Lecture Essentials of Economics: Chapter 10 - Bradley R. Schiller, Cynthia Hill

Chapter 10 The business cycle, after reading this chapter, you should be able to: Explain how growth of the economy is measured, tell how unemployment is measured and affects us, discuss why inflation is a problem and how it is measured, define “full employment” and “price stability”, recite the U.S. track record on growth, unemployment, and inflation.

Chapter 10

The Business Cycle

• Macroeconomics is the study of

aggregate economic behavior, of the

economy as a whole

• A basic purpose of macroeconomic

theory is to explain the business cycle.

• Macro policy tries to control the

business cycle

• GDP is the total value of output (goods and services) produced in an economy during a given time period

• An economy’s potential output is reflected

in its production possibilities curve (PPC):

– Production possibilities – the

alternative combinations of goods and

services that could be produced in a

given time period with all available

resources and technology.

• When there is GDP growth, the PPC shifts

outward.

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• The business cycle is the alternating

periods of economic growth and

contraction experienced by the

economy

• It shows the rise and fall of the

economy over time

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– Real GDP is the inflation-adjusted value

of GDP, the value of output measured in

constant prices.

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• Real GDP in 1939 was virtually the

same as in 1929

• GDP per capita was lower in 1939 than

in 1929, meaning that Americans had a lower standard of living in 1939 than

they did 10 years earlier

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• A recession is a decline in total output

(real GDP) for two or more consecutive quarters

• It is a slump or downturn in the

economy

• 1981–1982: Lasted 16 months, with an unemployment rate of 10.8 percent, the highest since the 1930s

• 1990–1991: A brief 8-month recession

• 2001: Another 8-month recession

• 2008–2009: Failures in financial and

real estate markets led to a significant

decline in real GDP and 10 percent

unemployment

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• Unemployment is the inability of labor

force participants to find jobs

• When output declines, jobs are

eliminated

• The labor force consists of everyone

over the age of 16 who is actually

working, plus all those who are not

working but are actively seeking

employment

• This includes about half of the total

population

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Figure 10.3

Rate

• The unemployment rate is the proportion of the labor force that is unemployed:

Unemployment rate = Number of unemployed

Number in labor force

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Figure 10.4

• The goal is to avoid as much cyclical

unemployment as possible

• To try to achieve full employment

• Full employment is the lowest rate of

unemployment compatible with price

stability:

– It is estimated to be between 4 and 6

percent.

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• The biggest fear as an economy

reaches full employment is inflation

• As an economy reaches its production

possibilities, prices will begin to rise as:

– Demand for goods outstrip supply.

– Costs of production rise

Relative versus  Average Prices

• The relative price is the price of one

good in comparison with the price of

other goods

• It is possible for individual prices to rise

or fall continuously without changing

the average price level

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Relative versus  Average Prices

• Relative changes can occur in a period

of stable average prices

• Changes in relative prices are market

signals that help reallocate resources

in the economy

• In a general inflation – when all prices

are rising – prices do not help to

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• Consumer Price Index (CPI) – a

measure of changes in the average

price of consumer goods and services

• Inflation rate – the annual rate of

increase in CPI

• CPI relates current prices to prices that

existed in 1982–1984, when CPI was set

to 100

• A current CPI of 230 in 2013 means that it takes $230 to buy what $100 could buy in 1983

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Policy Goal

• Price stability is the absence of

significant changes in the average

price level

• The Full Employment and Balanced

Growth Act of 1978 establishes a goal

for economic policy to hold the rate of

inflation at under 3 percent

• Congress weighs the tradeoff between inflation and full employment

• Zero percent inflation might harm the

goal of full employment

• Three percent inflation was determined

to be a safe target

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