Lecture Outlines - Week 6

The Business Cycle (Ch. 10 Schiller)

Learning Objectives:

• What is macroeconomics?
• Understand what is meant by the phrase "business cycle"
• Understand some of the factors that underlie business cycles
• Understand two important economic impacts of the business cycle: unemployment and inflation

What is macroeconomics about?

Macroeconomics is the study of economic aggregates, of the economy as a whole.

What is the business cycle?

The business cycle is made up of alternating periods of economic expansion and contraction.

The business cycle has enormous impacts on the well-being of people, and consequently on macroeconomics is primarily concerned with explaining and predicting the business cycle.

What is a recession?

A period of time (at least two consecutive quarters) during which real GDP is declining. In other words, during recessions, the inflation-adjusted value of US economic output declines. Since people get their incomes from the production of economic output, either directly or indirectly, then during recessions incomes fall. Moreover, demand for goods and services falls during recessions, which implies that fewer workers are needed by firms. Thus unemployment tends to rise. Finally, prices may actually fall during a recession (deflation) as firms compete for the diminished consumer demand.

The US has been in one of the longest periods of continuously rising economic growth in its peacetime history, since late December 1991. During growth periods unemployment tends to be low, and per-capita real incomes tend to rise (though not necessarily all incomes rise...). If the rate of growth of the economy becomes too high, the competition among firms for good workers and for inputs can begin to drive up input prices, which can initiate higher inflation.

Discuss Figure 10.2 in Schiller...

Extreme fluctuations in the business cycle:

1. Extreme Growth Spurts: Example: World War II in the US, during which time the economy grew by nearly 20 percent per year. Countries in the early stages of industrialization often times have growth rates that exceed 7 or 8 percent per year, such as China. Most high-income industrialized countries have average growth rates that rarely exceed 3 percent.

 

2. Extreme Recessions: During the Great Depression of the 1930s the US economy shrunk by nearly 1/2. Likewise the Russian economy during the post-Soviet transition has shrunk by somewhat less than 1/2. The "Asian Contagion" spurred by a financial crisis led to the economy of Indonesia shrinking by almost 17 percent during the last year. Likewise the Russian economy shrunk by almost 10 percent, the Malaysian economy shrunk by almost 9 percent, and the South Korean economy shrunk by almost 7 percent -- all in one year (1998).

We have already learned in this class how to calculate inflation. Now lets learn how to measure unemployment.

We begin with the overall population, and segregate from that the labor force -- all persons over age 16 who are either working for pay or are actively seeking employment. The labor force is about 1/2 of the overall population.

The unemployment rate is found by dividing the number of people in the labor force who are unemployed and actively seeking work by the total number of people in the labor force.

As shown in figure 10.3 in Schiller, "homemakers," students, retirees, and sick or disabled people are not a part of the labor force. Also excluded from the labor force are "discouraged workers" who are no longer actively seeking paying work, and thus are not technically unemployed.

During the Great Depression, the unemployment rate rose to approximately 25 percent. Since World War II, the unemployment rate has typically varied from around 5 percent during growth periods, to 7 to 9 percent during recessions.

A key goal of the President of the US and the Federal Reserve and US Congress is to get as close as possible to "Full Employment" without triggering accelerating inflation.

Full employment does not imply a zero unemployment rate, since some unemployment is inevitable.

• Seasonal Unemployment: For example, some jobs end after summer, or when the rains begin, or after a crop is harvested, and so people are at least temporarily unemployed as they seek alternative work.
• Frictional Unemployment: It takes time for people and employers to match up in the job market, and this natural period of unemployment during the job-seeking period is called frictional unemployment.
• Structural Unemployment: Technological change makes certain jobs, skills, and even whole industries obsolete.
• Cyclical Unemployment: As the macroeconomy slows down or enters a recession during the business cycle, some jobs are lost as businesses reduce their output or even shut down.

Economists in the US believe that after we take into account seasonal, frictional, and structural unemployment, the best "full employment" figure we can hope for is somewhere between 4 and 5.5 percent. We are currently at approximately 4.5 percent unemployment in the US, and have been so for a number of years. This is the lowest unemployment rate we have seen in the US in the last 40 years.

Inflation -- we've already covered this material, but be sure to read it over carefully.

Who benefits when inflation is larger than expected? Who suffers?

Inflation redistributes wealth when it is unanticipated.

• Price effects: some prices rise faster than others, therefore real incomes for some go up and for others go down.
• Income effects:
• Wealth effects: some assets gain more in value than others -- stock market inflation, housing inflation, etc.