Economic Costs of Unemployment

  • GDP Gap: Defined as the difference between actual GDP and potential GDP.

    • Formula:
      ext{GDP Gap} = ext{Actual GDP} - ext{Potential GDP}

    • Okun’s Law: Establishes a relationship between cyclical unemployment and GDP: every 1% increase in cyclical unemployment results in a 2% decrease in GDP.

Okun's Law Example Calculation

  • Assumed Variables: Actual Unemployment: 10%, NRU: 4%, Potential GDP: $100 Million

  • Steps to Calculate GDP Gap:

    1. Cyclical Unemployment:
      10 ext{%} - 4 ext{%} = 6 ext{%}

    2. Percent GDP Gap:
      6 ext{%} imes 2 = 12 ext{%}

    3. Dollar Value of GDP Gap:
      12 ext{%} imes 100M = 12M

Sources of Unemployment Disparity

  • Unequal Burdens: Vary based on factors such as occupation, age, race and ethnicity, gender, and education level.

  • Unemployment Rates by Demographic Group (2019 vs. 2020):

    • Overall: 3.7% (2019), 8.1% (2020)

    • Race and ethnicity impacts: African American 6.1% (2019) vs. 11.4% (2020).

Noneconomic Costs of Unemployment

  • Consequences of Unemployment on Individuals:

    • Loss of skills and self-respect.

    • Decreased morale and increased family disintegration.

    • Promotion of poverty and diminished optimism.

    • Heightened racial and ethnic tensions leading to potential social discord.

Inflation

  • General Definition: Inflation is characterized by a sustained increase in the overall price level within an economy. It diminishes the purchasing power of money.

  • Consumer Price Index (CPI): Measures the average change in prices over time for a basket of consumer goods and services.

    • CPI Calculation:
      ext{CPI} = rac{ ext{Price of Most Recent Market Basket}}{ ext{Price Estimate of Market Basket in 1982–1984}} imes 100

  • Example CPI Calculation: If CPI = 278.8 and CPI for the previous period = 260.5,
    ext{Inflation Rate} = rac{278.8 - 260.5}{260.5} imes 100 = 7.0 ext{%}

Inflation Trends and Perspectives

  • Annual Inflation Rates Analysis (1960–2021): Tracked variations in inflation over decades to understand general economic trends.

Types of Inflation

  • Demand-Pull Inflation: Arises from excessive demand over supply, often exacerbated by monetary policies, e.g., excessive central bank money supply. Effects include an increase in both prices and GDP.

  • Cost-Push Inflation: Results from increases in production costs. In figure of supply disruptions, this leads to higher prices and potentially lowers GDP.

  • Core Inflation: Excludes volatile categories like food and energy, focusing instead on stable prices to give a clearer economic picture.

Redistribution Effects of Inflation

  • Definitions:

    • Nominal Income: Income not adjusted for inflation.

    • Real Income: Income adjusted for inflation (nominal income adjusted for inflation).

    • Inflation Types: Unanticipated versus anticipated inflation significantly affects how income is perceived and managed.

    • Formula for Real Income Change:
      ext{Percentage Change in Real Income} = rac{ ext{Percentage Change in Nominal Income}}{ ext{Percentage Change in Price Level}}

Impacts of Inflation on Various Groups

  • Groups Affected by Inflation:

    • Fixed-Income Receivers: Experience a decline in real income.

      • social security is not one of these people because social security goes up as CPI goes up

    • Savers: Find the value of their savings eroding over time due to inflation.

    • Creditors: May lose as repayments occur in depreciated currency.

  • Groups Unaffected or Benefited by Inflation:

    • Flexible-Income Receivers: Include individuals with adjustments made for inflation like COLAs (Cost Of Living Adjustments), social security recipients, and union members.

    • Debtors: Can repay loans in cheaper dollars, mitigating their real debt burden.

Anticipated vs. Unanticipated Inflation

  • Interest Rates Analysis:

    • Real Interest Rate: Interest rate adjusted for inflation.

    • Nominal Interest Rate: Non-adjusted interest rate.

      • the one you actually pay is often higher due to additional fees and charges that can impact your overall cost of borrowing.

    • Inflation Premium Calculation:
      ext{Nominal Interest Rate} = ext{Real Interest Rate} + ext{Inflation Premium}

Other Issues Related to Inflation

  • Inflation: a general rise in prices, not all prices but general

  • Deflation: Leads to mixed outcomes, such as income rises but fixed asset values may decline and real debt can shrink for fixed-rate mortgage holders.

  • Variability in Inflation Effects: Points to the arbitrary nature of gains/losses among different economic classes.

Does Inflation Affect Output?

  • Cost-Push Inflation: Typically reduces real output while redistributing the decreased level of real income.

    • affects GDP

  • Demand-Pull Inflation: Two perspectives exist regarding its effects on output:

    • One perspective suggests that keeping inflation at zero is optimal; the other suggests mild inflation may stimulate economic growth.

Hyperinflation

  • Definition: Refers to inflation exceeding 50% each month, characterized by extraordinarily fast price increases.

  • Historical Examples:

    • Notable cases include Germany post-WWI and Japan post-WWII.

  • Consequences and Motivations: Explores the causal relationship leading to such extreme inflationary environments and their eventual termination.

The Great Resignation and Aftermath

  • Context: During the COVID-19 pandemic, many firms had to send employees home due to lockdown measures, resulting in a surge in generous unemployment benefits.

  • Labor Market Shift: Emerged from workers choosing not to return to jobs, leading to significant labor shortages. Even after unemployment benefits ended, many workers found themselves capable of transitioning to new jobs easily, perpetuating labor shortages in various sectors.

Practice problems:

  1. the consumer price index was 177.1 in 2001 and 179.9 in 2002. therfore, the rate of inflation in 2002 was about

            a. 1.6 percent

  1. if the rate of inflation is 12 percent per year, the price level will double in about

            a. 5.8 years

  1. rising per unit production costs are most directly associated with

            a. cost push inflation

  1. suppose that a person’s nominal income rises from $10,000 to $12,000 and the consumer price index rises from 100 to 105. the person’s real income will _____.

            a. rise by about 15 percent

  1. the table contains data for a hypothetical single-product economy. Nominal GDP in year 3 is _____.

            a. $450

  1. the table contains data for a hypothetical single-product economy. Real GDP in year 3 is _______.

            a. nominal GDP divided by price index in 100s = real GDP

                    price index: 300

                    450/300 times 100 = 150

  1. supposed a nation’s 2010 nominal GDP was $972 billion and the general price index was 90. to make the 2010 GDP comparable with the base year GDP, the 2010 GDP must be, __________.

            a. deflated to 1080 billion

  1. assume an economy that is producing only one product. output and price data for a 3 year period are shown in the table. if year 2 is chosen as the base year, in years 1 and 3 the price index values are ________.

            a. 20/100 = 5 year one