Phases of the Business CycleCalculating Official

Unemployment RateProblems with Measuring the

Unemployment RateFour Types of UnemploymentFull Employment (Natural Rate

of Unemployment)Potential Real GDPRecessionary Gap / Inflationary

Gap

In This Lecture…..

Business Cycle Phases Expansion: when Real GDP is rising.

Peak: when Real GDP stops rising, it has hit the peak.

Recession: when Real GDP is actually declining.Two consecutive quarters of declineDepression: if decline is very large

Trough: when Real GDP stops falling, it has hit the trough

Recovery: period while Real GDP is making up for the production that was lost during a recession.

Business Cycles

Recurrent swings (up and down) inReal GDP; alternating periods of expansions and recessions.

1950

1951

1952

1953

1954

1955

19561957

1958

1959

19601961

1962

1963

1964

19651966

1967

1968

1969

1970

1971

1972

1973

19741975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

19861987

1988

1989

1990

1991

1992

1993

1994

1995

1996

19971998

1999

2000

2001

2002

2003

2004

20052006

2007

-2

0

2

4

6

8

10

GD

P:

% C

han

ge

3.5%

Current Population Survey / Household Survey

» Conducted every month» U.S. Bureau of the Census» Sample of 60,000 households» 16 years of age and older» Labor Participation: Employed /

Unemployed» BLS: calculates monthly

unemployment rate

Determining Labor Participation & Unemployment Rate

Understanding the Unemployment Rate

and the Labor Force Participation Rate

Labor Force & Labor Force Participation Rate

Labor force participation rate - The percentage of the working-age population that is in the civilian labor force:

Labor forceLFPR = --------------------------------------------- x 100 Working-Age Population

Labor force – The labor force is the sum of those people who are officially employed and unemployed.

Calculating the Official Unemployment Rate

Unemployment Rate-The percentage of the civilian force that is unemployed:

Number of unemployed personsU = -------------------------------------------- X 100 Labor force

Problems with Measuring the Unemployment Rate

• Distinguishing between the unemployed and those not in labor force.

» Discouraged Workers

• Part-time vs. Full-time jobs• Inaccurate responses to survey

» Beware of Liars

• Working in the Underground Economy

Types of UnemploymentFrictional Unemployment and Job Search

Frictional unemployment: Short-term unemployment arising from the process of matching workers with jobs.

Structural Unemployment

Structural unemployment: Unemployment arising from a persistent mismatch between the skills and characteristics of workers and the requirements of jobs.

Types of UnemploymentCyclical Unemployment

Cyclical unemployment: Unemployment caused by a business cycle recession.

Full Employment

Natural rate of unemployment: The normal rate of unemployment, consisting of structural unemployment plus frictional unemployment.

EXAMINING UNEMPLOYMENT

How Is Unemployment Defined and Measured?

FIGURE 6.2Unemployment Rates in Developed Countries

Government Policies & the Unemployment Rate• Unemployment Insurance & Other Payments• Legislation against firing workers• Minimum Wage Laws

» Labor Unions» Efficiency Wages

12 - 5Average Unemployment Ratesin the United States, Canada,Japan, and Europe, 1995-2004

Self Test

1. What is the major difference between a person who is frictionally unemployed and one who is structurally unemployed?The frictionally unemployed person has readily transferable skills, and the structurally unemployed person does not.

Self Test

2. If the cyclical unemployment rate is positive, what does this imply?It implies that the (actual, measured) unemployment rate in the economy is greater than the natural unemployment rate. For example, if the unemployment rate is 8 percent and the natural unemployment rate is 6 percent, the cyclical unemployment rate is 2 percent.

Understanding Potential Real GDP

Potential Real GDP – The amount of production we need to have in order to have full employment. Potential GDP is a goal – the amount an economy would like to produce in order to have full employment.

Real GDP: Remember………..Real GDP is the amount we actually produce

GDP Gap: The difference between the actual Real GDP and the Potential Real GDP

Understanding GDP GapsRecessionary Gap – occurs when Real GDP falls below Potential Real GDP. Therefore, in this case, the unemployment rate is above the natural rate of unemployment. That is, the economy is not exhibiting full employment.

Inflationary Gap – occurs when Real GDP falls above Potential Real GDP. Therefore, in this case, the unemployment rate is below the natural rate of unemployment. That is, the economy can provide jobs to whomever wants one and inflation is on the rise.

Defining Price Level and InflationCalculating the Consumer Price

Index (CPI)COLACalculating Percentage Changes in

the CPIOverstating the CPIGDP DeflatorNominal Interest Rate vs. Real

Interest RateThe Effects of Inflation

In This Lecture…..

Defining Price Level & Inflation

Price Level - A weighted average of the prices of all good and services.

Inflation – an increase in the price level

Deflation – a decrease of the price level

Price Index – A measure of the price level

The Consumer Price Index (CPI)

Consumer price index (CPI): An average of the prices of the goods and services purchased by the typical urban

family of four.

12 - 6The CPI Market Basket,December 2004

The Consumer Price Index (CPI)

Base Year - The year chosen as a point of reference or basis of comparison for prices in other years; a benchmark year.

COLA – Cost of living adjustment…….income is adjusted automatically to reflect the increases in prices, as measured by the increase in the CPI.

Shortcomings of the CPI

Substitution Bias

Outlet Bias

Increase in Quality Bias

Overstated by 1%?

Computing the Consumer Price Index

Changes in Prices

In 2005 the CPI was 195.3; in 2006 the index was 201.6. What was the percentage change in prices from 2005-2006?

Click below for answer.

3.23 %

Consumer Price Index 1983-2007

Year Annual

1983 99.6

1984 103.9

1985 107.6

1986 109.6

1987 113.6

1988 118.3

1989 124.0

1990 130.7

1991 136.2

1992 140.3

1993 144.5

1994 148.2

1995 152.4

Year Annual

1996 156.9

1997 160.5

1998 163.0

1999 166.6

2000 172.2

2001 177.1

2002 179.9

2003 184.0

2004 188.9

2005 195.3

2006 201.6

2007 207.3

2008

Self-Test

1. What is a base year?It is a year that is used for comparison purposes with other years.

Self Test

2. Explain how the CPI is calculated.The CPI is calculated as follows: (1) define a market basket,(2) determine how much it would cost to

purchase the market basket in the current year and in the base year

(3) divide the dollar cost of purchasing the market basket in the current year by the dollar cost of purchasing the market basket in the base year, and

(4) multiply the quotient by 100.

The GDP Deflator

GDP Deflator: another measure of the price level . Evaluates changes in the prices of ALL products…….calculated as nominal GDP divided by Real GDP x 100.

Real GDP = Nominal GDP x 100 Real GDP

The GDP Deflator: Better Measure of Inflation?

No fixed Market Basket

Base Year is different from CPI

GDP Deflator measures changes in the prices of all goods and services, whereas the CPI measures only a basket of goods.

Self-Test

4. Assume there are three goods in the economy:

Quantity 2000 Quantity 2008 Price 2000 Price 2008

A 10 15 $1 $3

B 5 10 $2 $6

C 20 20 $5 $15

Using this data, calculate the GDP Deflator for 2008.

Effects of Inflation: Winners & Losers

WinnersDebtors

Nominal interest rate: interest rate quotedReal interest rate: nominal interest rate

minus the rate of inflation

HomeownersWage earnersGovernment

LosersCreditorsSaversWage Earners