Chapter 10
Unemployment,
Inflation, and the
Business Cycle
Learning Objectives
• List and explain the four types of
unemployment.
• Outline the steps involved in deriving the
measured rate of unemployment.
• Contrast anticipated with unanticipated
inflation and relate those concepts to the
nominal rate of interest.
• List the three potential causes of business
fluctuations.
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Macroeconomics
• Macroeconomics is the study of
economy-wide phenomena such as
unemployment, inflation, interest rates,
and government stabilization policies.
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10-3
Unemployment
• Unemployment is the inability of those
who are in the labor force to find a job.
• The labor force consists of those 16
years of age and older who are either
employed or are actively looking for
employment.
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10-4
Types of Unemployment
• No matter how one examines
unemployment, it costs the economy.
• There are several reasons why
individuals become unemployed.
• Economists categorize unemployment
into four basic types: frictional,
structural, cyclical, and seasonal.
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10-5
Frictional Unemployment
• We live in a dynamic economy. Some
people are fired or laid off and have to
look for a job. Others just want to
change occupations.
• All of the ins and outs in the labor
market result in frictional
unemployment, defined as the
continuous flow of individuals from job
to job and in and out of employment.
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Structural Unemployment
• Structural changes in our economy
cause some workers to become
unemployed permanently or for very
long periods, because they cannot find
jobs that use their particular skills.
• This is called structural
unemployment.
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Cyclical Unemployment
• Cyclical unemployment happens as
the business fluctuations cycle through
good times and bad times. When overall
economic activity slows down, there will
be cyclical unemployment.
• One way to lessen cyclical
unemployment is to reduce the intensity,
duration, and frequency of the ups and
downs of nationwide business activity.
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10-8
Seasonal Unemployment
• Seasonal unemployment varies with
seasons of the year in which the
demand for particular jobs rises and
falls.
• The official unemployment numbers
released by the Bureau of Labor
Statistics are typically “seasonally
adjusted” to remove the effects of
variations in seasonal unemployment.
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10-9
Measuring the Unemployment
Rate
• To determine the rate of unemployment, the
government first adds up the employed and
the unemployed, to obtain the measured
labor force. Then it divides the unemployed
by that total.
• For example, if the number of unemployed is
10 million and the number of employed is 140
million, then the labor force is 150 million, and
the measured rate of unemployment is 0.067
or 6.7 percent.
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10-10
The Discouraged Worker
Phenomenon
• Critics of the published unemployment rate
believe that it fails to reflect the true numbers
of discouraged workers—who have
dropped out of the labor force and are no
longer looking for a job because they believe
that the job market has little to offer them—
and hidden unemployed—those working
part time because they are unable to find full
time jobs.
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Labor Force Participation
• The labor force participation rate is
defined as the proportion (percentage)
of working-age individuals who are
employed or seeking employment.
• Over the last 60 years, the labor force
participation rate of females has risen
and the labor force participation rate of
males has fallen.
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10-12
Inflation
• We define inflation as a sustained rise
in the general price level of goods and
services.
• The value of a dollar does not stay
constant when there is inflation. The
value of money is usually referred to in
terms of its purchasing power.
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Purchasing Power
• A dollar’s purchasing power is the
amount of real goods and services that
it can buy. Consequently, another way
of defining inflation is as a decline in the
purchasing power of money over time.
• The faster the rate of inflation, the
greater the rate of decline in the
purchasing power of money.
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10-14
How We Measure the Rate of
Inflation
• Government statisticians use price
indexes to measure inflation.
• Two of these price indexes are:
– The CPI or Consumer Price Index, and
– The GDP Deflator.
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Computing a Price Index
• A price index is defined as the cost of a
market basket of goods and services today,
expressed as a percentage of the cost of that
identical market basket of goods and services
in some starting year, known as the base
year.
Cost today of market basket
Price =
 100
Cost in base year of market basket
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The Consumer Price Index (CPI)
• The CPI attempts to measure changes
only in the level of prices of all goods
and services purchased by all urban
consumers.
• The Bureau of Labor Statistics (BLS)
has the task of identifying a market
basket of goods and services of the
typical consumer. Today, the BLS uses
as its base the period 1982–1984.
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Flaws in Measuring the CPI
• The BLS has been unable to account
for the way consumers substitute less
expensive items for higher-priced items.
• Until recently, the BLS has been unable
to consider quality changes as they
occur.
• The CPI usually ignores successful
new products until long after they are
introduced.
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The GDP Deflator
• The GDP deflator measures the
changes in prices of all new goods and
services produced in the economy.
• The basket on which it is based is
allowed to change with people’s
consumption and businesses’
investment patterns.
• Usually, the GDP deflator is used to
create measures of real GDP.
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10-19
Anticipated versus Unanticipated
Inflation
• Anticipated inflation is the rate of
inflation that is generally expected by
individuals in the economy.
• Unanticipated inflation is inflation that
comes as a surprise to individuals in the
economy.
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Anticipated versus Unanticipated
Inflation (cont.)
• Some of the issues caused by inflation
arise when it is unanticipated. In
contrast, when inflation is anticipated,
many people are able to protect
themselves from disadvantageous
contracts, for example.
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How Inflation Hurts
• In most situations, unanticipated
inflation benefits borrowers because the
nominal interest rate they are being
charged does not fully compensate for
the inflation that actually occurred.
• Whenever inflation rates are
underestimated for the life of a loan,
creditors lose and debtors gain.
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Protecting Against Inflation
• Banks attempt to protect themselves
against inflation by raising nominal
interest rates to reflect anticipated
inflation. Adjustable-rate mortgages in
fact do just that.
• Workers can protect themselves
through cost-of-living adjustments
(COLAs) in their labor contracts.
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Inflation and Interest Rates
• The nominal rate of interest—market
rate of interest—is equal to the real rate
of interest plus an inflationary premium
to take account of anticipated inflation.
• The inflationary premium covers the
expected fall in the purchasing power of
the dollars repaid by borrowers.
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Business Fluctuations and
Business Cycles
• Nationwide economic activity does not just go
up at a steady pace every year.
• Business fluctuations used to be called
business cycles, but that term no longer
seems appropriate because cycle implies
regular or automatic recurrence, and we
normally don’t observe automatic recurrent
fluctuations in general business and
economic activity.
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Expansions and Contractions
• The ups and downs in economy-wide
economic activity are sometimes called
business fluctuations.
• When business fluctuations are positive, they
are called expansions—speedups in the
pace of national economic activity. The
opposite of an expansion is a contraction.
The top of an expansion is usually called its
peak, and the bottom of a contraction is
usually called its trough.
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Recessions and Depressions
• If the contractionary phase of business
fluctuations becomes severe enough, we call
it a recession. An extremely severe
recession is called a depression.
• The Great Depression lasted throughout
most of the 1930s. By 1932, 13 million
people were unemployed. By 1933, actual
output was at least 35 percent below the
nation’s productive capacity.
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A Typical Business Cycle
• In Figure 10-4, next, you see a typical
business cycle. Business fluctuations occur
around a growth trend in overall business
activity. A straight upward-sloping line shows
this growth trend.
• Starting out at a peak, the economy goes into
a contraction. Then an expansion, moves up
to its peak, and the sequence starts over
again. That is where the term cycle comes
from in business cycle.
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Figure 10-4: The Typical Course of
Business Fluctuations
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Key Terms and Concepts
• anticipated inflation
• business fluctuations
• consumer price index
• cyclical unemployment
• discouraged workers
• expansions
• frictional unemployment
• inflation
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• labor force participation
rate
• nominal rate of interest
• purchasing power
• real rate of interest
• recession
• seasonal
unemployment
• structural
unemployment
• unanticipated inflation
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