ECON 2 PRINCIPLES OF ECONOMICS 2
BUSINESS CYCLES, UNEMPLOYMENT, AND INFLATION
Lesson 8
THE BUSINESS CYCLE
Business cycles are alternating rises and declines in
the level of economic activity, sometime over several
years. Individual cycles (one up and one down) vary in
duration and intensity.
Phases of the Business Cycle
Peak – business activity has reached a temporary
maximum; economy is near or at full employment and the
level of real output is at or very close to economy’s
capacity; price level is likely to rise during this phase
Recession – period of decline in total output, income and
employment; lasts for 6 months or more; marked by the
widespread contraction in business activity in many
sectors; decline in GDP and increase in unemployment
Trough – output and employment bottom out at their
lowest levels; either short-lived or quite long
Expansion/Recovery – period in which real GDP, income
and employment rise; at some point the economy again
approaches full employment; inflation will occur
Why are there fluctuations in the business cycle?
Fluctuations are driven by shocks – unexpected
events that individuals and firms may have trouble
adjusting to.
Possible general sources of shocks that can cause cycles:
1. Irregular innovation
2. Productivity changes
3. Monetary factors
4. Political events
5. Financial instability
INSTRUCTOR: NIÑA MAE BIANCA J. MARTIN
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Whatever the source of economic shocks, most
economists agree that the immediate cause of the large
majority of cyclical changes in the levels of real output and
employment is unexpected changes in the level of total
spending.
If total spending unexpectedly sinks, with price
being constant: fewer goods and services purchased →
slower sales → cut back on production → GDP will fall →
employment will fall → recession
If total spending unexpectedly rises, with price being
constant: large volume of goods and services purchased
→ increase production of output → increase in GDP →
increase in employment → boom or expansion
Cyclical Impact: Durables and Nondurables
Firms and industries most affected by the business cycle:
1. Capital goods firms (i.e. housing, commercial
buildings, heavy equipment, and farm implements)
2. Consumer durable producers (i.e. automobiles,
personal computers, and refrigerators)
UNEMPLOYMENT
Unemployment is the state of a person is in if he
cannot get a job despite being willing to work and actively
seeking work. The existence of unemployment seems to
imply that the aggregate labor market is not in equilibrium.
Measurement of Unemployment
unemployed
Unemployment rate= x 100
labor force
Labor force – consists of people who are able and willing
to work; both employed workers and those who are
unemployed but are able and willing to work
In the Philippines, the National Statistics Office
conducts Labor Force Survey (LFS) to provide a
quantitative framework for the preparation of plans and
formulation of policies affecting the labor market.
Indicator Q4 2012 Q3 2012 Q4 2011
Employment Rate 93.2 93.6 93.6
Underemployment Rate 19 22.7 19.1
Unemployment Rate 6.8 7 6.4
Source: NSO
Underemployed – includes all employed persons who
desire to have additional hours of work in their present job
LESSON 8
 ECON 2 PRINCIPLES OF ECONOMICS 2
or an additional job, or to have a new job with longer
working hours. (NSO)
Unemployed – includes all those who are 15 years old and
over, have no job/business and actively looking for work.
Also considered as unemployed are persons without a job
or business who are reported not looking for work
because of their belief that no work was available or
because of temporary illness/disability, bad weather,
pending job application or waiting for job interview. (NSO)
Persons Not in the Labor Force – Persons 15 years old
and over who are neither employed nor unemployed
according to the definitions mentioned. Those not in the
labor force are those persons who are not looking for work
because of reasons such as housekeeping, schooling, etc.
(i.e. housewives, students, disabled or retired persons)
(NSO)
Types of Unemployment
1. Frictional Unemployment
 Workers who are between jobs; they recently
resigned, or been laid-off temporarily and will
be seeking reemployment
 The term frictional implies that the labor
market does not operated perfectly and
instantaneously in matching workers and jobs
 Inevitable but in part, desirable
2. Structural Unemployment
 Structural = compositional
 Changes over time in consumer demand and
technology alter the structure of the total
demand for labor, both occupationally and
geographically
 Occupationally, demand for certain skills may
decline or even vanish, thereby causing
unemployment to those workers whose skills
have become obsolete
 Geographically, as job opportunities shift from
one place to another, some workers become
structurally unemployed
3. Cyclical Unemployment
 Caused by a decline in total spending and
typically begins in the recession phase of the
business cycle
 As demand for goods and services
decreases, employment falls
 A very serious problem when it occurs
Full Employment Defined
Economists say that an economy is in full
employment when it is only experiencing frictional and
INSTRUCTOR: NIÑA MAE BIANCA J. MARTIN
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structural unemployment. They describe the
unemployment rate that is consistent with full employment
as the full-employment rate of unemployment or the
natural rate of unemployment (NRU). At the NRU, the
economy is said to be producing its potential output – the
real GDP that occurs when the economy is “fully
employed”.
Economic Cost of Unemployment
The basic cost of unemployment is foregone output.
Unemployment above the natural rate means that society
is operating at some point inside its production
possibilities curve. This sacrifice of output is called a GDP
gap.
GDP gap=actualGDP− potential GDP
If actual GDP > potential GDP, positive GDP gap
If actual GDP < potential GDP, negative GDP gap
In the case of unemployment above the natural rate, it is
negative because actual GDP is less than potential GDP.
Okun’s Law
 Proponent: macroeconomist Arthur Okun
 indicates that for every 1 percentage point by which
the actual unemployment rate exceeds the natural
rate, a negative GDP gap of about 2 percent occurs
Generalizations:
 occupation – workers in lower-skilled occupations
have higher unemployment rates than workers in
higher-skilled occupations; lower-skilled workers
have more and longer spells of structural
development and are less likely to be self-employed
 age – teenagers have much higher unemployment
rates than adults; teenagers have lower skill levels,
quit their jobs more frequently, are more frequently
fired and have less geographic mobility than adults
 gender – unemployment rates for men and women
normally are very similar
 education – less-educated workers on average,
have higher unemployment rates than workers with
more education
Noneconomic Costs
 Severe cyclical unemployment is a social disaster
 Unemployment → idleness → loss of skills, loss of
self-respect, plummeting morale, family
disintegration, sociopolitical unrest
 Widespread joblessness increases poverty,
heightened racial and ethnic tensions, and reduces
hope for material advancement
LESSON 8
 ECON 2 PRINCIPLES OF ECONOMICS 2

being produced and supplied are

consequently hiked

INFLATION
Inflation Rates of the Philippines
Inflation is the rise in general level of prices. When
inflation occurs, the purchasing power of money Philippines Dec 2012 Nov 2012 Year-to-date
decreases. But inflation does not mean that all prices are Headline 2.9 2.8 3.2
rising; some prices may be relatively constant and others Core 3.3 3.4 3.7
may even fall.
Core Inflation – the underlying increases in the CPI after
Measurement of Inflation volatile food and energy prices are removed.

Consumer-Price Index (CPI) is the main measure of Redistribution Effects of Inflation

inflation. It reports the price of a market basket of some
consumer goods and services that are purchased by a
typical consumer. In the Philippines the market basket is
composed of the following commodity groups:
 food and non-alcoholic beverages
 alcoholic beverages and tobacco
 clothing and footwear
 housing, water, electricity, gas, and other fuels
 furnishing, household equipment and routine
maintenance of the house
 health
 transport
 communication
 recreation and culture
 education
 restaurant and misc. goods and services
The CPI of the Philippines is compiled by the
National Statistics Office (NSO) monthly and yearly. The
data is available on the website of NSO.
The rate of inflation is equal to the percentage
growth of CPI from one year to the next.
Inflation redistributes real income. The number of
peso received as income (wages, rent, interest and profit)
is called nominal income. Real income is a measure of the
amount of goods and services nominal income can buy; it
is the purchasing power of nominal income, or income
adjusted for inflation.
nominal income
Real income=
price index
Real income will remain the same when nominal
income rises at the same percentage rate as does the
price index. When inflation occurs, not everyone’s nominal
income rises at the same pace as the price level, and so
therein lies the potential for redistribution of real income
from some to others.
Who is hurt by inflation?
 Fixed-income receivers
 Savers
 Creditors

Types of Inflation Who is helped or unaffected by inflation?

 Flexible-income receivers
1. Demand-Pull or Excess Demand Inflation  Debtors
 Inflation which arises due to various factors
like rising income, exploding population, etc.,
leading to an increase in aggregate demand
which exceeds aggregate supply, and tends
to raise prices of goods and services

2. Cost-Push Inflation or Supply-side Inflation

 When prices rise due to growing cost of
production of goods and services
 Example: if wages of workers are raised, then
the per-unit cost of production also increases.
As a result, the prices of products or services

INSTRUCTOR: NIÑA MAE BIANCA J. MARTIN LESSON 8

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