Business Cycles:Unemployment and Inflation

Topic Outline

I. Business Cycles• Theories of Business Cycles• Phases of the Cycle• The Business Cycle (Diagram)• Effects of Business Cycle

II. Unemployment • Effects of Unemployment

III. Full Employment Defined• Theories of Employment• Full Employment Policies

IV. Inflation• Types of Inflation

V. The Philippine Experience• Causes of the Recession• Government Policies• Economic Recovery depends on Government Officials

Business Cycles

Business Cycles

• John Maynard Keynes – “Father of Modern Economics”

• Business Cycle- refers to fluctuations in the economy.

• Unemployment and Inflation- biggest economic problems of business cycles.

Theories of Business Cycles

• Exogenous Theories – forces outside the economic system create the business cycle.– Forces: wars, political developments, natural

disasters, or major innovations.

• Endogenous Theories – forces within the economic system cause the fluctuations in the economy.

Forces : Accelerators , multipliers, innovations or monetary policies.

Theories of Business Cycles

Phases of the Cycle

• Prosperity – peak of the business cycle.• Recession - both production and employment fall.• Depression – both production and employment are at

either lowest levels.• Recovery – both employment and production rise

towards full employment.

The Business Cycle

Growth

Prosperity

Depression

Recession R

ecov

ery

Business Activities

Time

Effects of Business Cycles

• During bad economic times like recession and depression, various sectors are affected In different ways:– Those who produce capital goods are greatly

affected in terms of production and employment.– Firms have no reason to buy capital goods when

economic or business activities are down.

• Industries which produce consumer durables are adversely affected during bad economic times.

• Since consumers tend to be economical, both production and employment fall.

• Basic products which are non-durables, they are less sensitive to recession or depression.

Unemployment

Types of Unemployment

• Frictional Unemployment – caused by interruptions in production, for technical reasons, or when workers are temporarily laid off due to renovation works. It is also a situation when workers left their jobs and are looking for new ones.

• Structural Unemployment – A change in technology renders the skills and talents of some workers obsolete.

• Cyclical Unemployment - caused by the fall of business activities in the economy.

• Seasonal Unemployment - during slacks period, many workers in farming and construction are laid off.

Effects of Unemployment

• The productive resources of the economy are not fully used. This means less goods and services are produced. On the part of the country, unemployment means decline in national income or gross national product. In such situation, government revenues likewise fall. Evidently, the government has to put side some of its important projects due to lack of funds.

• Unemployment could lead to loss of self-confidence or to more serious social crimes.

Full Employment Defined

• When there is an available job for every person who is willing and able to work, it is full employment.

• Several Factors of unemployment during a period of full employment:– Sickness, dissatisfaction,– Legal minimum wage is more than the value of the

output of many young workers.– Old age, disabilities.

Theories of Employment

• Classical Theory of Employment states that employment increases at lower wages. Employers are willing to hire more workers because it is more profitable.

• Keynesian Theory of Employment which is the modern theory of employment states that employment is determined by aggregate or total demand for goods and services.

Full Employment Policies

• Shorter work week – a reduction of work week from 44 to 40 hours would increase the number of workers. If working hours are shortened, it is believed by those who proposed this policy that more workers would be hired.

• Postponement of technological developments - it is claimed that the use of time and labor-saving devices decreases the number of workers. • Public investment – the government should

utilize its resources to increase demand for goods and services.

Full Employment Policies

Inflation

• There is an inflation when there is a rising general level of prices. Nevertheless, it does not necessarily mean that all prices are increasing. In fact, some prices remain constant or even fall. Other prices rise very suddenly. In short, there is no even escalation of prices.

• Inflation adversely affects many sectors of the economy, particularly the fixed income-groups. Needless to say that their purchasing power declines as prices rise. Inflation also aggravates unemployment problems. Demand for goods and services decreases when prices increase.

• Unfortunately, inflation creates more inflation. When prices keep on increasing, people are inclined to spend their money before it loses its value. It is to be noted that the tendency of people to spend their money is of short duration. Once they have exhausted their surplus money, the natural demand for goods and services takes place.

Types of Inflation• Demand-pull Inflation – occurs when

demand for goods and services exceed supply. This is based on law of demand and supply. When all the productive resources re fully employed, an additional demand for goods increases prices. It is no longer possible to expand output or supply.

Another cause would be the excess of Money supply. When money supply increases, without corresponding increase in production of goods and services, prices rise.

Types of Inflation

• Cost-push Inflation – an increase in the cost of production results to an increase in prices. Cost increases whenever there is an increase in wages, oil prices, or prices of raw materials.

In addition, profit-push version of the labor sector is the cause of inflation.

Types of Inflation

Structural Inflation explains that the inability of some sectors of our economy to respond immediately to demand for goods and services. When supply cannot meet demand, prices increase. If there are no obstacles or constraints (financial, physical or institutional), whenever prices rise, producers are encouraged to enter the market. This increases supply and therefore prices fall.

The Philippine Experience

1984 • The Philippine Economy turned from bad to

worse.• Foreign loans did not come, dollars were difficult

to obtain and both domestic and foreign markets declined.• The average inflation rate for 1984 was 50 percent. • As of the end of December 1983 to March 1984,

almost one million workers lost their jobs.

The Philippine Experience

• On the other hand, there were groups who reaped economic benefits from our economic crisis.• It has been claimed that a few rich Chinese

businessmen owned the black market and they dictated the rates. • Likewise, foreign banks at the beginning of the

crisis in 1983 realized a 79 percent profit on their investments.

Causes of the Recession

• Economic recession in the industrial countries has greatly affected our exports to said countries. • Since exports of raw materials and primary farm

products are the main sources of our dollar earnings, their reduction has a great impact on our developing economy. • Another reason was the increase in OPEC prices

of oil products.

Causes of the Recession

• The UP Report pointed out authoritarianism and crony capitalism as the roots of the existing crisis. • It can be said therefore, that economic

opportunities were not equal and the principle of business efficiency was likely ignored. • Everything depended on right connections

Government Policies

• The government has introduced economic reforms or measures to reduce the problems of inflation and unemployment and these have been planned for economic recovery. Some of these measures have been:• To increase the production of short-gestation

crops and other small-scale industries. • To reduce over-supply of money.

Government Policies

• To reduce government expenditures through more economical use of its resources.• To concentrate more on the development of less

expensive agricultural projects and have shorter gestation than industrial projects.

• To encourage more foreign investments to accelerate our economic recovery.• To transform the people into more self-reliant and

productive groups.

Government Policies

Economic Recovery depends on Government Officials

• Honesty is one main reason why other countries experienced success. • Attitudes and values should be favorable to the

economic growth.• Economic programs are useless if they are not

properly implemented.