1. Business
Cycles,
Unemployment,
and Inflation
Chapter 26
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 26-2
Chapter Objectives
• The business cycle and its
phases
• Measuring unemployment and
inflation
• The types and impacts of
unemployment and inflation

3. 26-3
The Business Cycle
LevelofRealOutput
Time
Peak
Peak
Peak
Recession
Recession
Expansion
Expansion
Trough
Trough
Growth
Trend
Durable and nondurable industries
affected differently

4. 26-4
Causes of Business Cycles
• Shocks and price stickiness
• Supply and productivity shocks
• Monetary shocks
• Financial bursts and bubbles
• Unexpected political events
• Common link
–Unexpected changes in spending

5. 26-5
Unemployment
• Twin problems of the business cycle
–Unemployment
–Inflation
• Measurement of unemployment
–Who’s in the labor force
• Problems with the unemployment rate
–Part-time employment
–Discouraged workers
Unemployment Rate
Unemployed
Labor Force
= x 100

6. 26-6
Unemployment
Under 16
And/or
Institutionalized
(71.8 Million)
2007 data
Total
Population
(303.6 Million)
Not in
Labor Force
(78.7 Million)
Employed
(146.0 Million)
Labor
Force
(153.1 Million)
Unemployed
(7.1 Million) Source: Bureau of Labor Statistics

7. 26-7
Unemployment
• Types of unemployment
–Frictional
–Structural
–Cyclical
• Full employment defined
–No cyclical unemployment
• Natural rate of unemployment
• Full employment rate

8. 26-8
Unemployment
• Natural rate of unemployment
–1980’s 6%
–Today 4-5%
• Aging labor force
• Temp agencies and the internet
• New welfare laws and work
requirements
• Prison population has doubled

9. 26-9
Cost of Unemployment
• Foregone output
• Potential output
• GDP gap
–(Actual output – potential output)
• Okun’s Law
–Each 1% above NRU creates
negative 2% output gap

10. 26-10
Unemployment
5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
The GDP Gap
12,000
11,000
10,000
9,000
8,000
7,000
6,000
5,000
GDP(billionsof1996dollars)
0
2
4
6
8
10
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 20051985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
The Unemployment Rate
10
8
6
4
2
0
Unemployment
(percentofcivilian
Laborforce)
Source: Congressional Budget Office & Bureau of Economic Analysis
GDP gap
(positive)
GDP gap
(negative)
Potential GDP
Actual GDP

11. 26-11
Unemployment
• Unequal burdens
–Occupation
–Age
–Race and ethnicity
–Gender
–Education
–Duration
• Noneconomic costs

12. 26-12
Unemployment
Source: Bureau of Labor Statistics
Unemployment Rates in Five Industrial
Nations,1995-2005

13. 26-13
Inflation
• Rise in general level of prices
• Consumer price index (CPI)
–Market basket
–300 goods and services
–Typical urban consumer
–2 year updates
CPI
Price of the Most Recent Market
Basket in the Particular Year
Price estimate of the Market
Basket in 1982-1984
= x 100

14. 26-14
Inflation
Annual Inflation Rates in the United States,
1960-2007
0
5
10
15
1960 1970 1980 1990 2000
InflationRate(percent)
Source: Bureau of Labor Statistics

15. 26-15
Inflation
Source: Bureau of Labor Statistics
Inflation Rates in Five Industrial Nations,
1995-2005

16. 26-16
Inflation
• Types of Inflation
–Demand pull
–Cost-push
• Redistributive Effects
–Nominal and real income
–Growth in nominal income vs.
inflation rate
–Anticipated vs. unanticipated
inflation

17. 26-17
Inflation
• Who is hurt by inflation?
–Fixed-income receivers
–Savers
–Creditors
• Who is unaffected or not hurt by
inflation?
–Flexible-income receivers
• Cost-of-living adjustments (COLAs)
–Debtors

18. 26-18
Anticipated Inflation
–Nominal Interest Rate
–Real Interest Rate
–Inflation Premium
Nominal
Interest
Rate
Real
Interest
Rate
Inflation
Premium
11%
5%
6%
= +

19. 26-19
Other Inflation Issues
• Deflation
• Mixed effects
• Arbitrariness
• Cost-push inflation and real
output
• Demand-pull inflation and real
output
• Hyperinflation

20. 26-20
The Stock Market
• Stock prices and macro instability
• The market for stocks
• Volatile stock prices
• Wealth effect
• Investment effect
• Little impact on macroeconomy
• Stock market bubbles do have an
impact
• Index of Leading Indicators

21. 26-21
Key Terms
• business cycle
• peak
• recession
• trough
• expansion
• labor force
• unemployment rate
• discouraged workers
• frictional unemployment
• structural unemployment
• cyclical unemployment
• full-employment rate of
unemployment
• natural rate of unemployment
(NRU)
• potential output
• GDP gap
• Okun’s law
• inflation
• Consumer Price Index (CPI)
• demand-pull inflation
• cost-push inflation
• per-unit production costs
• nominal income
• real income
• anticipated inflation
• unanticipated inflation
• cost-of-living adjustments
(COLAs)
• real interest rate
• nominal interest rate
• deflation
• hyperinflation

22. 26-22
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Basic
Macroeconomic
Relationships