Economic Instability
Chapter 13
Is the economy getting better or
worse?
Business Cycle
• . The term business cycle refers to the recurrent ups
and downs in the level of economic activity, which
extend over several years.
•
•
√ Individual business cycles may vary greatly in
duration and intensity.
√ All display a set of phases.
THE BUSINESS CYCLE
Phases of the Business Cycle
RECESSION
TROUGH
RECOVERY
Level of business activity
PEAK
Time
Level of business activity
PEAK
Time
√ Peak or prosperity phase:
 Real output in the economy is at a high level
 Unemployment is low
 Domestic output may be at its capacity
 Inflation may be high.
Level of business activity
RECESSION
Time
√ Contraction/recession phase ((> 2 quarters of declining GDP):
 Real output is decreasing
 Unemployment rate is rising.
As contraction continues, inflation pressure fades.
 If the recession is prolonged, price may decline (deflation)
The government determinant for a recession is two
consecutive quarters of declining output.
Level of business activity
TROUGH
Time
√ Trough or depression phase:
 Lowest point of real GDP
 Output and unemployment “bottom out”
 This phase may be short-lived or prolonged
 There is no precise decline in output at which a
serious recession becomes a depression.
Level of business activity
RECOVERY
Time
√ Expansionary (> 2 quarters of ↑ rGDP):
 Real output in the economy is increasing
 Unemployment rate is declining
 The upswing part of the cycle.
Causes of the Business Cycle
• External shocks- such as increases in oil
prices and international conflicts, can cause
business cycles.
• Changes in investment spending-when the
economy is expanding, businesses expect
future sales to be high, so companies build
new plants or buy new equipment to replace
old equipment..
• Changes in monetary policy- tight money
policy of the Federal Reserve System slows
down the economy
Causes of the Business Cycle
(cont)
• Fiscal-policy- change in either taxation or
spending can affect decisions in the
economy.
• Speculation and “bubbles”-expectations
about the future
Business Cycles in the United
States
• Black Tuesday,” October 29th, 1929, marked the
beginning of the Great Depression.
– Between 1929 and 1933, real GDP declined nearly
50%.
– Unemployment rose nearly 800%.
– Average wage plunged from 55 cents/hour to 5 cents
– one-quarter of all banks failed.
• Depression scrip used because official paper
currency was in short supply
Causes of the Great
Depression
– Enormous gap in the distribution of income
– Easy credit
– Global economic conditions
– International trade
Recovery and Legislative
Reform
• Laws passed and government agencies were
established to prevent another depression.
– Social Security Act of 1935
– Minimum Wage
– Unemployment programs
• Securities and Exchange Commission
• Federal Deposit Insurance Corporation
• After World War II, business cycles had
shorter recessions and longer periods of
expansion.
Forecasting Business Cycles
• Economists use statistics and models to
predict business cycles.
• The Statistical series Is known as the Leading
economic indicator (LEI) monthly statistical
series that uses a combination of ten individual
indicators to forecast changes in real GDP
• Others use a tool called econometric modeling a mathematical model that uses algebraic
equations to describe how the economy
behaves.
How is Inflation Tracked?
• By comparing prices from one
year to the next
• These numbers are then
reported through the CPI
• CPI = Consumer Price Index
Consumer Price Index (CPI)
• The Labor Department surveyed the
purchasing patterns of consumers to
determine a group of about 400 items that
buyers typically use.
• These 400 items makes up a “Market
Basket”
• Each month surveyors check on the
prices of these items in cities across
America.
• Results are used to compute what the
market basket costs compared to what it
cost in a base period.
CAUSES OF INFLATION
• Demand-pull:
– All sectors of the economy try to buy
more than the economy can produce
– Causes shortages
– Excess demand for goods and services
causes businesses to raise prices; this
can result when there is an increase in the
money supply also
• Wage-price spiral-does not blame any
particular group or event for rising prices
CAUSES OF INFLATION(cont)
• Cost-push -labor negotiations as well
as an increase in the cost of inputs
causes businesses to raise prices
• Excessive monetary growth-occurs
when the money supply grows faster
than real GDP
Consequences of Inflation (cont.)
– Reduced purchasing power
– Distorted spending patterns
• Encourages speculation
• Distorted distribution of income
• Creditors are hurt more than debtors
generally.
Measuring Unemployment
• The Census Bureau surveys 50,000
homes each month.
• Each household must answer a series of
questions.
– Broken down into:
•
•
•
•
•
Non-institutional Population
Not in Labor Force
Labor Force
Employed
Unemployed
What is an Unemployed Person?
• People available for work who:
–Made a specific effort to find a job
during the past month
–Worked less than 1 hour for pay
or profit
–Worked in a family business
without pay for less than 15 hours
a week
Unemployment Rate
• The number of unemployed individuals
divided by the total number of persons in
the civilian labor force( sum of all persons
aged 16 and above who are either employed or
actively seeking employment)
• Unemployment rate rises during
recessions and comes down slowly
afterwards
• Affected by downturns in real GDP – cost
of a recession.
People NOT Counted
• People who have stopped looking
for work. “Dropouts”
• People who have no interest in
finding a job.
– Retired persons
– Housewives
– Students
– Disabled persons
Kinds of Unemployment
• Frictional
• Structural
• Cyclical
• Seasonal
• Technological
Frictional
• Workers who are between jobs
• Will always be present.
• Examples:
1. People who get “fired” or “quit” to look for a
better one.
• 2. “Graduates” from high school or college
who are looking for a job.
Structural
• Occurs when a fundamental change
in the operations of the economy
reduces a demand for workers & their
skills
• Consumer tastes change and
therefore causes certain goods to no
longer be demanded.
Cyclical
• Related to swings in the business
cycle
• Recession: people don’t buy as
many durable goods (cars, homes)
– May result in lay-offs
– People usually get their jobs back when
the economy improves
• These jobs do come back.”
Seasonal
• Results from changes in seasons and demand
for certain products
• Ex: construction
• Difference between seasonal and cyclical:
– Cyclical follows the business cycle. Can last
3-5 years.
– Seasonal can take place every year despite the
health of the economy
Technological
• Workers are replaced because
machines can do the work
more efficiently
Costs of Instability
• Recession, inflation, and unemployment hinder
economic growth and have human costs.
– Opportunity cost like the GDP gap
– Misery index or discomfort index (unofficial
statistic that is the sum of monthly inflation and the
unemployment rate.
– Uncertainty leads to fewer consumer purchases
– Political instability
– Community and domestic matters- crime, poverty
and family instability
“Should I make a big purchase?”
• Only if you know that you won’t lose
your job in a contraction. So, buy your
house during an expansion.
HOWEVER,
• When the economy starts to slow down
(contraction), interest rates will
decrease. Wait to buy a house until the
rates drop to a low point, if you are
sure you won’t lose your job.
“Don’t quit that job!”
• If the economy is going into a
contraction, jobs will become more
scarce. If you quit, you may not find
another job!
• But, if the economy is in a period of
expansion, jobs are readily available. It
may be a good time to switch careers.