1

Consequences

of Business

Fluctuations

Parts of Chapter 14 + Other Issues

• Fluctuations in business activity

• Consequences of business fluctuations

• Macroeconomic policy options

Discussion Topics

Length of cycles varies

over time…

Four Phases of a Business Cycle

Aggre

gat

e O

utp

ut

Time

Peak

Trough

Peak

Trough

2

• Keynesian – equilibrium levels differ from full

employment - changes to get to full employment

gives rise to the cycles

• Exogenous shocks – wars, credit crunch etc.

• Technological shocks - lumpy changes that increase

productivity

• Political – elect different administrations with

different policy goals

Causes of Business Cycles

• Lagging indicators - business inventories, duration

of employment, average interest rate

• Coincident indicators - current production, current

disposable income, current sales

• Leading indicators - new orders for goods, new

building permits, new investment in plant and

equipment, changes in the money supply

– Forecasting models - mathematical methods of

forecasting future trends in the economy

Indicators of Economic Activity

Conference Board – Components 2009 Weight /

Factor

Average weekly hours, manufacturing 0.2549

Average weekly claims, unemployment insurance 0.0307

Manufacturers’ new orders, consumer goods and materials 0.0774

Index of supplier deliveries – vendor performance 0.0677

Building permits, new private housing units 0.0270

Stock prices, 500 common stocks 0.0390

Money Supply, M2 0.3580

Interest rate spread, 10-year treasury bonds less federal funds 0.0991

Index of consumer expectations 0.0282

Manufacturers’ new orders, non-defense capital goods 0.0180

Leading Economic Indicators

http://www.conference-board.org/pdf_free/economics/bci/flaky.pdf

3

Conference Board – Components 2017 Weight /

Factor

Average weekly hours, manufacturing 0.2774

Average weekly claims, unemployment insurance 0.0330

Manufacturers’ new orders, consumer goods and materials 0.0821

Index of supplier deliveries – vendor performance 0.1587

Building permits, new private housing units 0.0298

Stock prices, 500 common stocks 0.0397

Leading Credit Index 0.0818

Interest rate spread, 10-year treasury bonds less federal funds 0.1123

Index of consumer expectations 0.1447

Leading Economic Indicators

http://www.conference-board.org/pdf_free/economics/bci/flaky.pdf

Note replaced money supply in 2012 with an index on interest rates S&D.

Indicator

index

Actual activity

several months

later…

A classical example

of a leading indicator

How it is Supposed to Work

http://www.conference-board.org/data/bcicountry.cfm?cid=1

4

http://www.conference-board.org/data/bcicountry.cfm?cid=1

Most Recent Notice Downturn Sept.

• Fluctuations in the unemployment rate

(civilian and capital) and implications for

policy

• Fluctuations in the rate of inflation and

implications for policy

Consequences of Business

Fluctuations

Monthly Unemployment Jan. 1948

– October 2017

Unemployment rate

during the great

depression was 25%

Full employment

barometer?

5

Monthly Unemployment U.S., Texas,

and B/CS 1976 – Sept. 2015

Texas lagged at the

start of the recession

Texas lagging at the

recovery?

Rate Number of civilians unemployed

Size of total civilian labor force =

where the size of the total civilian labor force is

determined by subtracting those not seeking jobs

(homemakers, students, etc.) from the total non-

institutional population (those not in prison) over

16 years of age, as well as, those who are in military

service.

Calculation of Civilian

Unemployment Rate

Assume the following values

Civilian labor force1 153.975 million

Employed persons 138.275 million

Unemployment 15.700 million

Not in force 82.316 million

Rate 15.700

153.975

=

= .102 or10.2 percent

1 The civilian labor force equals total population minus those not

seeking employment over age 16, those in institutions, and the military.

Example Oct. 2009

http://www.bls.gov/news.release/empsit.nr0.htm

6

Unemployment Rates

October

2009

March

2011

March

2013

March

2015

March

2017 Oct. 2071

All Workers

16+ 9 9.2 7.6 5.6 4.6 3.9

Adult men 7.3 10.2 8 6 4.9 3.9

Adult

women 7.3 8 7.2 5.1 4.1 3.8

Teenagers

16-19 21.5 23.6 23.3 17 13.1 13.4

White 8.5 5.3 6.9 4.9 4 3.3

Black /

African

American 13.5 15.5 12.8 10 9.1 7.5

Hispanic or

Latino 12.2 11.9 9.5 7 5.2 4.6

Earnings

Seasonally

adjusted

Private Workers Oct-09 Mar-11 Mar-13 Mar-15 Mar-17 Oct.-17

Average hours of

work /week 33.8 34.3 34.5 34.5 34.3 34.4

Average hourly

earnings 22.06 22.87 23.8 24.85 26.13 26.53

Average weekly

earnings 745.63 784.44 821.1 857.33 896.26 912.63

• Frictional - changing jobs and currently unemployed

• Cyclical - associated with business cycles

• Seasonal - associated with seasonal business activity

• Structural - associated with technological change

Forms of Unemployment

7

Monthly U.S. Percent Utilization of Refinery

Operable Capacity Jan. 1985 – Aug. 2017

Hurricane Ike

Hurricane Rita

Decreased from 92 to 81

Dec 2013 – Feb. 2013

Currently at 92.8

• Sustained rise in the general price level

• Not a change in the price of a single commodity

• Core rate of inflation excludes fuel and food price

increases

• Deflation (prices falling) vs. disinflation (prices

increasing at a slower rate)

What is Inflation?

CPI Index

• Consumer Price Index (CPI)

– CPI - represents changes in prices of all goods and

services purchased for consumption by urban

households

– Weighted basket of goods – Food and beverages, housing, apparel,

transportation, medical care, recreation, education and communication, and other goods

and services http://www.bls.gov/cpi/

8

Food and Beverages 14.649

Housing 42.634

Apparel 3.034

Transportation 15.318

Medical Care 8.539

Recreation 5.663

Education and communication 6.984

Other Goods and Services 3.178

Components / Weights in CPI 2016

https://www.bls.gov/cpi/cpiri_2016.pdf

Example Sub Category Weights

The consumer price index is a weighted average of

the prices consumers pay for goods and services.

It is measured by:

CPI =

Cost current year

Cost = WFB(PFB) + WH(PH) + … + WOTHER(POTHER)

= 15.757(PFB) + 43.421(PH) + … + 3.386(POTHER)

Cost of market basket in current year

Cost of market basket in base year × 100

Weights

Measuring the CPI

9

Grade Calculations

A) Total points = 600 possible = HW + clicker + tests + final + bonus points

B) HW 175 points = (sum of HW points / 429) * 175 = number out of 175

Note the value of 429 includes all possible HW

C) Clicker points = 75 possible = (sum of clicker points / 95.75)*75 - based

on values up to the start of class today will change as we have more

clicker questions

D) Test points = 200 possible = two highest test scores

E) Final 150 points – CURRENTLY YOU HAVE ZERO POINTS

F) Bonus points – added to total points = 10 possible = 5 each for out of class

videos

G) Up to you to check for missing / problems with grades by Friday

e-mail: j-mjelde@tamu.edu

A) We reserve the right to correct errors

The rate of inflation can be measured by the percent

change in the CPI, or

Inflation rate = current CPI – previous CPI

previous CPI

If the CPI was 216.17 in the last half of 2008 and

213.139 in the first half of 2009 what was the rate

of inflation rate

= (213.139 – 216.177) ÷ 216.1779

= -0.014 or -1.4%

Calculating Rates of Inflation

Year CPI Inflation rate

2005 195.300 ---

2006 201.600 = (201.6 – 195.3) / 195.3

= 0.0323 = 3.23%

2007 207.342 = (207.342 - 201.600) / 201.600

= 0.0285 = 2.85%

2008 215.303 =(215.303 – 207.342) / 207.342

= 0.0384 = 3.84%

Calculating Rates of Inflation

10

Annual Rates 1913 - 2016

Inflation thought

to be “under

control” in this

range. FED

2012 long run

goal is 2% Brought about a major

monetary policy action

CPI and Core Index –Quarterly

Red line – core some differences – mainly less variability

When describing growth in the economy on

the nightly newscast, the newscaster will

refer to the growth in real GDP after adjustments

for inflation. In the above example, real GDP

grew over the 1992-1999 period, but not at the

rate implied by comparisons in nominal terms.

11

GDP nominal rate of increase = (86-60)/60 *100 = 43%

GDP real rate of increase = (69-60)/60 *100 = 15%

Difference is because of inflation and not an increase in

productivity

Nominal and Real Growth GDP

Annual 1929 - 2016

• New Zealand Economist

– Educated at London School of Economics

– Phillips curve and MONIAC

• Early career

– Crocodile hunter and cinema manager

– Studied electrical engineering before the war

• WWII

– Singapore and than Java

– Captured

• learned Chinese, repaired and miniaturized a secret radio,

fashioned a secret water boiler for tea which hooked into camp

lighting system

W.E. Phillips

12

Phillips Curve U

nem

plo

ym

ent R

ate

Inflation Rate

9%

4%

3% 6%

Phillips curve named after

British economist A. W.

Phillips…

Policies that reduce

unemployment may

increase inflation in

the short run, and

vice versa…

Demand Pull Inflation

Pric

e L

ev

el

Y0 YPOT

AD0

AS

YFE

P0

AD1

P1

Y1

Inflation rate

(P1 – P0) ÷ P0

Aggregate Output

Demand oriented policies

that shift the aggregate

demand curve from AD0

to AD1 “pull up” the

general price level from P0

to P1.

This small increase in

inflation may make sense

since output increased

from Y0 to Y1, which would

lower unemployment.

Demand Pull Inflation and Unemployment

Pric

e L

ev

el

Y0 YPOT

AD0

AS

YFE

P0

AD1

P1

Y1 Inflationary gap

Created YE =

YPOT > YFE Inflation rate

(P3 – P1) ÷ P1

AD3

P3

Aggregate Output

Demand oriented policies

to maximize output at the

economy’s potential or

YPOT may bring about a

substantial increase in the

general price level (and

hence rate of inflation) for

a relatively small gain in

output and employment.

13

Cost Push Inflation and Unemployment

Pric

e L

evel

Y0

AS0

P0

AD0

P

1

Y1

Inflation rate

(P1 – P0) ÷ P0

Aggregate Output

Increase in the cost of

production thus a decrease is

AS0 to AS1 may bring about an

increase in the general price

level (and hence rate of

inflation) and a decrease in

output and employment.

AS1

Supply Side – Normal Range

Pric

e L

ev

el

Y0

AD0

AS0

YFE

P0

P1

Y1

Inflation rate

(P1 – P0) ÷ P0 Aggregate Output

AS1 Supply oriented policies that

enhance productivity reduce

the general price level.

Policies – See production

Research / Development

Technology

Infrastructure

Subsidies

Tax rates on business

Stimulates Y as with

demand side policies

Demand vs. Supply Policies

Pric

e L

ev

el

Y0

AD0

AS0

YFE

P0

P1

Y1

Aggregate Output

AS1

Pric

e L

ev

el

Y0

AD0

AS0

YFE

P0

P1

Y1

Aggregate Output

AD1

Both demand and supply

oriented policies stimulate

aggregate output.

Demand expansion policy “pulls up” the general price level….

Supply expansion policy reduces the general price level …

14

Demand vs. Supply Policies

YFE - new

AS1

Pric

e L

evel

Y0

AD0

AS0

YFE

P0

P1

Y1

Aggregate Output

AD1

In reality, both forms of

policy are typically carried

out at the same time.

New Equilibrium

Change in price levels depends

on the shifts in the two curves

New YFE

Summary

• A business cycle has four phases: peak, recession,

trough and expansion

• The two major consequences of business fluctuations

are unemployment and inflation

• Know how to calculate the civilian unemployment

rate and the rate of inflation facing consumers

• Understand the nature of the index of leading

economic indicators

• Understand the concept graphing of demand pull

inflation

• Understand the Phillips curve and demand and

supply policy impacts