ECO120 Macroeconomics
Rod Duncan
Lecture 6- The business cycle, or
why we do well in some years and
worse in others
Business cycle and the labour
market
•
We saw that GDP has two features over
time:
1. The trend for GDP is upwards over time
(growth); but
2. Growth is higher in some years than in
others (the “business cycle”).
• What’s the impact of the business cycle
on the labour market?
What do we care about?
• I want you to think behind the statistics and think
about what the statistics represent- what do they
mean?
• We saw that female labour force participation
has been rising over time. This means that
more women are engaged in the labour marketin paid jobs or looking for a job.
• Is a higher LFP rate better? Why?
• Why do we think a higher LFP is better for
women, but bad for others (say 12 year olds?)
What do we care about?
• Generally we don’t say “a higher LFP is a better
society”.
• Not everyone can, wishes to or would be wanted
to work. Should 80 year olds be forced to work if
their superannuation runs out?
• What we generally say is that “everyone who
wishes to should be able to find a job” and
“everyone who is capable and productive should
work”.
What do we care about?
• We don’t necessarily worry about everyone who
doesn’t have a job, just certain types of people
who don’t.
– Only those people of “working age” (15 to 69 years)
– Only those people not in school or university
– Only those people who are actually looking for jobs
• If someone satisfies those categories, do we call
them “unemployed”. What about all the other
people who don’t have jobs but we don’t call
“unemployed”?
Australia’s labour force
• Figure 21.2 (from the ABS in March 2006):
– Australia has a population of 20.51m.
– Of the 20.51m, 16.48m were of working age, and
4.03m were outside it.
– Of the 16.48m, 10.61m were in the labour force, and
5.87m outside it.
– Of the 10.61m, 10.07m were employed and 0.54m
were unemployed.
– Of the 10.07m, 7.19m had full-time jobs and 2.88m
had part-time jobs.
• Figure 21.2 from the McTaggart book.
Business cycle and the labour
market
• Economists think of
an Australia-wide
market for labour. In
this market, firms
demand the labour,
and households
supply the labour.
• We use the standard
market model from
micro.
Australian labour market
$
Supply of
labour
Wage
rate
Demand
for
labour
Hours
worked
Hours
Parts of the business cycle
Real
GDP
Actual GDP
Boom
Trend GDP or
Full-employment
GDP
Recession
1993
2006
Year
Recessions and the labour market
• In a recession firms
demand less labour than
in normal times. (We use
“0” to represent normal
times and “1” to be the
recession.)
• The labour demand curve
is to the left of its position
in normal times.
• Wages fall,
hours/employment falls,
and unemployment rises.
Australian labour market
$
S
W0
W1
D1
L1
L0
D0
Hours
Booms and the labour market
• In a boom (such as
today) firms demand
more labour than in
normal times. (We use
“0” to represent normal
times and “1” to be the
boom.)
• The labour demand curve
is to the right of its
position in normal times.
• Wages rise,
hours/employment rises,
and unemployment falls.
Australian labour market
$
S
W1
W0
D1
D0
L0 L1
Hours
Can we see this in the data?
• We should see that unemployment rises in
the recessions and drops in the booms.
• Figure 21.3 from the McTaggart book.
• Notice that unemployment is still high even
after the recession has ended because the
economy has to grow back to where it
would have been.
What data can we use?
Unemployment over the Business Cycle
12
10
Percent (%)
8
6
Unemployment
4
Change in GDP
2
0
1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995
-2
-4
Types of unemployment
• Economists like to differentiate four basic types
of unemployment based on the cause of the
unemployment:
– 1. Cyclical- unemployed because of the business
cycle- a recession
– 2. Frictional- unemployed because you are looking
for a better/different job
– 3. Structural- unemployed because the skills you
have are not needed now
– 4. Seasonal- unemployed because the industry you
work in doesn’t need you now (ie. fruit-picking)
Now which do we care about?
• Again you have to think behind the statistics to
consider what is being presented. Are all four
types of unemployment equally bad?
–
–
–
–
Cyclical
Frictional
Structural
Seasonal
• No. Structural is the most concerning of the
four. For the other three, the person will get reemployed in the future.
• But what future is there for a maker of saddles
after the car is introduced?
Exam question
B1. (a) When the economy is at full
employment, is the unemployment rate at
0 per cent? Why or why not?
(b) How would a more generous
unemployment benefits system affect the
full employment figure?
Prices
• We sense that prices for things in general have
gone up over time. You can think of lots of
things that were cheaper a long time ago.
• But not all prices go up all the time. The price of
petrol has been falling the last few weeks. DVD
players were $1,000 each when first introduced.
• And not all goods matter the same. Bananas
are just a tiny part of a household’s budget,
while housing is a large part. If the price of
housing rises, that’s more important than a rise
in banana prices.
Inflation
• Inflation is the rate of growth of the
average price level over time.
• But how do we arrive at an “average price
level”?
– The Consumer Price Index surveys
consumers and derives an average level of
prices based on the importance of goods for
consumers, ie. a change in the price of
housing matters a lot, but a change in the
price of Tim Tams does not.
Consumer Price Index
• We measure inflation (growth in prices) in the
same way we measured GDP growth.
• The CPI expresses average prices each year
relative to a reference year, which is a CPI of
100.
CPIt = (Average prices in year t)/(Average prices in
reference year) x 100
• Inflation can then be measured as the growth in
CPI from the year before:
– Inflationt = (CPIt – CPIt-1) / CPIt-1
2.0
0.0
-2.0
Sep-04
Sep-02
Sep-00
Sep-98
Sep-96
Sep-94
Sep-92
Sep-90
Sep-88
Sep-86
Sep-84
Sep-82
Sep-80
Sep-78
Sep-76
Sep-74
Sep-72
Sep-70
Inflation- growth in prices
Consumer Price Inflation
20.0
18.0
16.0
14.0
12.0
10.0
8.0
6.0
4.0
Inflation
Is there a simple link?
Consumer Price Inflation
20.0
18.0
16.0
14.0
12.0
10.0
8.0
6.0
4.0
Sep-04
Sep-02
Sep-00
Sep-98
Sep-96
Sep-94
Sep-92
Sep-90
Sep-88
Sep-86
Sep-84
Sep-82
Sep-80
Sep-78
Sep-76
Sep-74
Sep-72
Sep-70
2.0
0.0
-2.0
Inflation
Quarterly growth in Australian GDP
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Oct-1959
-0.5
-1.0
-1.5
Mar1965
Sep1970
Mar1976
Aug1981
Feb1987
Aug1992
Jan1998
Jul-2003
Practice question
B4. Eddie the hard-working financial planner is worried
that his wages are falling behind rising prices. Is he right?
Year
Eddie’s Nominal
Wage Rate
Price Level (2000
= 100)
2000
$22.00
110
2001
$22.00
112
2002
$22.50
115
2003
$23.00
119
Inflation (%)
Eddie’s Real Wage Rate (in
Year 2000 Prices)