Business Cycle, Unemployment, And Inflation (1)

Business Cycle,

Unemployment, and

InflationGroup 5

Business Cycle

Business Cycle• Is defined as the diffusion of

fluctuation in aggregate economic activities all over the economy and not just on a single industry

• Is a characteristic of industrialized and developing capitalistic economies; economic fluctuations occurred long before modern economies

Phases of a Business Cycle

1.Peak / Prosperity- phase where business activities

are in their temporary maximum

• Economy is at full employment• Level of real output is at its full

capacity • There is the tendency for the price

level to rise


2.Recession

- phase that is characterized by a decline in total output, income, trade, and ultimately, employment.

• Unemployment is induced


3.Trough / Depression- the turning point of recession, or

when economic activity is at its lowest.

• Unemployment is so severe


4. Expansion- there is a recovery in the

economy wherein income, output, trade, interest rate, wage, and employment are rising

• Unemployment is low

Selected Classical Theories Explaining

Business CyclesEndogenous Theories. These theories explain the causes of business cycle within rather than outside the economy.

1.Real structural hypothesis (RSH)

- based on the explanation that aggressive investment plans, together with import dependence, attain a normal frontier in the weak (structural) ability to bring foreign exchange.


Business Cycles

2. Innovation theory- holds that innovation is a

fundamental cause of business cycle. Innovation is defined as enhancement of an existing production system that leads to new and better products.


Business Cycles

3. Self-generating theory- According to Wesley Mitchell, one

phase of the business cycle grows out of the preceding phase.

4. Underconsumption theory- Economists subscribing to the

underconsumption view attribute the deficiency in purchasing power.


Business Cycles

5. Monetary Theory- If inflation is threatening the

economy, the Central Bank (CB) should slow the rate of growth of money supply. But this action of the CB will adversely affect economic growth as recession will ensue. If inflation is no longer a threat, the CB can now accelerate money growth to promote economic recovery.


Business Cycles

Exogenous Theories. These theories explain the causes of business cycle as disturbances outside the economy.

Unemployment

UnemploymentUnemployed is officially defined as all those who are 15 years old as of their last birthday and during the reference period, and are reported as:1. Without work2. Currently available for work3. Seeking work

UnemploymentUnemployment rate is the proportion in percent of the total number of unemployed persons to the total persons in the labor force.

UnemployedUnemployment Rate = ---------------- x 100 Labor Force

UnemploymentLabor Force includes all persons 15 years old and over as of their last birthday who contribute to the production of goods and services in the country whether employed or unemployed.

Labor Force = Employed + Unemployed

UnemploymentLabor force participation rate is the percentage of the total number of persons in the labor force to the total population of 15 years old and over

Total number of persons in the LFLFPR = --------------------------------------x 100 Total Population 15 yrs old and over

Types of Unemployment

1. Unavoidable unemploymenta. Frictional unemployment

- it is a temporary unemployment associated with the changes in the economy.

b. Structural unemployment- occurs when the location

and qualifications of the labor force do not match the available jobs.


c. Cyclical unemploymentunemployment caused by

the recession phase of the business cycle. It is caused by inadequate total spending.

• As the overall demand for goods and services decreases, unemployment rises


2. Avoidable unemployment- refers to unemployment usually

associated with insufficient demand for workers caused by many factors such as poor performance of the economy.

Full EmploymentHow much is full employment?

Full employment is unavoidable unemployment or if cyclical unemployment is zero. The full employment rate of unemployment is referred to as the natural rate of unemployment.

Underemployment

UnderemploymentUnderemployed are persons who are already employed but they express the desire to have additional hours of work in their present job or in an additional job, or to have a new job with longer working hours.

Classifications of Underemployed

Persons1. Invisibly underemployed

- person who already worked 40 hours during the reference week but still want additional hours of work

2. Visibly underemployed- person who worked less than 40

hours during the reference week and wanted additional hours of work

Okun’s Law

Okun’s Law• Developed by Arthur Okun• He developed the relationship

between GDP and unemployment.

• He concluded that for every 2-3% movement in GDP, unemployment changes by 1% in both opposite directions

Inflation

Inflation• Inflation means there is a sustained

increase in the price level.

• In economics, inflation is a persistent

increase in the general price level of

goods and services in an economy

over a period of time

• A measure of the overall cost of the goods and services bought by a typical consumer.

• It is used to monitor changes in the cost of living over time

What is CPI?

Example

845

CPI = X 100

746

= 113.27

Kinds of Inflation 1. Headline inflation is calculated as

the change in the weighted overall average prices of all goods and services in the CPI basket.

2. Core inflation is an alternative measure of inflation that is calculated as the rate of change in the CPI that excludes the items that have transitory effects on the CPI.

Inflation Rate• Rate of increase in the average

prices of goods and services

typically purchased by consumer

Current CPI – Previous CPIInflation Rate = x100

Previous CPI

Imagine that we are calculating the inflation based on the price of bread between 2010 and 2012. The price of bread in 2012 is $3.67 and the price of bread in 2010 is $3.25. Given: $3.25 – Previous CPI Current CPI – Prev. CPI

$3.67 – Current CPI Inflation Rate =

Prev. CPI

$3.67 – $3.25

= x 100 The price of bread in 2012

$3.25 is 12.9% higher than it was

= 12. 9% in 2010.

Example:

• The following table shows data extracted from the source for 2011 and 2012:

NOVEMBER DECEMBER AVERAGE

2011 226.230 225.672 224.951

2012 229.601 230.221 229.911

CURRENT CPI – PREV. CPI PREV. CPI X 100

BET. NOV 2011 & DEC 2011 BET. NOV 2012 & DEC 2012

225.672 – 226.230 230.221 – 229.601 = X 100 = X 100

226. 230 229.601= -0.246% = 0.270%

If positive, there's an increase in price If negative, there's a decrease in price

EFFECTS OF INFLATION

• Inflation may reduce the real income or purchasing power of an individual or individuals.

• It results to redistributive effects, meaning, the effects of inflation are redistributed to different individuals.

1. Fixed Income earners2. Savers3. Creditors4. Holders of Securities

LOSERS

1. Debtors2. Fixed Asset Owners3. Priducers

GAINERS/WINNERS

DEFLATION vs INFLATION

• Deflation is a sustained decrease in the average price level.

• It is also a broadly based decline in the price level, not just a month or two but for a period of years.

DEFLATION

• Deflation is no good than inflation, because producers will lose and eventually shut down their businesses.

• It is still better to have an inflation rate of 2-3% for both consumers and producers.

DEFLATION vs INFLATION

HYPERINFLATION

• refers to a period of extremely high inflation reaching 100,000% and above.

STAGFLATION

• means that the economy is experiencing increasing inflation and unemployment at the same time.

Gabay, Remotin, Uy, and Anna D. Rizarro-Uy. Economics Concepts and Principles. Manila, 2012.

https://en.wikipedia.org/wiki/Consumer_price_index

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Business Cycle, Unemployment, And Inflation (1)