Consequences of Business Fluctuations

1. Consequences of Business Fluctuations Chapter 14

2. Discussion Topics • Fluctuations in business activity • Consequences of business fluctuations • Macroeconomic policy options

3. Nature of Business Fluctuations • Expansionary phase • Peak of business cycle • Recessionary phase • Trough of business cycle Page 338

4. Four Phases of a Business Cycle Length of cycles varies over time… Page 338

5. Indicators of Economic Activity • Coincident indicators: current production, current disposable income, current sales • Lagging indicators: business inventories, duration of employment, average interest rate • Leading indicators: new orders for goods, new building permits, new investment in plant and equipment, changes in the money supply • Forecasting models: mathematical methods of forecasting future trends in the economy Pages 339-340

6. Actual activity several months later… Indicator index A classical example of a leading indicator Page 340

7. Two Consequences of Business Fluctuations • Fluctuations in the civilian unemployment rate and implications for policy • Fluctuations in the rate of inflation and implications for policy Pages 354-364

8. Unemployment Rate

9. Calculation of Civilian Unemployment Rate Annual rate Number of civilians unemployed Size of total civilian labor force = where the size of the total civilian labor force is determined by subtracting those not seeking jobs (homemakers, students, etc.) from the total non- institutional population (those not in prison) over 16 years of age as well as those who are in military service. Pages 341

10. An Example Assume the following values: Total labor force1 143.8 million Members of armed services 1.7 million Employed persons 136.2 million Annual rate 143.8 – 1.7 – 136.2 143.8 – 1.7 = = .0415 or 4.15 percent 1 The total labor force equals total population minus those not seeking employment over age 16 and those in institutions. Pages 341

11. Forms of Unemployment • Frictional: changing jobs and currently unemployed • Cyclical: associated with business cycles • Seasonal: associated with seasonal business activity • Structural: associated with technological change Pages 341

12. Unemployment rate during the great depression was 25% Full employment barometer? Page 342

13. Inflation Rate

14. What is Inflation? • Sustained rise in the general price level • Not a change in the price of a single commodity • Core rate of inflation excludes fuel and food price increases • Deflation (prices falling) vs. disinflation (prices increasing at a slower rate) Pages 342 – 343

15. Measuring the CPI The consumer price index is a weighted average of the prices consumers pay for goods and services. It is measured by: CPI = Or: CPI = WFB(PFB) + WH(PH) + … + WOTHER(POTHER) = 16.302(PFB) + 39.636(PH) + … + 10.203(POTHER) Cost of market basket in current year Cost of market basket in base year × 100 See Table 14.3 on page 344 Page 342

16. Rate of Inflation The rate of inflation can be measured by the percent change in the CPI, or: Inflation rate = current CPI – previous CPI previous CPI If the CPI was 166.6 in 1999 and 172.3 in 2000, the annual rate of inflation in 2000 would be: Inflation rate = (172.3 – 166.6) ÷ 166.6 = .0342 or 3.42% Pages 344

17. Brought about a major monetary policy action described in Chapter 13 Inflation thought to be “under control” in this range Page 345

18. When describing growth in the economy on the nightly newscast, the newscaster will refer to the growth in real GDP after adjustments for inflation. In the above example, real GDP grew over the 1992-1999 period, but not at the rate implied by comparisons in nominal terms. Page 347

19. Some examples of annual rates of inflation around the world vs. U.S. Page 346

20. Trade off between Inflation and Unemployment

21. Phillips curve named after British economist A. W. Phillips… Page 349

22. Policies that reduce unemployment may increase inflation in the short run, and vice versa… Page 349

23. Demand oriented policies that shift the aggregate demand curve from AD2 to AD3 “pull up” the general price level from P0 to P1. This small increase in inflation may make sense since output increased from Y2 to Y3, which would lower unemployment. Page 348

24. Demand oriented policies to maximize output at the economy’s potential or YPOT may bring about a substantial increase in the general price level (and hence rate of inflation) for a relatively small gain in output and employment. Page 348

25. Both demand and supply oriented policies stimulate aggregate output. Page 351

26. But demand expansion policy “pulls up” the general price level…. Page 351

27. …while supply oriented policies that enhance productivity reduce the general price level. Page 351

28. In reality, both forms of policy are typically carried out at the same time. Page 351

29. Summary • A business cycle has four phases: peak, recession, trough and expansion • The two major consequences of business fluctuations are unemploy-ment and inflation • Know how to calculate the civilian unemployment rate and the rate of inflation facing consumers • Understand the nature of the index of leading economic indicators • Understand the concept graphing of demand pull inflation • Understand the Phillips curve and demand and supply policy impacts

30. Chapter 15 focuses on how macroeconomic policy affects agriculture….