ema atw108_ch27

Business Cycles, Unemployment, and

Inflation

Chapter 27

Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

27-2

Learning Outcomes

1. Describe the business cycle & its primary phases.2. Illustrate how unemployment is measured & explain

different types of unemployment.3. Explain how inflation is measured & distinguish

between cost-push inflation & demand-pull inflation.4. Relate how unanticipated inflation can redistribute

real income5. Discuss how inflation may affect the economy’s

output level

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• Alternating increases and decreases in economic activity over time

• 4 phases of the business cycle• Peak - when biz xtvt reaches a temporary max with full

(100%) employment and near-capacity output• Recession - a decline in Y, I, Empl, & trade lasting 6

months or more; aka ‘economic contraction’• Trough - the bottom of the recession period • Expansion - when output and employment are

recovering and expanding toward the full employment level.

The Business Cycle

LO1

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Leve

l of r

eal o

utpu

t

Time

Peak

Peak

Peak

Recession

RecessionExpansion Expansion

Trough

Trough

Growth

Trend

The Business Cycle

LO1

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U.S. Recessions since 1950

PeriodDuration,Months

Depth(Decline in Real

Output)1953-54 10 -2.6%1957-58 8 -3.71960-61 10 -1.1

1969-70 11 -0.21973-75 16 -3.21980 6 -2.21981-82 16 -2.9

1990-91 8 -1.42001 8 -0.42007-09 18 -3.7

Source: National Bureau of Economic Research, www.nber.org, and Minneapolis Federal Reserve Bank, www.minneapolisfed.gov. Output data are in 2000 dollars

The Business Cycle

LO1

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• Malaysia’s long-run growth has many interruptions (normal).• Aka ‘uneven growth’• When there is rapid growth, normally we will have inflation. • When there is recession / depression , we’ll have decline in

employment & output.• Business cycle fluctuations

• Economic shocks• Prices are “sticky” downwards• Economic response entails decreases in output and

employment

The Business Cycle

LO1

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Normally, high growth, high inflation

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• Economic shocks are unexpected events.• Cause trouble for us (indv + firm) to adjust.• Prices can be inflexible downwards• if total spending decline fast & firms cannot lower

prices, the firms will end up selling fewer units of output.

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• The “sticky” prices (price that is hard to change) result in slower sales

• consequently will cause firms to cut back on production; • --> GDP to fall.• Then employment will fall (due to fall in demand)• Then economic contraction• Inflexible prices are said (blaimed) to be a major factor in

preventing the economy from quickly adjusting to economic shocks. These shocks are outlined on the next slide.

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Causation: A First Glance

• Causes of shocks• Irregular innovation• Productivity changes• Monetary factors• Political events• Financial instability

• Recession of 2007

LO1

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Cyclical Impact (what happen if country is going through recession period)

• The Durable goods (expected life >3 years) affected most• Capital goods• Consumer durables

• Nondurable consumer goods affected less• Services• Food and clothing

LO1

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Unemployment

Under 16and/or

Institutionalized (71.6 million)

Not inlaborforce

(88.3 million)

Employed(142.5 million)

Unemployed(12.5 million)

Total population (314.9 million)

Labor force (155 million)

Unemployment rate =

12,500,000 155,000,000

X 100 = 8.0%

Unemployment rate = # of unemployed labor force

X 100

LO2

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Unemployment

• Criticisms of unemployment (causing official report to understate actual unemployment)

• Involuntary part-time workers counted as full-time

• Discouraged workers are not counted as unemployed (nak kerja, tapi tak mencari secara active)

LO2

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• Frictional unemployment• Individuals searching for jobs or waiting to take

jobs soon (grads)• Structural unemployment

• Occurs due to changes in the structure of the demand for labor (from MAS to AirAsia)

• Cyclical unemployment• Caused by the recession phase of the business

cycle (Shell)

Types of Unemployment

LO2

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Definition of Full Employment

• Full employment ≠ 0 unemployment• Full employment ≠ 0 cyclical unemployment• Aka Natural Rate of Unemployment (NRU)

• Full employment level of unemployment• Can vary over time

• Demographic changes• Changing job search methods• Public policy changes

• Actual unemployment can be above or fall below the NRU

LO2

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Economic Cost of Unemployment(How much does a country ‘loss’ if there’s high

unemployment)

• GDP Gap• GDP gap = actual GDP – potential GDP• Can be negative or positive

• Okun’s Law• Every 1% of cyclical unemployment creates a

2% GDP gap

Country is underproduced, inefficient

LO2

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Economic Cost of Unemployment

LO2

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Economic Cost of Unemployment

LO2

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Unequal Burdens

• Occupation• Age• Race and ethnicity• Gender• Education• Duration

LO2

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Unequal Burdens

Unemployment Rates by Demographic Group: Full Employment Year (2007) and Recession Year (2009)*

Demographic GroupUnemployment Rate

2007 2009Overall 4.6% 9.3%

Occupation: Managerial and professional Construction and extraction

2.1 4.6

7.6 19.7

Age: 16-19 African American, 16-19 White, 16-19 Male, 20+ Female, 20+

15.7 24.3

29.4 39.5

13.9 21.8

4.1 9.6

4.0 7.5

Race and ethnicity: African American Hispanic White

8.3 14.8

5.6 12.1

4.1 8.5

Gender: Women Men

4.5 8.1

4.7 10.3

Education:** Less than high school diploma High school diploma only College degree or more

7.1 14.6

4.4 9.7

2.0 4.6

Duration: 15 or more weeks 1.5 4.7LO2

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Noneconomic Costs(the side effect of being

unemployed)

• Loss of skills and loss of self-respect• Plummeting morale• Family disintegration• Poverty and reduced hope• Heightened racial and ethnic tensions• Suicide, homicide, fatal heart attacks, mental

illness• Can lead to violent social and political change

LO2

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Global Perspective

LO2

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Inflation

• General rise in the price level• Inflation reduces the “purchasing power” of money• Consumer Price Index (CPI)

CPIPrice of the Most Recent Market

Basket in the Particular Year

Price estimate of the MarketBasket in 1982-1984

= x 100

CPI207.3 - 201.6

201.6= x 100= 2.8%

LO3

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Inflation

LO3

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2 Types of Inflation

• Demand-Pull inflation, happens when• Excess spending relative to output (S > Y)• Central bank issues too much money• “too much spending chasing too few goods”

• Cost-Push inflation, happens when• per-unit input costs increases, but output falls.• As a result, economy’s supply decline, • supply shocks

LO3

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2 Types of Inflation

• Cost-Push inflation, happens when• Lets say wage rate increase, or oil price increases• per-unit input costs increases, but output falls.• Rising cost reduce profit, • Rising cost reduce amount of supply,• As a result, economy’s supply decline, • supply shocks• And price level increases; inflation

HOW TO SOLVE ?

LO3

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Inflation• Difficult to distinguish the causes of inflation types• Types differ in sustainability

• Demand-pull continues as long as the excess spending continues (eg: if Malaysians continue to shop regardless of their declining income)

• Cost-push ends in a recession (during recession, less spending)

LO3

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Redistribution Effects of Inflation

• Nominal income• Unadjusted for inflation• The one u see in report/news

• Real income – refers to purchasing power of income.• (how much u can actually purchase with ur income)

• Nominal income adjusted for inflation• Anticipated vs. unanticipated income

Percentagechange in real income =

Percentage change in nominal income

Percentage change inprice level

LO4

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Who is Hurt by Inflation?

• Fixed-income receivers• Real incomes fall

• Savers• Value of accumulated savings deteriorates

• Creditors• Lenders get paid back in “cheaper dollars”

LO4

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Who is Unaffected by Inflation?

• Flexible-income receivers• COLAs (CosT OF Living adjustments)• Social Security (PERKESO) recipients• Union members

• Debtors• Pay back the loan with “cheaper dollars”

LO4

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Anticipated Inflation• If inflation is anticipated, individuals can plan ahead mitigating the effects of inflation.

• “Inflation premium” is the amount that the interest rate is raised to cover effects of anticipated inflation.

• “Real interest rate” is defined as the nominal rate minus the inflation premium.

• Real interest rate• Rates adjusted for inflation

• Nominal interest rate• Rates not adjusted for inflation

LO4

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Anticipated Inflation

NominalInterest

Rate

RealInterest

Rate

InflationPremium

11%

5%

6%= +

LO4

the amount that the interest rate is raised to cover effects of anticipated inflation.

Rates adjusted for inflation

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Other Redistribution Issues

• Deflation (a decrease in the general price level of goods and services)

• Mixed effects• Incomes may rise• Fixed assets values may fall• For fixed-rate mortgages, real debt declines

• Arbitrariness

LO4

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Hyperinflation

• Extraordinarily rapid inflation• Devastates an economy• Businesses don’t know what to charge• Consumers don’t know what to pay• Money becomes worthless• Zimbabwe’s 14.9 billion percent inflation in

2008

LO5

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Unemployment After the Great Recession

• Why has recovery been so slow?• Higher federal minimum wage• Longer unemployment benefits• Structural adjustments• Higher labor costs

LO5

ema atw108_ch27

Economy & Finance