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Chapter 7 - Business cycles, unemployment, and inflation (with important formulas)

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Ryerson University
ECN 204
Thomas Barbiero

Chapter 7 – Business cycles, Unemployment, and Inflation 7.1 The Business Cycle • Business cycle refers to alternating rises and declines in the level of economic activity, sometimes over several years Causation: a first glance Remember that if all expectations in an economy are fulfilled and prices are fully flexible, there would be no fluctuations around the long term trend line Some believe the following are some key causes of fluctuations: o Innovation: the railroads, automobile, microchip etc., have great impact on investment and consumption. These innovations occur irregularly o Changes in productivity: increase lead to booms and vice versa o Money supple changes (government printing): expansions lead to booms and vice versa o Most economists agree that the immediate cause of fluctuations are total spending changes Cyclical impact: durables and nondurables Affects different segments in different ways and to different degrees Firms producing capital goods, i.e. machines and consumer durables, i.e. cars, affected most because these purchases can be postponed Service industries (medical, legal) and nondurable consumer goods (food, clothing) are insulated in the business environment 7.2 Unemployment Measurement of unemployment How the unemployment rate is understated o Part-time employment statistics: no distinction in the statistics for full time and part time employment o Discouraged workers: not counted. If in the survey you are not looking for a job, you are NOT in the labour force Types of unemployment Frictional unemployment: people in between jobs; they are either searching or waiting to take a job in the near future. Frictional unemployment is inevitable in a free society. May be actually desirably because some are moving from low to high productivity (and better pay) jobs Structural unemployment: those who don’t have the skills required by the available positions or aren’t willing to move to far off places where their skills are in demand. Requires training Cyclical unemployment: due to deficient aggregate demand. This is what most people think of as the cause of unemployment due to insufficient spending. Begins in the recession phase Seasonal unemployment: temporary unemployment due to weather (i.e. construction workers, lawn mowers etc.) Definition of ‘Full’ employment Natural rate of unemployment (NRU) NOT zero unemployment – there will always be some sort of unemployment Full employment occurs when there is no cyclical unemployment Not automatic Economic cost of unemployment GDP Gap and Okun’s law: o The amount by which actual GDP falls short of potential GDP (full employment) o GDP gap = actual GDP – potential GDP o Okun’s law = for every 1% unemployment exceeds the natural rate, a GDP Gap of about 2% occurs Unequal burdens o Occupation: low skilled occupations have higher unemployment o Age: teenagers have high unemployment rate (due to lack of marketable skills) o Gender: generally the same o Education: less educated workers have higher unemployment IMPORTANT EXAMPLE Given for 1992: o Unemployment rate is 11.3% o Natural rate is 7.5% o Potential GDP if $770 billion What is the GDP Gap? o 11.3% - 7.5% = 3.8% (gap in % terms( o 3.8%*2 = 7.6% (apply Okun’s Law) o 7.6% of $770 billion = $59 billion Non-
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