Business Cycles, Wages and Unemployment
EC 202 February 7, 2011
Business Cycles, Wages and Unemployment 1) Business cycle ⇒ Alternating periods of economic growth and contraction, which can be measured by changes in the real GDP.
a) Four phases of business cycle i ) Peak ⇒ Real GDP reaches its maximum after rising in a recovery ii ) Recession ⇒ Real GDP declines, and the unemployment rate rises (also known as a contraction). iii ) Trough ⇒ Real GDP reaches its minimum after falling in a recession.
February 7, 2011 Page 2 iv ) Recovery ⇒ Upturn in the business cycle during which real GDP rises (also called an expansion) b) Economic growth ⇒ An expansion in national output measured by the annual increase in the nation’s real GDP i ) Macroeconomic performance determined through interaction of aggregate demand and aggregate demand (1) Aggregate demand is the total quantity of output (real GDP) demanded at alternative price levels in a given time period (2) Aggregate supply is the total quantity of output (real GDP) producers are willing and able to supply at alternative price levels in a given time period (3) Macroeconomic equilibrium is the unique combination of prices and output that is compatible with both buyers and sellers (i.e., mutually compatible exchange transactions throughout economy)
February 7, 2011 Page 3 ii ) Macro equilibrium indicates economy on its PPC iii ) Goal is to grow economy over time iv ) The long-term average economic growth in the US is 3% v ) In 2007, Real GDP growth rate for (1) China = 10.0% (2) India = 8.4% (3) Japan = 2.3% (4) United States = 2.0% (5) Germany = 1.8% c) Macro growth varies over time due to shifts in aggregate demand and aggregate supply curves i ) Instability in system causes business cycles (1) Increase in price of oil will shift aggregate supply to left (2) Housing bubble burst of 2007 shifted aggregate demand ii ) Government intervention via fiscal and monetary policy is attempt to reduce instability in business cycle 2) Business Cycle indicators a) Leading indicators ⇒ Variables that change before real GDP changes. Used to forecast future trend in business cycle (1) Average workweek (2) Unemployment claims (3) New consumer goods orders (4) New orders for plant and equipment (5) New building permits (6) Stock prices (7) Money supply (8) Interest rates (9) Consumer expectations b) Coincident indicators ⇒ Variables that change at the same time that real GDP changes. (1) Nonagricultural employment (2) Personal income (3) Industrial production (4) Manufacturing and trade sales c) Lagging indicators ⇒ Variables that change after real GDP changes. (1) Unemployment rate (2) Duration of unemployment (3) Labor cost per unit of output (4) Consumer price index for services (5) Commercial and industrial loans
February 7, 2011 Page 4 (6) Prime rate (The Prime Interest Rate is the interest rate charged by banks to their most creditworthy customers) 3) Wages a) Labor market i ) Wages based on productivity of individual workers and the added value the workers contribute to production ii ) Value (i.e., wage) of worker is the worker’s marginal production multiplied by the price of that production (1) Revenue generated by worker must be equal-to-orgreater-than the worker’s wage rate (2) Value of marginal production >= Wage rate iii ) Demand for labor and, therefore, wages, will increase if (1) The price of output increases (2) The workers’ productivity increases iv ) Supply of labor (1) Cost/benefit principle (a) Worker will accept job only if the pay (benefit) exceeds the worker’s opportunity cost (b) Worker’s opportunity cost should include both monetary values (e.g., pay of other job opportunities) and nonmonetary values (e.g., value of leisure time) (2) Factors that, overtime, will shift labor supply curve (a) Domestic birthrate (b) Immigration and emigration (c) Age at which individuals enter and retire from workforce (d) Percent of working age population seeking employment b) Five important labor market trends i ) Over the long-term, workers in all industrial countries have experienced substantial increase in real wages (i.e., purchasing power of income) ii ) Since the 1970s, real wage growth in the US has slowed iii ) In the US, the wage inequality between unskilled and skilled workers has increased iv ) In the US, the percent of working age population that are employed has increased v ) In most European countries, the unemployment rate has been higher than that in the US (Note: excluding 2007-2009 recession) 4) Unemployment a) Unemployment rate ⇒ Determined by the Bureau of Labor Statistics (BLS, US Dept of Labor) b) Definitions used by BLS
February 7, 2011 Page 5 i ) Civilian labor force ⇒ The number of people 16 years of age or older who are employed or who are actively seeking a job (excludes individuals in the armed forces, homemakers, discouraged workers, and other persons not in the labor force) ii ) Unemployment rate ⇒ The percentage of people in the civilian labor force who are without jobs and are actively seeking jobs c) Criticisms ⇒ i ) Unemployment rate does not count discouraged workers (1) Person who wants to work, but has given up searching for work because discouraged by lack of job offers/opportunities (2) BLS counts a discouraged worker as anyone who has searched for work within the last twelve months, but for the past four weeks is no longer actively looking for work ii ) Involuntary part-time workers are counted as employed (1) Person who would like to work full-time, but can only find part-time work (i.e., underemployed workers) (2) Some suggest these workers should be counted as partially unemployed iii ) The problem of Discouraged and Involuntary part-time workers in the US appears to be significant d) Types of unemployment i ) Frictional (1) Unemployment caused by the normal search time required by workers with marketable skills who are changing jobs, initially entering the labor force, reentering the labor force, or seasonally unemployed (2) Normal condition in economic system that allows freedom of job choice ii ) Structural (1) Unemployment caused by a mismatch of the skills of workers out of work and the skills required for existing job opportunities (2) Many causes (a) New technology and products (b) Limited education reduces job opportunities (c) Foreign competition (d) Geographic differences (i.e., new opportunities may not be where you live) (e) Government priorities and policies (f) Restricted entry in jobs iii ) Cyclical (1) Unemployment caused by lack of jobs during a recession
February 7, 2011 Page 6 (2) During contractions in business cycle jobs disappear and labor supply exceeds labor demand (3) Macroeconomic policy is used in an attempt to moderate cyclical unemployment 5) The Goal of Full Employment a) Also called the Natural Rate of Unemployment i ) The situation in which an economy operates at an unemployment rate equal to the sum of the frictional and structural unemployment rates ii ) Does not include cyclical unemployment b) Current general consensus is that the Natural Rate of Unemployment is about 5 percent (considered 4% in 1960s) i ) Difficult to determine because (1) Composition of labor force changes overtime (2) Changes in government policies regarding transfer payments ⇒ unemployment insurance, food stamps, Social Security benefits 6) The GDP Gap a) The difference between real GDP and the potential (i.e., full employment of resources) real GDP b) GDP Gap = Actual Real GDP – Potential Real GDP c) Measures the monetary losses of real goods and services to the nation from operating at less than full employment of resources d) Nonmonetary and Demographic consequences of GDP Gap i ) Individuals who have difficulty supporting family suffer emotional stress and potentially associated impacts on physical and mental health ii ) Burden of unemployment tends to vary depending on race, age, and educational attainment. For example, in 2007 (1) Overall unemployment rate was 4.7% (2) Among all teenagers it was 15.7% (3) Race (a) White – 4.1% (b) Hispanic – 5.6% (c) African-American – 8.3% (4) Education (a) Less than High School – 7.1% (b) High School – 4.4% (c) Bachelor’s degree or higher – 2%
Business Cycles, Wages and Unemployment 1) Business cycle ⇒ Alternating periods of economic growth and contraction, which can be measured by changes in the real GDP.
a) Four phases of business cycle i ) Peak ⇒ Real GDP reaches its maximum after rising in a recovery ii ) Recession ⇒ Real GDP declines, and the unemployment rate rises (also known as a contraction). iii ) Trough ⇒ Real GDP reaches its minimum after falling in a recession.
February 7, 2011 Page 2 iv ) Recovery ⇒ Upturn in the business cycle during which real GDP rises (also called an expansion) b) Economic growth ⇒ An expansion in national output measured by the annual increase in the nation’s real GDP i ) Macroeconomic performance determined through interaction of aggregate demand and aggregate demand (1) Aggregate demand is the total quantity of output (real GDP) demanded at alternative price levels in a given time period (2) Aggregate supply is the total quantity of output (real GDP) producers are willing and able to supply at alternative price levels in a given time period (3) Macroeconomic equilibrium is the unique combination of prices and output that is compatible with both buyers and sellers (i.e., mutually compatible exchange transactions throughout economy)
February 7, 2011 Page 3 ii ) Macro equilibrium indicates economy on its PPC iii ) Goal is to grow economy over time iv ) The long-term average economic growth in the US is 3% v ) In 2007, Real GDP growth rate for (1) China = 10.0% (2) India = 8.4% (3) Japan = 2.3% (4) United States = 2.0% (5) Germany = 1.8% c) Macro growth varies over time due to shifts in aggregate demand and aggregate supply curves i ) Instability in system causes business cycles (1) Increase in price of oil will shift aggregate supply to left (2) Housing bubble burst of 2007 shifted aggregate demand ii ) Government intervention via fiscal and monetary policy is attempt to reduce instability in business cycle 2) Business Cycle indicators a) Leading indicators ⇒ Variables that change before real GDP changes. Used to forecast future trend in business cycle (1) Average workweek (2) Unemployment claims (3) New consumer goods orders (4) New orders for plant and equipment (5) New building permits (6) Stock prices (7) Money supply (8) Interest rates (9) Consumer expectations b) Coincident indicators ⇒ Variables that change at the same time that real GDP changes. (1) Nonagricultural employment (2) Personal income (3) Industrial production (4) Manufacturing and trade sales c) Lagging indicators ⇒ Variables that change after real GDP changes. (1) Unemployment rate (2) Duration of unemployment (3) Labor cost per unit of output (4) Consumer price index for services (5) Commercial and industrial loans
February 7, 2011 Page 4 (6) Prime rate (The Prime Interest Rate is the interest rate charged by banks to their most creditworthy customers) 3) Wages a) Labor market i ) Wages based on productivity of individual workers and the added value the workers contribute to production ii ) Value (i.e., wage) of worker is the worker’s marginal production multiplied by the price of that production (1) Revenue generated by worker must be equal-to-orgreater-than the worker’s wage rate (2) Value of marginal production >= Wage rate iii ) Demand for labor and, therefore, wages, will increase if (1) The price of output increases (2) The workers’ productivity increases iv ) Supply of labor (1) Cost/benefit principle (a) Worker will accept job only if the pay (benefit) exceeds the worker’s opportunity cost (b) Worker’s opportunity cost should include both monetary values (e.g., pay of other job opportunities) and nonmonetary values (e.g., value of leisure time) (2) Factors that, overtime, will shift labor supply curve (a) Domestic birthrate (b) Immigration and emigration (c) Age at which individuals enter and retire from workforce (d) Percent of working age population seeking employment b) Five important labor market trends i ) Over the long-term, workers in all industrial countries have experienced substantial increase in real wages (i.e., purchasing power of income) ii ) Since the 1970s, real wage growth in the US has slowed iii ) In the US, the wage inequality between unskilled and skilled workers has increased iv ) In the US, the percent of working age population that are employed has increased v ) In most European countries, the unemployment rate has been higher than that in the US (Note: excluding 2007-2009 recession) 4) Unemployment a) Unemployment rate ⇒ Determined by the Bureau of Labor Statistics (BLS, US Dept of Labor) b) Definitions used by BLS
February 7, 2011 Page 5 i ) Civilian labor force ⇒ The number of people 16 years of age or older who are employed or who are actively seeking a job (excludes individuals in the armed forces, homemakers, discouraged workers, and other persons not in the labor force) ii ) Unemployment rate ⇒ The percentage of people in the civilian labor force who are without jobs and are actively seeking jobs c) Criticisms ⇒ i ) Unemployment rate does not count discouraged workers (1) Person who wants to work, but has given up searching for work because discouraged by lack of job offers/opportunities (2) BLS counts a discouraged worker as anyone who has searched for work within the last twelve months, but for the past four weeks is no longer actively looking for work ii ) Involuntary part-time workers are counted as employed (1) Person who would like to work full-time, but can only find part-time work (i.e., underemployed workers) (2) Some suggest these workers should be counted as partially unemployed iii ) The problem of Discouraged and Involuntary part-time workers in the US appears to be significant d) Types of unemployment i ) Frictional (1) Unemployment caused by the normal search time required by workers with marketable skills who are changing jobs, initially entering the labor force, reentering the labor force, or seasonally unemployed (2) Normal condition in economic system that allows freedom of job choice ii ) Structural (1) Unemployment caused by a mismatch of the skills of workers out of work and the skills required for existing job opportunities (2) Many causes (a) New technology and products (b) Limited education reduces job opportunities (c) Foreign competition (d) Geographic differences (i.e., new opportunities may not be where you live) (e) Government priorities and policies (f) Restricted entry in jobs iii ) Cyclical (1) Unemployment caused by lack of jobs during a recession
February 7, 2011 Page 6 (2) During contractions in business cycle jobs disappear and labor supply exceeds labor demand (3) Macroeconomic policy is used in an attempt to moderate cyclical unemployment 5) The Goal of Full Employment a) Also called the Natural Rate of Unemployment i ) The situation in which an economy operates at an unemployment rate equal to the sum of the frictional and structural unemployment rates ii ) Does not include cyclical unemployment b) Current general consensus is that the Natural Rate of Unemployment is about 5 percent (considered 4% in 1960s) i ) Difficult to determine because (1) Composition of labor force changes overtime (2) Changes in government policies regarding transfer payments ⇒ unemployment insurance, food stamps, Social Security benefits 6) The GDP Gap a) The difference between real GDP and the potential (i.e., full employment of resources) real GDP b) GDP Gap = Actual Real GDP – Potential Real GDP c) Measures the monetary losses of real goods and services to the nation from operating at less than full employment of resources d) Nonmonetary and Demographic consequences of GDP Gap i ) Individuals who have difficulty supporting family suffer emotional stress and potentially associated impacts on physical and mental health ii ) Burden of unemployment tends to vary depending on race, age, and educational attainment. For example, in 2007 (1) Overall unemployment rate was 4.7% (2) Among all teenagers it was 15.7% (3) Race (a) White – 4.1% (b) Hispanic – 5.6% (c) African-American – 8.3% (4) Education (a) Less than High School – 7.1% (b) High School – 4.4% (c) Bachelor’s degree or higher – 2%
