Business Cycles

            The term business cycle (or economic cycle) refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (expansion or boom), and periods of relative stagnation or decline

            These fluctuations are often measured using the growth rate of real gross domestic product. Despite being termed cycles, most of these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern.

Definition

            Definition shows a stylized picture of a typical business cycle. It shows that economies go through periods of increasing and decreasing real GDP, but that over time they generally move in the direction of increasing levels of real GDP. A sustained period in which real GDP is rising is an expansion; a sustained period in which real GDP is falling is a recession. Typically, an economy is said to be in a recession when real GDP drops for two consecutive quarters, but in the United States, the responsibility of defining precisely when the economy is in recession is left to the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER). The Committee defines a recession as a “significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

Figure 5.1. Phases of the Business Cycle

            The business cycle is a series of expansions and contractions in real GDP. The cycle begins at a peak and continues through a recession, a trough, and an expansion. A new cycle begins at the next peak. Here, the first peak occurs at time t₁, the trough at time t₂, and the next peak at time t₃. Notice that there is a tendency for real GDP to rise over time.

Historical Record

            A depression is a prolonged period of severe economic contraction. The fact that people refer to “the Depression” when speaking about the recession that began in 1929 indicates the severity of that contraction relative to others in recent experience. There was widespread suffering during the Depression. Many people were jobless and homeless and many firms went bankrupt.

Indicators

Leading indicators : A measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators are used to predict changes in the economy, but are not always accurate.

 Coincident Indicator : An economic factor that varies directly and simultaneously with the business cycle, thus indicating the current state of the economy.

Lagging indicators :  A technical indicator that trails the price action of an underlying asset and is used by traders to generate transaction signals or to confirm the strength of a given trend. Since these indicators lag the price of the asset, a significant move will generally occur before the indicator is able to provide a signal.

Unemployment

            The unemployment rate is the percentage of the labor force that is not working. The rate is calculated by dividing the number of people who are unemployed by the number of people in the labor force:

Interpreting the Unemployment Rate

Discouraged workers: is a person of legal employment age who is not actively seeking employment or who does not find employment after long-term unemployment. This is usually because an individual has given up looking or has had no success in finding a job, hence the term "discouraged".

Unemployment:  is the underutilization of workers including part-time workers who prefer full-time employment.

Types of Unemployment

                   Economists have identified four basic types of unemployment:

Frictional Unemployment: A product of the short-term movement of workers between jobs and of first-time job seekers.

Structural Unemployment: A product of technological change and other changes in the structure of the economy.

Cyclical Unemployment: is unemployment in excess of the unemployment that exists at the natural level of employment.

Seasonal Unemployment: A product of regular, recurring changes in the hiring needs of certain industries on a monthly or seasonal basis.


Cost of Unemployment
            The cost of being unemployed is more than the obvious loss of income and status suffered by the individual who is not working. In a broader sense, society as a whole loses when resources are unemployed. Unemployed worker produce no output. So an economy with unemployment will operate inside its production possibilities curve rather than on the curve. Economists measure this lost output in term of the GDP gap:

GDP gap = potential real GDP – actual real GDP

            Potential real GDP is the level of output produced when nonlabor resources are fully utilized and unemployment is at its natural rate. The natural rate of unemployment is the unemployment rate that would exist in the absence of cyclical unemployment, so it includes seasonal, frictional, and structural unemployment.


Potential and real GDP

                Looking graph above percent trend growth path for nominal expenditures during the Great Moderation, the current level is 10.38 percent below the $16,089 billion that is the current value of that growth path. This is an increase in the gap from last quarter, which was 9.74 percent. (This is slightly higher than the figures I was posting earlier this week, I suppose I was still using one of the prior vintages of third quarter 2009 Final Sales of Domestic Product.)


Inflation


            Inflation is a sustained increase in the average price of all goods and services produced in an economy.  Money loses purchasing power during inflationary periods since each unit of currency buys progressively fewer goods.


Absolute versus relative price change
            In the modern economy, over any given period, some prices rise faster than others. To evaluate the rate of inflation in a country, then, economists must know what is happening to prices on average. Here it is important to distinguish between absolute and relative price changes.




Effect of Inflation
            The real value of money is what it can buy, its purchasing power:

 Real value of $1 =     $1/price level

Types of Inflation
Demand-pull inflation: Increase in total spending that are not offset by increases in supply of goods and services and so cause the average level of price to rise.
Cost-push Inflation: As the name suggests, if there is increase in the cost of production of goods and services, there is likely to be a forceful increase in the prices of finished goods and services. For instance, a rise in the wages of laborers would raise the unit costs of production and this would lead to rise in prices for the related end product. This type of inflation may or may not occur in conjunction with demand-pull inflation. 

The Inflationary Record

            Hyperinflation is also known as runaway inflation or galloping inflation. This type of inflation occurs during or soon after a war. This can usually lead to the complete breakdown of a country’s monetary system. However, this type of inflation is short-lived. In 1923, in Germany, inflation rate touched approximately 322 percent per month with October being the month of highest inflation.