Chapter 26

The business cycle shows changes over
time in the economy regarding growth and
recessions
The black arrow
indicates growth
over time

The length on contractions versus expansion
differ depending on the circumstances
◦ In other words, this chart will not tell us when the
current recession/depression will end
◦ It does tell us that it is likely to end 

At PEAK the economy is at or near full
employment and the economy is producing
maximum output
◦ Prices are likely to go up at this point

During a recession the economy total output,
income and employment shrink
◦ This generally lasts 6+mos. and if it lasts long enough it
becomes a depression—at this point prices will begin to
fall

During a TROUGH you experience output,
employment, etc. at their lowest levels
◦ This can be short-lived or long term and you do not
know you’ve experienced the trough until you have
come out of it

During RECOVERY you being to increase
output (thus employment increases)
◦ Prices may begin to rise again

The Great Depression is one of the most
severe fluctuations we have seen
◦ Our current economic troubles are insignificant in
comparison

Growth can be seen over the course of time
as depicted below:

What causes the cycle to change?
◦ New technology/better efficiency
◦ Better productivity
◦ SPENDING!!!

If we aren’t spending the companies are
producing, if companies aren’t producing
they are laying off, if the companies are
laying off, there are few people to
spend…this is a vicious cycle that is very
difficult to correct
Business
lays off
employees
Consumers
stops
spending
Business
stops
producing
Goods that are durable
(washers, cars, etc.) and capital
goods (construction, heavy
equipment, etc.) are hit first
and hardest by this cycle.
People are willing to make due
with what they have when the
economy starts slipping.

When we talk about employment and the labor
force, you need to know who counts and who
doesn’t
Counts
Doesn’t Count
People able and
willing who are 16
or older
<16 years old
Part time employees
(count as full time)

Institutionalized
Eligible but not seeking work
People who have given up because the believe they
won’t be able to find work
To get the unemployment rate
◦ UR = unemployed/labor force x 100
 [8,266,000/142,535,000] x 100 = 5.8%

There are four types of unemployment
◦ Frictional—people “between jobs”, temporary
layoffs, are expecting to be back to work quickly
 You still possess a valuable skill set
◦ Structural—when demand for your skill set
disappears
 Demand for farm labor decreases due to new
technology
◦ Cyclical—when demand for goods and services
decrease overall people get laid off due to the
business cycle
◦ Seasonal—jobs that can only be done during certain
seasons
 Santa Claus impersonators are laid off after Christmas

Because some unemployment is expected,
achieve 100% employment doesn’t happen
◦ Full employment occurs when there is no cyclical
unemployment and the number of job seekers
equals the number of job vacancies
◦ When this happens we are operating at the Natural
rate of unemployment-NRU (NOTE: this rate will
change…there is no consistent natural rate)
◦ Sometimes the economy can function below the
NRU—people who had not been in the labor force
join and skew the numbers
◦ The NRU is roughly 4-5% today…

What is the cost of unemployment?
◦ When we have people willing and able to produce
who don’t have jobs we are losing what they could
have produced
◦ This is called the GDP gap


Okun’s law states that for every 1% that the
actual unemployment exceeds the natural
rate, a 2% GDP gap is seen
If you have a positive GDP gap (you are
producing more than was thought possible)
you will run into the issue of inflation, thus
positive GDP cannot be sustained long term

Certain groups bear the burden of
unemployment more than others
◦ People with lesser skills are prone to longer terms
of structural unemployment
◦ Teenagers have higher unemployment than others
because of transportation issues, lack of skills, and
lack of maturity
◦ Minorities tend to have higher unemployment due
to educational attainment and discrimination
◦ Education plays a large role in employed versus
unemployed—less education, less likely to keep a
job

Unemployment is a social nightmare
◦ Leads to loss of self-respect, poor morale, family
disintegration, and political unrest
◦ Chronically unemployed have higher suicide rates,
heart attacks, strokes, mental illness, and homicide

We can compare unemployment to other
countries, but we have to bare in mind that
other countries may be in a different part of
the business cycle

Inflation is a general rise in prices
◦ Gas10 years ago was $0.99, now its about $3.60
◦ Inflation reduces your purchasing power
◦ One of the difficult parts of factoring for inflation is
that prices rise erratically and illogically

The main measure of inflation is the
Consumer Price Index (CPI)
◦ The government uses CPI to determine adjustments
in Social Security Benefits and tax brackets

They use a market basket made up of 300
typical consumer goods purchased by an
urban family in a month

When calculating CPI the Bureau of Labor
Statistics arbitrarily chooses 1982-1984 as
their baseline
◦ CPI = Price of the current market basket
Price of same market basket from 82-84

To find inflation
◦ Inflation Rate = current year-base year
base year
X 100
X 100