I. The Business Cycle
A. Essential Questions
1. What are the four stages?
2. Why does it happen?
B. Your Questions?
II. Full employment and the natural rate of unemployment
(NRU).
A. Unemployment rate when there are actually
enough jobs fore people that want them.
B. Currently about 4 – 5%.
C. Just takes time to match workers up with jobs.
Inflation
• General rise in the price level
• Inflation reduces the “purchasing power” of
•
money
Consumer Price Index (CPI)
CPI =
Inflation
Rate
LO2
=
Price of the Most Recent Market
Basket in the Particular Year
Price estimate of the Market
Basket in 1982-1984
This year’s CPI – Last year’s CPI
Last year’s CPI
x
100
x
100
26-2
Inflation
LO2
26-3
Types of Inflation
• Demand-Pull inflation
• Excess spending relative to output
• Central bank issues too much money
• Cost-Push inflation
• Due to a rise in per-unit input costs
• Supply shocks
LO3
26-4
Inflation
• Difficult to distinguish inflation types
• Without knowing what’s causing inflation, it
can be difficult for the Federal Reserve to
correct it.
LO3
26-5
Redistribution Effects of Inflation
• Nominal income
• Unadjusted for inflation
• Real income
• Nominal income adjusted for inflation
Real Income = Nominal Income
Price Index ÷ 100
Percentage
change in
real income
LO3

=
Percentage
change in
nominal income
Inflation rate
26-6
Unanticipated Inflation Hurts…
• People on a fixed-income
• Why?
• Savers
• Why?
• Creditors
• Why?
LO3
26-7
Who is unaffected (or even helped) by
unanticipated inflation?
• Flexible-income receivers
• COLAs
• Social Security recipients
• Union members
• Debtors
• Why?
LO3
26-8
Anticipated Inflation
• Real interest rate
• Rates adjusted for inflation
• Nominal interest rate
• Rates not adjusted for inflation
LO3
26-9
Anticipated Inflation
6%
11%
=
+
5%
Nominal
Interest
Rate
Inflation
Premium
Real
Interest
Rate
Real interest rate = Nominal interest rate – inflation rate.
LO3
26-10
Does Inflation Affect Output?
• Cost-Push inflation
• Reduces real output
• Leads to a decreased level of real income
• Demand-Pull inflation
• One view is that zero inflation is best
• Another view is that mild inflation is best
LO3
26-11
Costs of Inflation
• Page 607 of your text, it doesn’t use these
terms (but other AP sources do):
• Menu costs: the cost of actually changing prices.
•
•
LO3
Can be substantial if prices change rapidly.
Unit of Account costs: it’s difficult to know what
the real value of money is (prices, wages, interest
rates)
Shoe-leather costs: the cost of actually managing
your finances to avoid getting hurt by inflation.
26-12
Hyperinflation
•
•
•
•
•
•
LO3
Extraordinarily rapid inflation
Devastates an economy
Businesses don’t know what to charge
Consumers don’t know what to pay
Money becomes worthless
Caused by the central bank issuing too much
money.
26-13