Understanding Unemployment and Inflation Dynamics in Economic Cycles

1. Chapter 4: Unemployment and Inflation

2. Business cycle • Pattern of rising and falling real GDP

3. Business cycle

4. Leading indicators • Change before real GDP changes • Often provide false indicators of the start of a recession

5. Coincident indicators • Tend to change at the same time as real GDP

6. Lagging indicators • Tend to change after real GDP

7. Unemployment • Unemployment = • # unemployed / labor force • Labor force = noninstitutionalized residents 16+ years of age who are: • Working, or • Actively seeking work • Labor force (and unemployment statistic) does not include those who are discouraged and have stopped looking for work

8. Unemployment rate • may understate the cost of unemployment to society due to: • underemployment, and • discouraged workers. • May overstate the cost of unemployment due to: • the underground economy

9. Types of unemployment • Seasonal – recurring seasonal pattern of unemployment (voluntary unemployment) • Frictional – short-term movement between jobs and during first job search (search unemployment) (voluntary unemployment) • Structural – due to technological change and/or changing patterns of labor demand (involuntary) • Cyclical – due to business cycle (involuntary)

10. Costs of unemployment • GDP gap = potential real GDP – actual real GDP • Potential real GDP = GDP that occurs if unemployment rate = natural rate (no cyclical unemployment) • Social and psychological costs

11. Unemployment statistics • Unemployment rate is usually higher for women • Teenagers have the highest unemployment rates • Nonwhites have higher unemployment rates

12. Inflation • Sustained increase in the average level of prices

13. Costs of inflation • Arbitrary redistribution of income and wealth • Higher transaction costs • Creditors and debtors are affected by unexpected changes in the inflation rate • Real interest rate = nominal interest rate minus inflation rate • Unexpected inflation harms creditors and benefits debtors

14. Types of inflation • Demand-pull inflation • Cost-push inflation • Structural inflation (wage-price spiral)

15. Hyperinflation • Extremely high rate of inflation

16. Inflation • The inflation rate is measured by changes in the Consumer Price Index (CPI). • The CPI is an index that measures the quarterly changes in the prices of a selected weighted basket of consumer goods and services. • The basket includes a wide range of goods and services purchased by households, such as food, alcohol and tobacco, clothing and footwear, housing, health, transport, communication, recreation and education. • Inflation Rate = (CI-PI)/PI * 100

17. What are the major causes of inflation in the Australian economy? • Outline two factors that contributed to the reduction in the inflation rate in the Australian economy during the 1990s. • Why is the underlying rate of inflation seen by economists as a better measure of inflation than the headline inflation rate? • Describe two economic factors that could determine the future level of inflation in the economy.