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 Depression

Causes• 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