CHAPTER 29

Business Cycles, Unemployment, and Inflation

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 Chapter Contents
The Business Cycle
Unemployment
Inflation
Redistribution Effects of Inflation
Does Inflation Affect Output?

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 The Business Cycle
Alternating increases and decreases in economic
activity over time
Phases of the business cycle:
• Peak
• Recession
• Trough
• Expansion 29-3
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 The Business Cycle Illustrated

Peak

Level of real output

Peak

Peak

i on
Trend

Expans
Re
c es

ion
th
Grow sio

ns
n
Re

Expa
ce

Trough
s
sio
n

Trough

Time
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 U.S. Recessions since 1950
Depth
Duration, (Decline in Real
Period Months Output)
1953–54 10 –2.6%
1957–58 8 –3.7
1960–61 10 –1.1
1969–70 11 –0.2
1973–75 16 –3.2
1980 6 –2.2
1981–82 16 –2.9
1990–91 8 –1.4
2001 8 –0.4
2007–09 18 –4.3

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 Business Cycle Fluctuations
Economic shocks.
Prices are “sticky” downwards.
Economic response entails decreases in output and
employment.

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 Causation: A First Glance
Causes of shocks:
• Political events
• Financial instability
• Irregular innovation
• Productivity changes
• Monetary factors
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 Cyclical Impact
Durable goods affected most:
• Capital goods
• Consumer durables
Nondurable consumer goods affected less:
• Services
• Food and clothing
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 The U.S. Labor Force, Employment, and
Unemployment, 2018 
Under 16 Unemployment rate =
and/or
Institutionalized # of unemployed × 100
(69.5 million)
labor force
Not in
Total labor Unemployment rate =
force
population 6,300,000
(328.2
(95.6 million) × 100 = 3.9%
million) 163,200,000
Employed Labor
(156.9 million) force
(163.2
million)

Unemployed
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LO29.2 (6.3 million)
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 Criticisms of Unemployment
Involuntary part-time workers counted as full-time.
Discouraged workers are not counted as unemployed.

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 Types of Unemployment
Frictional unemployment: Individuals searching for
jobs or waiting to take jobs soon
Structural unemployment: Occurs due to changes in
the structure of the demand for labor
Cyclical unemployment: Caused by the recession
phase of the business cycle

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 Definition of Full Employment
Natural Rate of Unemployment (NRU)
• Full employment level of unemployment.
• Can vary over time due to:
• Demographic changes
• Changing job search methods
• Public policy changes
• Actual unemployment can be above or fall below the
NRU. 29-12
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 Economic Cost of Unemployment
GDP Gap
• GDP gap = actual GDP – potential GDP
• Can be negative or positive
Okun’s Law: Every 1% of cyclical unemployment
creates a 2% GDP gap

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 Actual and Potential Real GDP and the Unemployment Rate

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LO29.2 Sources: Congressional Budget Office; Bureau of Economic Analysis; and
©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. Bureau of Labor Statistics.
 Unequal Burdens
Occupation
Age
Race and ethnicity
Gender
Education
Duration
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 Unemployment Rates by Demographic Group
Unemployment Rate
Demographic Group 2007 2009 2018
Overall 4.6% 9.3% 4.1%

Occupation:
Managerial and professional 2.1 4.6 2.0
Construction and extraction
7.6 19.7 6.7

Age:
15.7 24.3 11.5
16–19
African American, 16–19 29.4 39.5 19.9
White, 16–19 13.9 21.8 10.1
Male, 20+
Female, 20+ 4.1 9.6 3.3
4.0 7.5 3.2

Race and ethnicity:

African American 8.3 14.8 6.1
Hispanic
5.6 12.1 4.3
White
4.1 8.5 3.2

Gender:
Women 4.5 8.1 3.5
Men
4.7 10.3 3.6

Education:
Less than high school diploma 7.1 14.6 5.8 29-16
High school diploma only
4.4 9.7 3.8
College degree or more Source: Civilian labor force by detailed
2.0 4.6 2.1
LO29.2 age, sex, race, and ethnicity.
Duration:
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 Noneconomic Costs
Loss of skills and loss of self-respect
Plummeting morale
Family disintegration
Poverty and reduced hope
Heightened racial and ethnic tensions
Suicide, homicide, fatal heart attacks, mental illness
Can lead to violent social and political change 29-17
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 Inflation
General rise in the price level.
Inflation reduces the “purchasing power” of money.
Consumer Price Index (CPI):
Price of the most recent market
CPI = basket in the particular year
Price estimate of the market
× 100

basket in 1982–1984

251.1 – 245.1
CPI = 245.1
× 100 = 2.4%

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 Annual Inflation Rates in the United States, 1960–2018
December-to-December changes in the CPI

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 Global Perspective 29.1
INFLATION RATES IN FIVE INDUSTRIAL NATIONS, 2008–2018 

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 Demand-Pull and Cost-Push Inflation
Demand-pull inflation:
• Excess spending relative to output
• Central bank issues too much money
Cost-push inflation:
• Due to a rise in per-unit input costs
• Supply shocks
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 Types of Inflation
Difficult to distinguish inflation types.
Types differ in sustainability:
• Demand-pull continues as long as the excess spending
continues.
• Cost-push ends in a recession.
Core inflation:
• Without food and energy goods.
• Focuses on more stable prices. 29-22
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 Redistribution Effects of Inflation
Nominal income: Unadjusted for inflation.
Real income: Nominal income adjusted for inflation.
Anticipated versus unanticipated income.

Percentage Percentage Percentage

change in  change in nominal − change in
real income = income price level

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 Who Is Hurt by Inflation?
Fixed-income receivers: Real incomes fall.
Savers: Value of accumulated savings deteriorates.
Creditors: Lenders get paid back in “cheaper dollars.”

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 Who Is Unaffected by Inflation?
Flexible-income receivers
• COLAs
• Social Security recipients
• Union members
Debtors: Pay back the loan with “cheaper dollars.”

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 Anticipated Inflation
Real interest rate: Rates adjusted for inflation.
Nominal interest rate: Rates not adjusted for inflation.

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 The Inflation Premium and Nominal and Real
Interest Rates

6%
11%
= + Inflation
premium
5%

Nominal Real
interest interest
rate rate
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 Other Redistribution Issues
Deflation
Mixed effects:
• Incomes may rise
• Fixed assets values may fall
• For fixed-rate mortgages, real debt declines
Arbitrariness
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 Does Inflation Affect Output?
Cost-push inflation:
• Reduces real output.
• Redistributes a decreased level of real income.
Demand-pull inflation:
• One view is that zero inflation is best.
• Another view is that mild inflation is best.
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 Hyperinflation
Extraordinarily rapid inflation
Adverse effects
Examples:
• Germany after WWI
• Japan after WWII
Causation
Motivation
Termination 29-30
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 Last Word: The Great Skills Shortage
Job market slow to recover after the Great Recession.
More job openings than people unemployed.
Skills mismatch due to decrease in vocational
education programs.
Demographic and geographic issues.
Unrealistic expectations of employers.
29-31

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