A. Recession: commonly accepted definition is two consecutive quarters of negative growth in Real GDP.
B. Why business activity fluctuates
1. Inventory Recession: Excessive optimism causes inventories to over expand and
eventually they must be worked down causing a recession.
2. Rolling Recessions: Economic downturn is limited to areas or sectors of the economy.
3. Innovation Cycle: railroads, computers, bio-technology
4. Political Events: wars, international trade
5. Misuse of Monetary and Fiscal Policy: government creates and/or borrows an incorrect
amount of money
6. Non-cyclical Fluctuations
a. Seasonal variation: Christmas buying rush, spring construction
b. Long-Term Secular Trends: the expansion or contraction in the level of economic activity
over a long period of years (the dark ages, the industrial revolution)
7. Durable Goods have a long useful life (houses, equipment, etc.) Sale of durable goods
contract substantially during a recession as their purchase may be easily postponed.
C. Leading, coincidental, and lagging indicators are measures such as the unemployment rate,
which respectively change before, with or after general economic activity. Economists use to predict
future economic activity.
D. Unemployment Types and special topics
1. Frictional is caused by time lags in the operation of labor markets.
a. Workers are between employment because they have been fired, are changing
careers, are seasonal workers, have been temporarily laid off, etc.
b. Short-term, inevitable, temporary, and is eliminated with time.
2. Structural is caused by changes in consumer demand and technology.
a. Result is an oversupply of workers with a particular skill.
b. This unemployment is often concentrated in a particular area, associated with a particular industry,
and is often permanent.
c. Increased economic activity will not decrease this type of unemployment as training and/or
relocation are required.
d. Happened in the 1970's and early 1980's as consumers decided to buy small foreign built cars
and other products produced in the Rust Belt. Now it is happening because NAFTA and
foreign competition are causing industries
to restructuring is needed because of foreign competition.
3. Cyclical
a. Caused by a lack of total demand at the end of an economic expansion
b. Temporary
c. Recession of the early 1990's was due to a drop in demand caused by a debt buildup in the
1980's by individuals, businesses, and the federal government. Apprehension caused by high
structural unemployment of both blue and white collar workers slowed the recovery.
d. Recession of 2001 was caused by debt build up of individuals resulting from the long period of
prosperity and the stock market bubble, excess capital investment caused by Y2K and
internet optimism, and September 11.
e. Great Recession of 2008-09 was caused by the end of an excessive building boom
compounded by a banking and stock market crisis.
4. Special topics
a. Natural unemployment (frictional + structural unemployment) is usually 4% to 6% of
the labor force
b. Full employment is when cyclical unemployment equals zero
c Okun's Law: a 1% increase in cyclical unemployment will cause a 1% increase in cyclical
unemployment will cause given a 2.5% annual drop in GNP
1) GNP change = 2.5 (unemployment rate change)
2) If unemployment goes up 2% as it did in the 1990-91 recession then the drop in
GNP would be 2.5 X 2% or 5%.
3). Cost to a 6 trillion dollar economy of 250 million people
(5% X $6,000,000,000,000) / 250,000,000 = $1,200/person/year.
E. Inflation is an increase in prices
as measured by a price index such as the
consumer producer index, CPI and
the Producer Price Index, PPI.
1. The PPI measures the change in wholesale
prices.
2 The PPI is a
leading indicator for CPI as
wholesalers can usually pass price changes
on to retailers who pass them to consumer.
a. Recent increases in
foreign competition made passing price increases on difficult.
b. The internet
had the same kind of affect in the late 1990's.
3. The inflation rate for a year when a basket of
consumer goods increase from
$400 to $420 would be calculated as follows.
4. Causes of inflation
a. Demand-pull inflation
1. Increases in C + I + G + XN will cause GDP to increase.
2. As the economy nears full employment, the prosperity caused by high
employment increases demand and put upward pressure on prices.
3. When this happens, the
economy is said to be overheated.
b. Cost-push inflation
1. As the economy approaches full employment factor resources become
scarce
allowing their owners to increase prices.
2. Supply-side shocks can cause high resource prices even if demand for
resources is low, i.e., OPEC's two oil embargoes of the 1970's
5. Economic effect of inflation
a. Both income and resource allocations are affected by inflation
as the market tries
to
adjust to the loss in value caused by inflation.
1. High gas prices in
the 1970's caused a switch to small cars and many people
bought wood stoves.
2. Low gas prices in the
1990's made RV's less expensive to run.
b. Debtors (homeowners, businesses, government) are helped by high inflation
because they pay back with dollars worth less than those
borrowed.
c. Creditors are hurt by inflation as they are paid
back in less valuable dollars.
d.Those on a fixed income are also hurt by the
cheaper dollars.
d. Cost-of-Living Increases (COLA's) were instituted in the 1970's
to negate
the severe effects of that period's high inflation.
e. Deflating GDP
1. Inflation can be taken
out of growth in GDP by expressing later year production
at earlier year prices.
2. In the following
chart, letters Q, P and T are quantity, price per unit
and total respectively.
1.
Laffer Curve
