Unemployment,+Inflation+and+Business+Cycles

Fundamental Questions

> **Business cycles** are recurring patterns of ups and downs in real GDP. A typical cycle has four stages: expansion, peak, contraction, and trough. During an economic expansion (boom), output, employment, incomes, and prices all rise. A peak is reached, after which economic activity declines. During the contraction (**recession**) phase, output, employment, and income all drop. If the contraction is severe enough, prices may also decline. The trough marks the end of a contraction and the beginning of a new expansion. > The **unemployment rate** is the percentage of the labor force that is not working. Economists do not include the entire population in the labor force; it is of little consequence, for example, that a newborn baby is unemployed. To be in the U.S. labor force, an individual must be working or actively seeking work. > Some types of unemployment have more impact on the economy than others. //Frictional unemployment// occurs when previously employed workers change jobs or new workers seek their first jobs. Seasonal unemployment is a product of regular, recurring changes in the hiring needs of certain industries. Both these types of unemployment tend to be short-term. Structural unemployment, on the other hand, results from fundamental changes in the structure of the economy and can be long-term. Structurally unemployed persons can't find any job they can do. Likewise, cyclically unemployed persons who are out of work because the economy is in a recession may be unemployed for a long time. > The cost of unemployed resources is lost output. **Potential real GDP** is the level of output that can be produced if all non labor resources are fully utilized and unemployment is at its natural rate—that is, if the economy is producing the level of output it can realistically produce. To measure lost output, one subtracts the actual real GDP from potential real GDP. The resulting figure indicates the //GDP gap//—the cost of unemployed resources. > Economists do not advocate a zero unemployment rate. Some unemployment is necessary so workers may be channeled to their most productive employment as their skills change. Economists use the term natural rate of unemployment to describe the unemployment rate that would exist in the absence of cyclical unemployment. It describes the labor market when the economy is producing what it realistically can produce. Estimates of the **natural rate of unemployment** vary from 4 percent to around 7 percent. > **Inflation** is a sustained rise in the average level of prices. This does not mean that //all// prices will rise. Some may rise and some may fall, but inflation occurs when the //average// level of prices rises. > Inflation is not a problem if prices and incomes rise at the same rate. But if incomes rise more slowly than prices, households will not be able to buy as many goods and services as they did before. Unanticipated inflation redistributes income away from those who receive fixed incomes toward those who make fixed expenditures. Suppose that your mother agrees to lend you $1,000 for school and that prices unexpectedly double between the time you receive the money and the time you repay your mother. Your mother has lost half of her purchasing power; the $1,000 that you paid back can only buy what $500 bought at the time she lent you the money. Your mother, like other creditors, has lost purchasing power to inflation.
 * 1) **What is a business cycle?**
 * 1) **How is the unemployment rate defined and measured?**
 * 1) **What is the cost of unemployed resources?**
 * 1) **What is inflation?**
 * 1) **Why is inflation a problem?**