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Chapter Eight Economic Fluctuations, Unemployment, and Inflation

Chapter Eight Economic Fluctuations, Unemployment, and Inflation. Swings in the Economic Pendulum. Instability in the Growth of Real GDP. Annual Rate of Growth in Real GDP (long-run growth rate approximately 3%).

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Chapter Eight Economic Fluctuations, Unemployment, and Inflation

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  1. Chapter EightEconomic Fluctuations, Unemployment, and Inflation

  2. Swings in theEconomic Pendulum

  3. Instability in the Growth of Real GDP Annual Rate of Growth in Real GDP(long-run growth rate approximately 3%) • Although real GDP in the United States has grown at an average rate of approximately 3%, the growth has been characterized by economic ups-and-downs. Note:periods of recession are indicated with shading. 8% 6% 4% 2% 0% -2% -4% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: Economic Report of the President, various issues.

  4. Trend line Business peak Business peak Recessionary trough Expansion Contraction Recessionary trough The Hypothetical Business Cycle Real GDP • The four phases of the hypothetical business cycle are expansion, peak, contraction, and recessionary trough. • In contrast with the business cycle represented here, as the previous exhibit illustrated, real world business cycles are characterized by expansions and contractions of varying duration and magnitude. Time

  5. Economic Fluctuationsand the Labor Market

  6. Labor Market Classifications • Employed – a person (16 years old or over) who is: • working for pay at least one hour per week, • self employed, or, • working 15 hours or more each week without pay in a family-operated enterprise. • Unemployed – a person not currently employed who is: • actively seeking a job, or, • waiting to begin a job, or, • on layoff, waiting to return to a previous job.

  7. Labor Market Classifications • Civilian Labor force – civilians (16 years and older) who are: • either employed or unemployed. • Not in the labor force – persons (16 years and older) who are: • neither employed nor unemployed (like retirees, students, homemakers, or disabled persons).

  8. Employed + Unemployed Recall the Labor Force= # in the Labor Force Civilian population (16+) Labor Market Indicators • The non-institutional civilian adult population is grouped into two broad categories: • Persons not in the labor force, and, • persons in the labor force (this group includes both the employed and unemployed). Labor ForceParticipation Rate =

  9. 239.1 million Civilian population 153.4 million 16 and over 85.7 million Civilian Not in the 13.7 million labor force labor force • Household workers • Students • Retirees • Disabled Employed • Employees • Self-employed 139.7 million workers 153.4 Civilian labor force = Labor Force Participation Rate = = 239.1 Civilian population (16+) 139.7 = Number employed = Employment / Population Ratio = 239.1 Civilian population (16+) 13.7 Number unemployed = = Rate ofUnemployment = 153.4 Civilian labor force U.S. Population, Employment,and Unemployment: May 2009 Unemployed • New entrants • Reentrants • Lost last job • Quit last job • Laid off 64.2% 58.4% 9.0%

  10. Instability in the Growth of Real GDP Labor Force Participation Rate of Men and Women 87 % 83% • The labor force participation rate of women has been steadily increasing for several decades. • During the same period the rate of men has been falling. 78 % 76 % 71 % 59 % 58 % 46 % 38 % 33 % 1948 1960 1975 1990 2010 1948 1960 1975 1990 2010 –––––– Women –––––– ––––––– Men ––––––– Source: www.bls.gov.

  11. Composition of the Unemployed by Reason in 2011 Breakdown of Unemployed 2011 Job leavers New entrants • There are various reasons why persons were unemployed in 2011. • Half (49.9%) of the unemployed were dismissed from their previous jobs. • 34.2% of the unemployed were either new entrants or reentrants into the labor force. 6.8% 9.8% Reentrants 24.4% 49.9% Dismissedfrom Previous Job 9.1% On Layoff

  12. 20-24 16-19 25+ 16-19 20-24 25+ –– Women aged –– –– Men aged –– The Unemployment RateBy Age and Gender: May 2009 Civilian Rates of Unemployment – April 2011 28.1% • In 2011, the unemployment rate of men was 9.4%, compared to only 8.4% for women. • The male-female differential was even higher for younger workers. • Note: unemployment for persons under age 25 was much higher than for older workers. 21.8% 16.1% 13.7% 9.4% 9.0% 8.4% 7.9% 7.3% Allmen Allwomen Both Source: www.bls.gov.

  13. Three Types of Unemployment

  14. Three Types of Unemployment • Frictional Unemployment: • Caused by imperfect information. • Occurs because: • employers are not aware of all available workers and their qualifications, and, • available workers are not fully aware of all the jobs being offered by employers.

  15. Three Types of Unemployment • Structural Unemployment: • Reflects an imperfect match of employee skills to skill requirements of the available jobs. • Also reflects structural and demographic characteristics of the labor market. • Cyclical Unemployment: • Reflects business cycle conditions • When there is a general downturn in business activity, cyclical unemployment increases.

  16. Employment Fluctuations: The Historical Record

  17. Unemployment and Output AreLinked Over the Business Cycle • The unemployment rate from 1960-2011 is illustrated here. • As expected, unemployment rose rapidly during each of the eight recessions (the shaded years indicate periods of recession). • In contrast, after each recession ended, the unemployment rate began to decline as the economy moved into an expansionary phase of the business cycle. • Note that the actual rate of unemployment was greater than the natural rate during and immediately following each recession. Unemployment Rate (U.S) 1960 - 2011 12% 10% 8% 6% 4% 2% 0% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2011 Actual rate Natural rate of unemployment of unemployment Source : http://www.bls.gov/ and, Robert J. Gordon, Macroeconomics (Boston: Addison-Wesley, 2011).

  18. The Concept of Full Employment • Full Employment: Level of employment resulting when the rate of unemployment is normal, considering both frictional and structural factors. • Full employment is closely related to the concept of the natural rate of unemployment. • Natural Rate of Unemployment: Level of unemployment that reflects “job shopping” in an economy of imperfect information and dynamic change.

  19. The Concept of Full Employment • The natural rate of unemployment is: • neither a temporary high nor temporary low. • a rate that is both achievable and sustainable. • the level of unemployment accompanying an economy’s “maximum sustainable rate of output.” • Both demographic factors (e.g. young workers as a share of the labor force) and public policy (e.g. the level of unemployment benefits) influence the natural rate of unemployment. • Actual rate of unemployment generally rises above natural rate during a recession and falls below the natural rate during a boom.

  20. Unemployment Across Economies Average Unemployment Rate (2001-2010) • The unemployment rate in the United States, United Kingdom, and Japan has been persistently lower than the comparable rate of major continental European economies. • The high unemployment countries have higher unemployment benefits, less flexible collective bargaining, and more regulated labor markets. 8.9 % Germany 8.6 % France 7.9 % Italy 6.1 % U.S. 5.7 % U.K. 4.3 % Japan

  21. Actual and Potential GDP

  22. Actual and Potential GDP • Potential output: Maximum sustainable output level consistent with the economy’s resource base, given its institutional arrangements. • Actual and potential output will be equal when the economy is at full employment.

  23. 2001recession 1990-91recession PotentialGDP 1982recession 2008-10recession 1980recession 1960recession 1974-75recession 1970recession Actual & Potential GDP, 1960-2011 Real GDP(billions of 2000 $) 14,000 ActualGDP 12,000 • Here we illustrate both actual GDP and potential GDP. • Note the gap (shaded area) between actual and potential GDP during periods of recession. 10,000 8,000 6,000 4,000 2,000 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2011

  24. The Effects of Inflation

  25. Inflation • Inflation is a change in the general level of prices as measured by a price index such as the GDP deflator or the consumer price index. • Inflation is generally measured at an annual rate. • When inflation is high, the year-to-year changes in the inflation rate are nearly always highly variable, making them difficult to predict.

  26. 1973-1981 averageinflation rate = 9.2 % 1983-2011 averageinflation rate = 2.9 % 1956-1965 averageinflation rate = 1.6 % Actual & Potential GDP, 1960-2011 • Between 1956 and 1965, the general price level increased at an average annual rate of only 1.6%. • In contrast, the inflation rate averaged 9.2% from 1973 to 1981, reaching double-digits during several years. • Since 1982, the average rate of inflation has been lower (2.9% from 1983-2011) and more stable. 15% 10% 5% 0% -5% 1956 1960 1965 1970 1975 1985 1990 1995 2000 2005 2011 2011

  27. Unanticipated and Anticipated Inflation • There are two different kinds of inflation: • Unanticipated inflation: An increase in the price level that comes as a surprise, at least for most individuals. • Anticipated inflation: A widely expected change in the price level.

  28. Effects of Inflation • High & variable rates of inflation are harmful for several reasons: • Because unanticipated inflation alters the outcomes of long-term projects like the purchase of a machine or operation of a business, it will both increase the risks and retard the level of such productive activities. • Inflation distorts the information delivered by prices. • People will respond to high and variable rates of inflation by spending less time producing and more time trying to protect their wealth and income from the uncertainty created by inflation.

  29. What Causes Inflation? • Nearly all economists believe that rapid expansion in the money supply is the primary cause of inflation.

  30. End of Chapter 8

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