Economic Instability

Chapter 13 Vocab

1. Inflation2. Deflation3. Price index4. Consumer price

index5. Market basket6. Base year7. Creeping inflation8. Hyperinflation9. Stagflation10. Demand-pull

inflation

11. Cost-push inflation

12. Civilian labor force

13. Unemployed14. Unemployment

rate15. Frictional

unemployment16. Structural

unemployment

17. Outsourcing18. Technological

unemployment19. Cyclical

unemployment20. Seasonal

unemployment21. GDP gap22. Misery index/

Discomfort index

Business Cycles vs. Business Fluctuations

• Business Cycles: regular increases and decreases in real GDP

• Business Fluctuations: irregular increases and decreases in real GDP

They both can interrupt economic growth

First phase is recession, a period during which real GDP

(GDP measured in constant prices) declines for at least 2

quarters in a row or 6 consecutive months.

The recession begins when the economy reaches a peak,

the point where real GDP stops going up.

The recession ends when the economy reaches a trough,

the turnaround point where real GDP stops going down.

As soon as the declining real GDP

bottoms out, the economy moves into the second

phase, expansion – a period of recovery

until the economy reaches a new peak.

When it does, the current business cycle ends and a new one begins.

Trend line: growth path the economy

would follow if it were not interrupted by

alternating periods of recession and recovery

Causes of Changes in the Business Cycle1. Changes in investment spending: When the

economy is expanding, businesses expect future sales to be high, so they invest heavily in capital goods.

2. Innovation and Imitation: Come up with a new product or new way of doing things; copying what other companies may be doing

3. Monetary Policy Decisions: Change of interest rates causing incentives to invest or not

4. External Shocks: oil prices, wars, international conflict, natural disasters

What Happens if a recession becomes very severe?

Depression: a state of the economy with large numbers of people out of work, acute shortages, and excess capacity in manufacturing plants.

The Great DepressionCauses

• Unequal distribution of income

• Easy Credit• Global economic

conditions

Effects• GDP fell almost 50 percent• Unemployment rose nearly

800 percent• Average manufacturing

wage fell from 55 cents an hour to 5 cents an hour

• Banks failed• Money supply contracted

What’s the difference between inflation and deflation?

• Inflation: increase in the general level of prices of goods and services

• Deflation: decrease in the general level of prices for goods and services

Market Basket: commonly purchased goods and services

Total of approx. 354 determined

items

Constructing the Consumer Price Index• Consumer Price Index (CPI): series used to

measure prices changes for a representative sample of frequently used consumer items

1. Select a Market Basket2. Find the average price of each item in the

market basket. Then add up the total for the basket.

3. Have a base year: a year that serves as a comparison for all other years

4. Convert the dollar cost of a market basket to an index value so that it is easier to interpret.

Measuring Inflation

(current year CPI – previous year CPI)Previous year CPI

Types of Inflation

• Creeping Inflation: 1-3% inflation per year; not much of a problem

• Hyperinflation: 500% and above inflation per year; very very rare

• Stagflation: period of slow economic growth coupled with inflation

Causes of InflationCauses of inflation include strong demand,

rising costs, and wage-price spirals, along with a growing supply of money.

• Demand-pull inflation: prices rise because all sectors try to buy more goods and services than the economy can produce; cause shortages, which drive up prices

• Cost-push inflation: rising costs drive up prices of products

Consequences of InflationInflation can reduce purchasing power, distort

spending, and affect the distribution of income.• Reduce Purchasing Power: dollar buys less as

prices rise• Distort Spending Patterns: • Encourage Speculation: Spend money on

luxury items if the prices are expected to increase

• Distorted Distribution of Income:

UNEMPLOYMENT

Measuring Unemployment

• Civilian Labor Force: sum of all people age 16 and above who are either employed or actively seeking employment

• Who is classified as unemployed?– People available to work who made a specific

effort to find a job during the past month AND worked less than 1 hour for pay in a week

– Work 15 hours or less in a week in a family business for no pay

How to Calculate the Unemployment Rate

Number of unemployed personsCivilian Labor Force

7,015,000 = 0.046 = 4.6% 150,991,000

Unemployment RateBedford Co.

10.8%

Tennessee9.5%

All U.S.9.2%

Limitations of the Unemployment Rate

1. Doesn’t measure people too frustrated or discouraged to look for work

2. People are considered employed even if they only have part-time jobs

Sources of Unemployment1. Frictional: workers are between jobs; short-term

condition2. Structural: fundamental change in the economy;

more serious type of unemployment, also includes Technological: workers are replaced by machines or automated systems

3. Cyclical: related to changes in the business cycle, also includes Seasonal: annual changes in the weather or other conditions that reduce the demand for jobs