CHAPTER 8  
 Economic Fluctuations

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UNIT THREE

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I.      Swings in the Economic Pendulum

                A.    A Hypothetical Business Cycle

                        1.                The phases of the business cycle are: expansion, peak (or boom), contraction, and recessionary trough.

                        2.                The duration of business cycles is irregular and the magnitude of the swings in economic activity varies.

        II.        Economic Fluctuations and the Labor Market

                A.    The noninstitutional civilian adult population is grouped into two broad categories: (1) persons not in the labor force and (2) persons in the labor force.

                B.        Labor market participation rate = number in labor force (employed + unemployed)/population (age 16 and over).

                C.    In order to be classified as unemployed, one must either be on layoff or actively seeking work.

B.       Rate of unemployment = number unemployed/number in labor force

      (employed + unemployed)

        III.   Three Types of Unemployment

                A.        Frictional Unemployment

                        1.        Caused by imperfect information in a world of dynamic change.

                        2.                Occurs because (1) employers are not fully aware of all available workers and their job qualifications and (2) available workers are not fully aware of the jobs being offered by employers.

                B.        Structural Unemployment

                        1.        Imperfect matchup of employee skills and the skill demands of available jobs.

                        2.        Reflects structural and demographic characteristics of labor market.

                C.         Cyclical Unemployment

                        1.        Reflects business cycle conditions

                        2.                When there is a general downturn in business activity, cyclical unemployment increases.

        IV.   Employment Fluctuations—The Historical Record

                A.  The Concept of Full Employment

                        1.                Level of employment that results when the rate of unemployment is normal, considering both frictional and structural factors.

                        2.        Closely related to concept of natural rate of unemployment

                        3.                Natural rate of unemployment is the amount of unemployment that reflects this job shopping in a world of imperfect information and dynamic change.

                        4.                The natural rate of unemployment is neither a temporary high nor a temporary low; it is a rate that is both achievable and sustainable into the future. It is the rate of unemployment accompanying the economy s "maximum sustainable rate of output."

                        5.                Natural rate of unemployment is influenced by both demographic factors (e. g., youthful workers as a share of the labor force) and public policy     (e. g., generous unemployment benefits)

                        6.                The actual rate rises above the natural rate during a recession and falls below the natural rate during an  economic boom.

        V.  Unemployment and Measurement Problems

                A.    The definition of unemployed involves some subjectivity.

                B.        Some economists argue that the employment/population ratio—the number employed divided by population 15 and over)—is a better indicator of job availability than the unemployment rate.

        VI.   Actual and Potential GDP

                A.        Potential output: maximum sustainable output level consistent with the economy’s resource base, given its institutional arrangements.  

                B.        Actual and potential output will be equal when economy is at full employment.

        VII. Effects of Inflation: An Overview

                A.  The rate of inflation is equal to:

                                This year’s Price Index – last year’s Price Index          X 100

                                                                last year's Price Index

                B.        Inflation is a general rise in the level of prices. High rates of inflation are almost always associated with substantial year‑to‑year swings in the inflation rate.

                C.        Anticipated and Unanticipated Inflation

                        1.                Unanticipated inflation: an increase in the price level that comes as a surprise, at least to most individuals.

                        2.        Anticipated inflation: a change in the price level that is widely expected.

                D.  Harmful Effects of High and Variable Rates of Inflation

                        1.                Because unanticipated inflation alters the outcomes of long-term projects like the purchase of a machine or operation of a business, it will increase the risks and retard the level of such productive activities.

                        2.        Inflation distorts the information delivered by prices.

                        3.                People will respond to high and variable rates of inflation by spending less time producing and more time trying to protect their wealth and income from the uncertainties created by the inflation.

        VIII. What Causes Inflation?