Chapter 8
Economic Fluctuations, Unemployment, and Inflation
OUTLINE
I. Swings in the Economic Pendulum
A. A Hypothetical Business Cycle
2. The duration of business cycles is irregular and the magnitude of the swings in
economic activity varies.
II. Economic Fluctuations and the Labor Market
A. The non-institutional, civilian, adult, population is grouped into two broad categories:
(1) persons not in the labor force and (2) persons in the labor force.
B. Labor market participation rate = number in labor force (employed + unemployed) /
population (age 16 and over).
C. In order to be classified as unemployed, one must either be on layoff or actively
seeking work.
III. Three Types of Unemployment
A. Frictional Unemployment
1. Caused by imperfect information in a world of dynamic change.
2. Occurs because (1) employers are not fully aware of all available workers and their
B. Structural Unemployment
2. Reflects structural and demographic characteristics of labor market.
C. Cyclical Unemployment
2. When there is a general downturn in business activity, cyclical unemployment
increases.
IV. Employment Fluctuations The Historical Record
A. The Concept of Full Employment
1. Level of employment that results when the rate of unemployment is normal,
considering both frictional and structural factors.
2. Closely related to the concept of the natural rate of unemployment.
4. The natural rate of unemployment is neither a temporary high nor a temporary low;
it is a rate that is both achievable and sustainable into the future. It is the rate of
out
5. Natural rate of unemployment is influenced by both demographic factors (e. g.,
7. The unemployment rates of major European countries were substantially higher in
the last decade than the comparable figures for the United States and Japan.
V. Actual and Potential GDP
A.
VI. Effects of Inflation
A. Inflation is a sustained general rise in the level of prices. High rates of inflation are
almost always associated with substantial year-to-year swings in the inflation rate.
B. Anticipated and Unanticipated Inflation
1. Unanticipated inflation: an increase in the price level that comes as a surprise, at
least to most individuals.
2. Anticipated inflation: a change in the price level that is widely expected.
C. Harmful Effects of High and Variable Rates of Inflation
1. Because unanticipated inflation alters the outcomes of long-term projects like the
2. Inflation distorts the information delivered by prices.
3. People will respond to high and variable rates of inflation by spending less time
producing and more time trying to protect their wealth and income from the
uncertainties created by the inflation.
D. What Causes Inflation?
1. Nearly all economists believe that rapid expansion in the supply of money is the
cause of inflation.
OBJECTIVES
This chapter is designed as an overview of the material that will be discussed in the subsequent
chapters and introduces the student to several important economic issues. The business cycle is
defined and related to real-world economic indicators. The cost of obtaining information, economic
uncertainty, and inadequate aggregate demand are presented as factors contributing to real-world
unemployment. The concepts of
goods and services. Inflation is also defined and its effects are analyzed from an economic
Chapter 8/Economic Fluctuations, Unemployment, and Inflation 95
IMPORTANT POINTS AND TEACHING SUGGESTIONS
1. Carefully define the four phases of the business cycle. This is a good place to provide an
2. Discuss the data of Exhibit 3. This table will help students understand the various categories of
3. Many students have the idea that all unemployment is indicative of economic inefficiency. The
4. The term full employment is troublesome to both laypersons and professionals. Students
5. Of course, full employment incorporates the idea that at a given time there is a natural rate of
unemployment consistent with dynamic change, institutions, and the characteristics of the labor
6. Students are interested in how the unemployment rate is derived how many households are
sampled; what determines whether a person is classified as employed or unemployed; and
7. As the result of the ambiguities associated with the rate of unemployment, economists
increasingly have felt the need to supplement unemployment data with data on the rate of
8. Students (among others) often forget that inflation influences money earnings as well as prices.
If the rate of inflation in 1980 had been two percent (rather than approximately 12 percent), the
9. The social costs of inflation stem largely from the uncertainty that it generates. Be sure to bring
11.
representing the maximum sustainable level of real output. In turn, the output associated with
12. A humorous way to introduce discussion of issues such as discouraged workers and how the
typically reported unemployment data masks some very important information is to propose
Don Rickles to go berate those in the unemployment compensation lines about how they are
into stopping their search for work, the unemployment rate will decline. Then pose the
following questions: Does the lower unemployment rate indicate that society is better off? Will
output increase? Is the unemployment rate a good indicator of labor market conditions? Why
or why not?
13. It is worth emphasizing here that macroeconomic issues are not about statistical data but are
all social coordination issues, where coordination failures lead to adverse consequences for
14. Games 1 to 4 in the next section will help reinforce the material in chapter 8.
GAMES
Type: In-Class Assignment
Topics: unemployment categories
Textbook: Chapter 8: Economic Fluctuations, Unemployment, and Inflation
Chapter 8/Economic Fluctuations, Unemployment, and Inflation 97
Purpose
This assignment helps familiarize students with labor force statistics.
Instructions
Ask the students to classify each of the following individuals in one of the following categories:
employed, unemployed, not in the labor force.
Steve worked forty hours last week in a Music Supply store.
Last week, Elizabeth worked 10 hours as a computer programmer for the National Video
Company and attended night classes at the local college. She would prefer a full-time job.
Roger lost his job at the R-gone Manufacturing Company. Since then he has been trying to find a
job at other local factories.
Linda is a homemaker. Last week she was occupied with her normal household chores. She
neither held a job nor looked for a job.
Scott has a Ph.D. He worked full-
job.
Mary-Helen has been out of work for a full year. She would take a job if it was offered, but no
local companies are hiring. She is not actively searching for work.
Common answers and points for discussion
Steve, Elizabeth, and Scott are employed.
Roger is unemployed.
8.2 The Inflation Fairy
Type: In-Class demonstration
Topics: inflation
Textbook: Chapter 8: Economic Fluctuations, Unemployment, and Inflation
Materials Needed: none
Time: 10 minutes
Class limitations: works in any size class
98 Chapter 8/Economic Fluctuations, Unemployment, and Inflation
Purpose
This activity demonstrates the effects of inflation.
Instructions
Ask the class to consider the effect of an overnight doubling of prices.
Tell them everything doubled in price while they slept. A soft drink that sold for a dollar, now
sells for two dollars; a car that sold for $20,000 now sells for $40,000.
The price of labor doubled as well, so a job paying $6 an hour, now pays $12; a $30,000 annual
salary becomes a $60,000 annual salary.
closing. A thousand-dollar bond becomes a two thousand dollar bond. A $35 balance in a
checking account become $70, and so on.
Debts have also doubled. The $5 borrowed from a roommate becomes $10. The $3000 in student
loans becomes $6000. A $75,000 home mortgage becomes a $150,000 mortgage.
And even cash balances double. The inflation fairy sneaks in at night and replaces the $10 bill in
their wallet with a new $20 bill. The inflation fairy even doubles the coins in their penny jars.
If the prices of everything doubled overnight, what would happen?
Points for discussion
If the prices of everything doubled overnight, what would happen: NOTHING!
If all prices adjusted perfectly there would be no real effect. Everyone would have exactly the
same purchasing power. They have twice as much money but everything costs twice as much.
There have been no relative changes in price.
8.3 Changes in a Student Price Index
Type: Take-home assignment
Topics: inflation
Textbook: Chapter 8: Economic Fluctuations, Unemployment, and Inflation
Materials needed: Initial prices for a market basket (see Game 1 for Chapter 7)
Class limitations: works in any size class
Purpose
This assignment looks at how prices for a small market basket of goods change during the school
term. These price changes can be related to the overall rate of inflation. The importance of the
choice of market basket is also illustrated.
Instructions
A month after collecting the Price Index Assignment (Game one for Chapter 7), ask the students
to return to the stores and find the current prices for the same bundle of products.
Points for discussion
100 Chapter 8/Economic Fluctuations, Unemployment, and Inflation
Name____________________ Course ________________
Price Index Assignment II
Changes in the Consumer Price Index are a widely used measure of inflation.
Use your personalized student price index to calculate how prices have changed.
1. Use the same products and the same quantities at the same retail outlet.
3. Calculate the total cost of buying these products at their current prices.
8.4 Prices and Time
Type: Take-home assignment
Topics: Inflation
Textbook: Chapter 8: Economic Fluctuations, Unemployment, and Inflation
Class limitations: works in any size class
Purpose
This assignment looks at how prices change over a long period of time. These price changes can
be related to the overall rate of inflation.
Instructions
This assignment asks students to compare prices in the year they were born to current prices for
the same goods.
Points for discussion
Inflation makes comparisons of prices across long periods of time difficult. Old nominal prices
102 Chapter 8/Economic Fluctuations, Unemployment, and Inflation
Name____________________ Course _______________
Date of Birth _______________
Prices and Time
Part I. Historic Prices
1. Find the prices for 5 (or more) products in the year you were born. Be as specific as possible
2. What was the Federal minimum wage, when you were born?
Part II Current Prices
1. Find the current price for each of the products in Part I.
2. What is the Federal minimum wage now?
Part III. Comparisons
1. Do you think there has been a change in the quality of any of these products over this time
period?
2. How has technological change affected these products?
4. Calculate the percentage change in the minimum wage.
5. What has happened to the purchasing power of people earning the minimum wage?
Chapter 8/Economic Fluctuations, Unemployment, and Inflation 103
HINTS FOR ANSWERING CRITICAL ANALYSIS QUESTIONS
4. Full employment is the maximum level of employment that is both achievable and sustainable
11. The opportunity cost of job search for laidoff workers will drop since unemployment benefits