Chapter 10: The Business Cycle

Chapter 10The Business CycleMacroeconomicsMacroeconomics 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.10-*Assessing Macro PerformanceThere are three basic measures of macro performance:Output (GDP) growth.Unemployment.Inflation.10-*GDP GDP is the total value of output (goods and services) produced in an economy during a given time period.10-*GDP GrowthAn 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.10-*The Business CycleThe 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.10-*Figure 10.110-*Real GDPBusiness cycles are measured by changes in real GDP:Nominal GDP is measured in current prices.Real GDP is the inflation-adjusted value of GDP, the value of output measured in constant prices.10-*Figure 10.210-*The Great DepressionThis was the most prolonged departure from our long-term growth path.Real GDP fell 30 percent from 1929 to 1933.The economy grew moderately from 1934 to 1936.Another decline occurred in 1936–1937.10-*The Great DepressionReal 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.10-*RecessionA recession is a decline in total output (real GDP) for two or more consecutive quarters.It is a slump or downturn in the economy.10-*Recent Recessions1981–1982: 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.10-*UnemploymentUnemployment is the inability of labor force participants to find jobs.When output declines, jobs are eliminated.10-*The Labor ForceThe 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.10-*Figure 10.310-*The Unemployment RateThe unemployment rate is the proportion of the labor force that is unemployed:Unemployment rate = Number of unemployed Number in labor force10-*Figure 10.410-*The Policy GoalThe 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.10-*InflationThe 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. 10-*Relative versus Average PricesThe 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. 10-*Relative versus Average PricesRelative 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 reallocate resources.10-*Figure 10.510-*Measuring InflationConsumer 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.10-*Measuring InflationCPI 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 1983.10-*Price Stability and Policy GoalPrice 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.10-*The Policy GoalCongress 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.10-*