Business Cycles
• Business Cycle: the pattern of real GDP
rising and falling: expansions and
contractions.
• Recession (Contraction): two or more
successive quarters of falling real GDP.
• Depression: a severe, prolonged economic
contraction.
– Prior to the 1930s, economic downturns were
called “crises.” The term depression was
introduced so people wouldn’t be scared.
– The Great Depression gave “depression” a bad
name. We now speak of “recessions.”
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The Great Depression
Year
U.S. Unemployment Rate
1929
3.2%
1930
8.7%
1931
15.9%
1932
23.6%
1933
24.9%


1939
17.2%
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U.S. Real GDP
(Recessions Shaded)
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Annual Growth: Percent Changes in
Real GDP
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The Business Cycle: Some Terminology
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Indicators of Economic Activity
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Unemployment
The unemployment rate is the percentage
of the labor force that is not working.
Rate of
Unemployment
=
number unemployed
number in the Labor Force
The labor force is:
• All U.S. residents
• Over the age of 16
• Who are not institutionalized
• Who are looking for work
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Understating Unemployment
• Discouraged Workers: workers who
have looked for work in the past year,
but have stopped because they believe
no one will offer them a job.
• Underemployment: employment of
workers in jobs that do not fully utilize
their productive skills.
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Flavors of Unemployment




Seasonal Unemployment
 Results from recurring changes in hiring needs
of certain industries on a seasonal basis.
Frictional Unemployment: searching for jobs
 Results from short-term movement of workers
between jobs and job search by those entering
the labor force.
 Improved labor market information can reduce
frictional unemployment
Structural Unemployment
 Reflects imperfect match between employee
skills and requirements of available jobs.
 Results from technological change and other
changes in the structure of the economy.
Cyclical Unemployment
 Results from business cycle fluctuations.
Business activity down cyclical unempl’mt up.
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Unemployment: Comparative Rates
• In most years, the unemployment rate for
women is higher than for men.
• Teenagers have the highest unemployment
rate.
• Whites have lower unemployment rates than
nonwhites.
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Unemployment and Its Costs
• “Natural” Rate of Unemployment
A normal rate, considering both frictional and
structural factors.
– Also called the NAIRU (Nonaccelerating Inflation
Rate of Unemployment) -- ~5% for US economy
The “natural” rate can change
• Potential Real GDP
The level of output when nonlabor resources
are fully utilized and unemployment is at its
natural rate.
• GDP gap = potential real GDP – actual GDP
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•
Flavors of Price Inflation
Demand-pull inflation:
– caused by increases in aggregate
demand outpacing increases in
aggregate supply.
• Cost-push inflation:
– increased production costs cause firms
to raise prices.
• Wage-push inflation
• Energy costs and inflation
•
Hyperinflation:
– extremely high rate of inflation.
• Printing money as last resort
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Rates of Inflation for Selected Countries,
1990-2001
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Recent Hyperinflations
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Interest Rates
• Nominal Interest Rate (i): the
observed interest rate in the
market.
• Real Interest Rate (r): nominal rate
adjusted for inflation ().
• r=i-
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The Real Interest Rate on U.S. Treasury
Bills (Short-Term Securities of US Gov’t)
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