MACROECONOMICS

Business Cycle, Unemployment Rate and Inflation Rate

Corpus, Kristine S.Cruz, Martin Joseph S.

Del Rosario, Beatrice Camille G.Estrada, Jemia Pearl A.Franco, Juan Miguel L.

Overview

1. Business Cycle 2. Labor Force Concepts 3. Unemployment 4. Okun’s Law5. Misery Index6. Consumer Price Index (CPI) 7. Inflation 8. Phillip’s Curve and Stagflation

SUCCESSFUL BUSINESSMEN

Business Cycle • Economic cycle or boom-bust cycle • “Ups and Downs” of the economy

• Fluctuations that an economy experiences over time resulting from changes in economic growth.

• Fluctuations are measured by considering the real GDP and unemployment

• Long term growth trend • Not recurring but periodic

Burns and Mitchell: Business Cycle

1. Measuring commodity output, income, prices, interest rates, banking transactions, and transportation services.

2. Business cycle divided into phases

Business Cycle Indicators

Leading Economic Indicators Manufacters’ new orders for consumer goods and materials, index

of vendor performance, manufacturer’s new orders for capital goods, new building permits, index of consumer expectations

Coincident Economic Indicators Industrial production, real personal income, real manufacturing

and trade sales, number of employees on payrolls

Lagging Economic Indicators Labor cost, average prime interest rate, Consumer Price Index,

Average duration of unemployment

Phases of the Business Cycle

• Contraction or the “Slow Down” • Peak• Trough • Expansion

Business Cycle

Contraction or Slow Down

• Slowdown in the economic activity• Defined by: low or stagnant growth, high

unemployment and decreasing prices • Accompanied by a bear market

Peak

• Upper point of the cycle and economy is defined as overheated

• Expansion turns into contraction • “irrational exuberance”

Trough

• Lowest point of the business cycle• Usually occurs in a period of recession

Expansion

• Speed up in the economic activity• Economy starts to grow again (bull market) • Defined by: high growth, low unemployment

and increasing prices

• GDP GDP = C + I + G + (N-X) GDP = Consumption + Investment + Government spending + Net exports (Exports – imports)

GDP = C(Y-T) + I(r) + G + (N-X) Y: income T: taxesR: interest rate As r increases, I decreases As r decreases, I increases

Labor Force

Working Age Population

Labor Force

Employed

Persons

Unemployed

Persons

Person’s Outside the Labor Force

In the Philippines, the working age population is defined by: person’s ages 15 and above.

A person who is part of the labor force, is a person of age who is looking for a job, is employed during reference period.

Labor Force Concepts

Concept Meaning

1. Labor Force Population of 15 yo and over who contribute to the production of goods and services to the country

2. Employed Persons in the labor force who are reported as either at work or with a job

3. Unemployed Persons in the labor force reported as:a. No workb. Currently available for work c. Seeking or or not seeking work

4. Underemployed Employed persons who desire to have additional hours of work in their present job or want an additional job

Labor Force Concepts Concept Meaning

5. Labor Force Participation Rate (LFPR) Proportion of total labor force to total household

6. Employment Rate Proportion of employed persons to the total labor force

7. Unemployment Rate Proportion of underemployed persons to the total labor force

Unemployment•Unemployment Rate •Types of Unemployment •Full Employment

Unemployment

Manapat, Olaguer and Pedrosa (2010) :– Scenario– 15 years old and above– Available for work but without work– Seek/do not seek– At least 4 weeks

Unemployment rate

Labor force = Employed + Unemployed• 15 years old and above• Contributed goods and services

*** exemptions

X 100

ExampleQuestion: In December 2012, 143,060 Filipino residents

were employed and 11,844 were unemployed. Find the unemployment rate for December 2012

Unemployment rate = 11,844 ÷ (143,060 + 11,844)

= 7.64%

Types of unemployment

Unemployment

Unavoidableunemployment

Avoidableunemployment

1. Frictional2. Structural3. Cyclical4. Seasonal

1. Frictional Unemployment• temporary, associated with the changes in the

economy

Unavoidable unemployment

2. Structural Unemployment• location and qualification of labor force do

not match the available jobs• technology

Gabay, Remotin, Uy and Pizarro-Uy (2012) :

Unavoidable unemployment

3. Cyclical Unemployment

• Caused by the recession phase of the business cycle

4. Seasonal Unemployment

• Jobs that are seasonal in nature

Medina (2003) :

Underemployment

• Employed• Desire– additional working hours– Additional job– New job with longer hours

Underemployment

Invisibly Underemployed

Visibly Underemployed

•Worked 40 hours

•Want additional working hrs

•Worked less than 40 hours

•Want additional working hrs

Full Employment

• Unemployment rate ≠ 0

• Cyclical Unemployment = 0

• The inverse relationship between GDP growth & unemployment

• As GDP rises above its natural rate, unemployment falls

For every 1% increase in the unemployment rate, a country's GDP will be roughly an additional 2% than its potential GDP. (EconedLink)

Okun’s Law

2 (unemployment rate-natural employment) = potential GDP-actual GDP potential GDP

X 100%

Formula of Okun’s Law

In other words, when unemployment rate goes up by 1%, GDP goes down by 2%

Practice Questions

Q According to Okun's law, when cyclical unemployment changes from -3% to -2%, the output gap changes from _____, measured relative to potential output.

A. -6% to -4%B. -3% to -2%C. -1% to 0%D. 3% to 2%E. 6% to 4%

Okun’s Law in the United States

-Okun’s law in the short can only be used in the short run-law must be regarded only as a rule of thumb and not as

a “structural feature” of the economy

Practice Questions

Q According to Okun's law, when cyclical unemployment increases from 2 to 4%, the output gap increases from ___ %.

A. -4 to -8B. -2 to -4C. 0 to 2D. 2 to 4E. 4 to 8

GDP Growth and Unemployment Rate in The Philippines

Misery Index

• A measure of economic well-being for a specified economy

• computed by taking the sum of the unemployment rate and the inflation rate for a given period

Unemployment rate + Inflation rate

• An increasing index means a worsening economic climate for the economy in question, and vice versa.

Example

Philippines as the 80th miserable country out of 108 countries--2014

Factors contributing in World Misery Index

• Inflation rate• Unemployment rate• Interest rate• GDP per capita

Consumer Price Index (CPI)

• It indicates the average prices paid by consumers for a market basket of goods and services from a base period.

Examples of goods and services: transportation, food and medical care

• Market basket is the term used for commonly purchased goods and services by an average household

Consumer Price Index (CPI)

• Measure of changes in the purchasing-power of a currency and rate in inflation (increase in prices)

CPI: Index that expresses the current prices of a basket of goods and services in terms of the prices during the same period in a previous year • Shows the effect inflation rate on purchasing

power

How is the CPI used?

1. As an economic indicator2. As a deflator of other economic series3. As a means of adjusting the value of the peso

Solving for the CPI

Sample Problem

Consumer Price Index CPI in Philippines increased to 142.60 Index Points in March from 142.50 Index Points in February of 2016. Consumer Price Index CPI in Philippines averaged 42.94 Index Points from 1957 until 2016, reaching an all time high of 142.90 Index Points in January of 2016 and a record low of 1.30 Index Points in February of 1957. Consumer Price Index CPI in Philippines is reported by the National Statistics Office of Philippines.

•When the general prices of goods and services increase• As inflation happens, the purchasing power of

peso decreases• The purchasing power of peso indicates how much

peso in the base year is worth in the current year•Measured using CPI

Inflation

Inflation rate

• Annual rate of change of the consumer price index (CPI)

Types of Inflation

1. Wage Inflation2. Cost-Push3. Price Power Inflation4. Sectoral Inflation

Wage Inflation• Also known as demand-pull or excess demand

inflation

• Total demand for goods and services > supply of goods and services

• Less supply; higher prices

Cost - Push • Increases in production cost push the increase

of increased prices• Increase in wages = Increase in the overall price

of the product

Pricing Power Inflation• Administered Price Inflation• Business houses and industries increase price

to increase profit margins• Cannot happen at times of economical crises

and economic depressions• Oligopolistic Inflation

Sectoral Inflation•Whenever a certain sector of industries

increase prices, increases the prices of other industries related to it• Layoffs will happen whenever this happens at

times of economic recession

Effects of Inflation: Two Types of Effects

Pros• Labor Market

Adjustment• Room to Maneuver•Mundell-Tobin

Effect• Instability with

Deflation

Cons• Cost-Push Inflation• Hoarding• Shoe Leather Cost• Social Unrest and

Revolt• Hyperinflation•Menu Cost

Labor Market Adjustments

• Results in high employment• Enables labor markets to reach equilibrium

Room to Maneuver

• Liquidity Trap•Moderate level of inflation = nominal interest

rates stay sufficiently above 0

Mundell-Tobin Effect• Moderate inflation = induce savers to substitute

lending for money holding• Fall of market clearing interest rates• Increase in investments due to lower interest rates

• Deflation is expected• Happens only after deflation occurs• Continual fall of prices• Long term deflation followed by periodic spikes in

prices

Instability with Deflation

Cost-Push Inflation

• Demand of an increase in wages = increase in price• Continual increase in prices due to increasing

demand for more pay

Hoarding

• Creates shortage in hoarded goods• Caused by fear in a decrease in the buying

power caused by inflation

Shoe Leather Cost

• Increases the opportunity cost in holding cash balances in interest paying account•More transaction will be needed slowly

depleting the cash

Social Unrest and Revolts• Revolutions caused by underpaid,

underemployment, etc

Hyperinflation

• An extremely rapid period of inflation• Caused by a rapid increase in money supply

Menu Costs

• Constant changing of menus by firms to keep up with the increase in prices

Phillips Curve

Simply states that employment rates are directly related to the inflation rate

Phillips Curve

● Wt - Wage in last period● Wt-1 - Wage in current period● E - Response of wage change to employment rate● U - U* - Employment Gap● U - Actual Employment● U* - Natural Rate of Unemployment

Wt-1 = Wt[1 - E(U-U*)]

Stagflation

Persistent high inflation combined with high unemployment rate and stagnant demand in the country's economy