McConnell 22nd edition

1. CHAPTER 29
Business Cycles, Unemployment, and Inflation

2. The Business Cycle
Unemployment
Inflation
Redistribution Effects of Inflation
Does Inflation Affect Output?
29-2
Chapter Contents

3. U.S. Real GDP since 1970
• U.S. GDP tends to increase over time with ups and downs
14-3

4. The Business Cycle
• Two observations on U.S. GDP over time
• An upward-trend line: Potential GDP growth.
• Alternating increases and decreases along the trend line.
• The business cycle is alternating increases and decreases in
economic activity over time
• It is measured by changes in real GDP.
LO29.1
29-4

5. Phases of Business Cycle
• Expansion
• When production (real GDP)
increases
• Recession
• When production (real GDP)
decreases
• Peak and Trough
• An expansion ends at a peak
and a recession ends at a
trough.
14-5
Levelofrealoutput
Time
Peak
Trough
Trough
Peak
Peak

6. Most Recent Business Cycle
• The shaded periods show the recessions — periods of falling
production that lasts for at least six months.
14-6

7. U.S. Recessions since 1950
Period
Duration,
Months
Depth
(Decline in Real
Output)
1953–54 10 –2.6%
1957–58 8 –3.7
1960–61 10 –1.1
1969–70 11 –0.2
1973–75 16 –3.2
1980 6 –2.2
1981–82 16 –2.9
1990–91 8 –1.4
2001 8 –0.4
2007–09 18 –4.3
LO29.1
29-7
• Not all recessions
are equal.
• Recessions vary in
duration (length)
and severity
(depth).

8. Duration of Business Cycle
• Figure summarizes U.S.
recession, expansion, and
cycle length since 1854.
• Recessions have shortened.
• Expansions have lengthened,
and complete cycles have
lengthened
14-8

9. Recessions and Industries
• Business cycle has different impacts on industries
• Durable goods affected most
• Capital goods
• Consumer durables
• Nondurable consumer goods affected less
• Services
• Food and clothing
14-9

10. Causes of Business Cycles
• Unexpected events (shocks) trigger changes in
production and employment
• Sources of shocks that cause business cycles
• Irregular innovation
• Productivity changes
• Monetary factors
• Political events
• Financial instability
• Resource availability and prices
LO29.1
29-10

11. Measurement of Labor Market Condition
• Current Population Survey
Every month, 1,600 interviewers working on a joint project of the
Bureau of Labor Statistics (BLS) and the Bureau of the Census
survey 60,000 households to establish the age and job market
status of each member of the household.
• It classified peoples into categories
• Working-age population
• Labor force
• Employed and Unemployed
14-11

12. Labor Force
• Working-Age Population
Working-age population is the total number of people aged 16
years and over who are not in a jail, hospital, or some other form
of institutional care or in the U.S. Armed Forces.
• Labor Force
Labor force is the number of people employed plus the number
unemployed.
• People not in labor force are working-age population who are not
willing to work (not working or looking for work) — students, full-time
housewife, senior citizen.
14-12

13. Employed vs. Unemployed
• Employed under Population Survey: The survey counts as employed
all persons who, during the week before the survey:
1. Worked at least 1 hour in a paid job or 15 hours unpaid in family business.
2. Were not working but who had jobs from which they were temporarily
absent.
• Unemployed under Population Survey: The survey counts as
unemployed all persons who, during the week before the survey:
• Had no employment & Were available for work,
and either:
1. Had made efforts to find employment during the previous four weeks, or
2. Were waiting to be recalled to a job from which they had been laid off. 14-13

14. Two Main Labor Market Indicators
• Unemployment rate: The percentage of people in the labor force
who are unemployed.
• Labor force participation rate: The percentage of the working-age
population who are members of the labor force.
14-14
Unemployment rate =
Number of
people unemployed
x 100
Labor force
Labor force
participation rate Working-age population
x 100
Labor force
=

15. The U.S. Labor Force, Employment, and
Unemployment, 2018
Under 16
and/or
Institutionalized
(69.5 million)
Not in
labor
force
(95.6 million)
Employed
(156.9 million)
Unemployed
(6.3 million)
Total
population
(328.2
million)
Labor
force
(163.2
million)
Unemployment rate =
6,300,000
163,200,000
× 100 = 3.9%
Labor Force participation rate =
163,200,000
258,800,000
× 100 = 63.1%
LO29.2
29-15
Working-age
population
(258.8 million)

16. U.S. Unemployment Rate since 1929
• U.S. unemployment rate: 1929–2011
14-16
• From 1948 to 2011, the
average unemployment
rate was 5.8%.

17. Global Perspective
• Unemployment rates
vary from one country to
another, but all show
cyclical up and down
along the business cycle.
• Some countries like
Japan have low
unemployment rate as
compared with the U.S.
14-17

18. Shortcomings of Unemployment Measure
Unemployment rate reported on Population Survey is not accurate
measurement of unemployment. The official definition of
unemployment omits two types of labor:
• Involuntary part-time workers counted as full-time
Involuntary part-time workers are people who work 1 to 34
hours per week but are looking for full-time work.
• Discouraged workers are not counted as unemployed
Discouraged worker is a person who does not have a job, is
available and willing to work, but has not made specific efforts
to find a job within the previous four weeks because previous
unsuccessful attempts were discouraging.
LO29.2
29-18

19. Labor Participation Rate in the U.S.
• The average labor force
participation rate
increased.
• The labor force
participation rate of
women has increased,
while the labor force
participation rate of men
has decreased.
14-19

20. Global Perspective
• Women in the Labor Force
14-20
• The Labor Force
participation rate varies
among countries.
• It depends on social and
cultural norms, social
infrastructure
(availability of daycare),
and opportunities for
women.

21. Types of Unemployment
• Four Types of Unemployment
Unemployment is classified into four types based on its
cause.
• Frictional unemployment
• Structural unemployment
• Cyclical unemployment
• Seasonal unemployment
LO29.2
29-21

22. Frictional Unemployment
• Frictional unemployment
the unemployment that arises from normal labor
turnover—from people entering and leaving the labor force
and between jobs while searching jobs and waiting to take
jobs.
14-22
For example, a college graduate
looking for his first job.

23. Structural Unemployment
• Structural unemployment
the unemployment that arises due to changes in the
structure of the demand for labor—changes in technology
or international competition change the skills needed to
perform jobs or change the locations of jobs.
14-23
For example, telephone switching is
now done by computer, rather than by
operators. Also, call centers have been
relocated to India.

24. Cyclical Unemployment
• Cyclical unemployment
Caused by the recession phase of
the business cycle— it fluctuates
over the business cycle that
increases during a recession and
decreases during an expansion.
14-24

25. Seasonal Unemployment
• Seasonal unemployment
the unemployment that arises
because of seasonal patterns.
14-25
For example, lifeguards are only
needed during summer.
During Christmas season, additional
salespersons are hired at retail
stores.

26. Characteristics of Unemployment
• Seasonal unemployment occurs regularly and is predictable.
The Bureau of Labor Statistics reports the unemployment
rate adjusted for seasonal changes (seasonally adjusted).
• Seasonal unemployment cannot be avoided.
• Structural unemployment is a result of dynamics (growth) of
economy – no pain, no gain.
• Frictional unemployment is considered desirable for the
economy.
• Only cyclical unemployment is desirable to avoid.
14-26

27. Natural Rate of Unemployment
• Natural Unemployment
After adjusting for seasonal changes, the unemployment
that arises from frictions and structural change when there
is no cyclical unemployment—when all the unemployment
are frictional, structural, and seasonal.
Natural rate of unemployment (NRU) is the natural
unemployment as a percentage of the labor force
14-27

28. Natural Rate of Unemployment
• Natural rate of unemployment (NRU) can vary over
time due to
• Demographic changes (e.g. age distribution)
• Changing job search methods
• Public policy changes (e.g. unemployment benefit,
minimum wage)
• Pace of structural changes
• Actual unemployment can be above or below the NRU
LO29.2
29-28

29. Full Employment
• Full employment
When the economy is experiencing only frictional, structural
or seasonal unemployment, but not cyclical unemployment.
• It occurs when the unemployment rate equals the
natural rate of unemployment.
• Full employment DOES NOT mean everyone has job.
14-29

30. Potential GDP Revisited
• Potential GDP
The level of real GDP when the economy is at full
employment (at natural rate of unemployment).
Actual real GDP can be above or below the potential GDP.
• When the actual unemployment rate is below the NRU,
the actual real GDP is greater than the potential GDP.
• When the actual unemployment rate is below the NRU,
the actual real GDP is greater than the potential GDP.
14-30

31. LO29.2
GDP Gap
• GDP Gap = actual GDP – potential GDP
• Sources: Congressional Budget Office; Bureau of Economic
Analysis; and Bureau of Labor Statistics.
29-31
• GDP gap can be negative
or positive.
• When GDP gap is
negative, some resources
are unemployed, that is,
cyclical unemployment.

32. Okun’s Law
• Okun’s Law:
Every 1% of cyclical unemployment creates a 2%
GDP gap.
LO29.2
29-32

33. LO29.2
Actual and Potential Real GDP and the Unemployment Rate
• At peaks phase of business cycle,
unemployment rat is low.
• At trough phase of business cycle,
unemployment rate is high.
• When unemployment is higher than the
natural rate (around 5%), there is
negative GDP gap. When unemployment
rate is lower than the natural rate, there
is positive GDP gap.
• In 2008, there was large negative GDP
gap, and the unemployment rate was far
above the natural rate of unemployment
(around 5%).
• Sources: Congressional Budget Office; Bureau of Economic
Analysis; and Bureau of Labor Statistics.
29-33
NRU

34. Economic Cost of Unemployment
• Costs to the Economy
• Forgone output (lower GDP) and consumption: Unemployed
could be used to produce goods and services valuable to the
economy
• Costs to Individuals
• Lost income and consumption (lower standard living)
• Missed opportunities for developing skills through work
• Costs to the Society
• Taxes for unemployment benefits and welfare
• Crimes, protectionism, anti-immigration
14-34

35. Unequal Burdens
• Burden of Unemployment fall more in
• Occupation: Blue color
• Age: Young
• Race and ethnicity: Black and Hispanic
• Gender: Male (Mancession)
• Education: low education attainment
• Duration of Unemployment varies along business cycle
• Longer unemployment during recessions
LO29.2
29-35

36. Unemployment Rates by Demographic Group
• Source: Civilian labor force by
detailed
• age, sex, race, and ethnicity.
• Bureau of Labor Statistics
LO29.2
Demographic Group
Unemployment Rate
2007 2009 2018
Overall 4.6% 9.3% 4.1%
Occupation:
Managerial and professional
Construction and extraction
2.1 4.6 2.0
7.6 19.7 6.7
Age:
16–19
African American, 16–19
White, 16–19
Male, 20+
Female, 20+
15.7 24.3 11.5
29.4 39.5 19.9
13.9 21.8 10.1
4.1 9.6 3.3
4.0 7.5 3.2
Race and ethnicity:
African American
Hispanic
White
8.3 14.8 6.1
5.6 12.1 4.3
4.1 8.5 3.2
Gender:
Women
Men
4.5 8.1 3.5
4.7 10.3 3.6
Education:
Less than high school diploma
High school diploma only
College degree or more
7.1 14.6 5.8
4.4 9.7 3.8
2.0 4.6 2.1
Duration:
15 or more weeks
1.5 4.7 1.3
29-36

37. Noneconomic Costs
• Some costs of unemployment cannot be measured
• 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
LO29.2
29-37

38. Consumer Price Index (CPI)
• Consumer Price Index (CPI): a measure of the average of the
prices paid by urban consumers for a fixed market basket of
consumer goods and services.
• Each month, BLS employees check the prices of the 80,000
goods and services in the CPI basket in 30 metropolitan
areas.
• We can use these numbers to compare what a fixed basket
of goods costs this month with what it cost in some previous
month.
14-38

39. CPI as Index Number
• Reference base period: a period for which the CPI is defined
to equal 100.
• Currently, the reference base period is 1982-1984.
In 2018, CPI = 251.1
In 2019, CPI = 255.7
14-39

40. CPI Basket
• Make the relative importance of the items in the CPI basket
the same as in the budget of an average urban household. It
includes more than 700 items.
• The CPI is calculated each month, but the CPI basket is not
updated each month.
• The CPI basket is updated periodically, based on information
obtained from the Consumer Expenditure Surveys
conducted in the most recent years.
14-40

41. Example of CPI Basket
• CPI basket in July 2011
14-41

42. CPI Calculation Steps
• The CPI calculation has three steps:
1. Find the cost of the CPI basket at base period prices.
2. Find the cost of the CPI basket at current period prices.
3. Calculate the CPI for the base period and the current period.
14-42

43. Calculating Cost of CPI Basket
• To calculate a cost of
CPI basket in 2005, use
quantities in CPI basket
and multiply by prices
on goods in 2005.
• To calculate a cost of
CPI basket in 2012, use
the same quantities in
CPI basket and multiply
by prices on goods in
2012.
14-43

44. Calculating CPI
• CPI is a ratio of “Cost of CPI basket” of the year to “Cost of CPI
basket” in base year.
14-44
For Base Year: CPI = = 100
$50
$50
x 100
For 2012: CPI = = 140
$70
$50
x 100
CPI
Cost of CPI Basket in Particular Year
Cost of CPI Basket in Base Period
= x 100

45. Inflation
• Inflation: General rise in the price level
• Deflation: General fall in the price level
• Inflation rate: A percentage change in price index
• From 2018 to 2019 (CPI in 2018 = 251.1, CPI in 2019 = 255.7)
LO29.3
29-45
CPI in current year  CPI in previous year
CPI in previous year
x 100Inflation rate =
Inflation Rate
255.7 - 251.1
251.1
= x 100 = 1.8%

46. Annual Inflation Rates in the United States, 1960–2018
• Inflation rate
varies from year
to year.
• The U.S. economy
experienced high
inflation in 1980.
• Since 1980, the
inflation rate has
been less than
5%annually.
• Source: U.S. Bureau of Labor Statistics.
LO29.3
December-to-December changes in the CPI
29-46

47. Global Perspective 29.1
• Inflation rate varies from
one country to another.
• All countries experienced
low or negative inflation rate
during worldwide recession
in 2018.
• As economy shifted to an
expansion phase in many
countries, an inflation rate
went up in 2010 to 2012.
• Source: International Monetary Fund.
LO29.3
INFLATION RATES IN FIVE INDUSTRIAL NATIONS, 2008–2018
29-47

48. Types of Inflation
• Demand-pull inflation:
• Excess spending relative to output
• Central bank issues too much money
• Cost-push inflation:
• Due to a rise in per-unit input costs
• Supply shocks
LO29.3
29-48

49. Demand-Pull vs. Cost-Push
• Difficult to distinguish inflation types.
• Types differ in sustainability:
• Demand-pull continues as long as the excess
spending continues.
• Cost-push ends in a recession.
LO29.3
29-49

50. Core Inflation
• Due to frequent supply shocks, food and energy prices
change much more than other items in frequency and
magnitude
• CPI is greatly affected by changes in food and energy prices
• Core inflation:
• Without food and energy goods.
• Focuses on more stable prices.
• Used to evaluate a long run trend of inflation
LO29.3
29-50

51. Nominal and Real Values
• Nominal value of a good: its value in terms of money.
• Real value of a good: its value relative to other good,
service, or bundle of goods.
• Example: Nominal GDP vs. Real GDP
• As prices increase (inflation), a value of money decreases
and its purchasing power.
• You cannot compare prices of same goods in two different
period directly.
14-51

52. Nominal and Real Income
• Nominal income: Unadjusted for inflation.
• A dollar amount of income
• Real income: Nominal income adjusted for inflation.
• How much goods your nominal income can purchase
• If prices increase, the nominal income can purchase less.
LO29.4
Percentage
change in
real income =
Percentage
change in nominal
income
Percentage
change in
price level
 −
29-52

53. Nominal and Real Interest Rate
• Nominal interest rate: the dollar amount of interest
expressed as a percentage of the amount loaned.
• Real interest rate: the goods and services forgone in interest
expressed as a percentage of the amount loaned. Interest
rate adjusted for inflation.
Real interest rate = Nominal interest rate – Inflation rate
• In 2019, the inflation rate was 1.8%, and an interest rate on
saving account at SECU was 0.75%. Then, the real interest
rate was 0.75% - 1.8% = -1.05%.
LO29.4
29-53

54. Inflation Premium
• Real interest rate tells you
how much actually you gain.
• If you want 5% real interest
rate and anticipate 6%
inflation rate, then you
should demand 11%
nominal interest rate (which
include 6% premium for
inflation over real interest
rate). Nominal
interest
rate
Real
interest
rate
Inflation
premium
11%
5%
6%
= +
LO29.4
29-54

55. Distributional Effect of Inflation
• 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”
• Who benefits from inflation?
• Debtors (Borrowers): Pay back the loan with “cheaper
dollars”
• Who is unaffected by Inflation?
• COLA-income receivers: Social security recipients
LO29.4
29-55

56. Anticipate and Unanticipated Inflation
• When people anticipate inflation, they demand inflation
adjustment to protect their income or return from inflation.
• When anticipated correctly, inflation will not have distributional
effect.
• If nominal wage is increased proportional to inflation rate, then
inflation will not affect real income.
• Lenders demand inflation premium to preserve real interest rate.
• Unanticipated inflation can lower real income or real interest
rate and will cause distributional effects.
LO29.4
29-56

57. Deflation
• Deflation can also have negative economic effects.
• Like inflation, deflation has distributional effects (opposite to
inflation)
• Deflation lowers current spending: Consumers postpone
durable-goods purchases with anticipation of lower prices.
• Given nominal interest rate, deflation increases real interest
rate and discourages borrowings (and spending with loans)
• Lower consumer spending may lead to recession.
LO29.4
29-57

58. Does Inflation Affect Output?
• Cost-push inflation:
• Reduces real output.
• Redistributes a decreased level of real income.
• Demand-pull inflation:
• One view is that zero inflation is best.
• Another view is that mild inflation is best.
LO29.5
29-58

59. Hyperinflation
• Hyperinflation: Extraordinarily rapid inflation
• Zimbabwe’s 14.9 billion percent inflation in 2008
• Hyperinflation devastates an economy
• Businesses don’t know what to charge
• Consumers don’t know what to pay
• Money becomes worthless
LO29.5
29-59

60. Last Word: The Great Skills Shortage
• Job market slow to recover after the Great Recession
(2008 recession).
• More job openings than people unemployed.
• Skills mismatch due to decrease in vocational
education programs.
• Demographic and geographic issues.
• Unrealistic expectations of employers.
29-60