Business Cycles and Economic Fluctuations

Business Cycles

• A business cycle is the cycle of short-term ups and downs in the economy
• Recession: a period of decline in aggregate output, conventionally defined as a decline in output for two consecutive quarters
• Depression: a prolonged and deep recession
• Expansion or Boom: a general increase in output and employment
• Contraction, Recession, or Slump: a period of decline in output and employment from a peak to a trough
• Peak: a period of high aggregate demand and output growth
• Trough: the lowest point of economic activity in the business cycle
• Recovery stage: the phase after the trough, where the economy starts growing again

Causes of Business Cycles

• Political factors: pre-election spending increases and tax cuts, and post-election reversals of these policies
• International economic factors: globalization of product and financial markets, international transmission of economic activity
• Domestic economic factors: the multiplier-accelerator model, focusing on stock (inventory) adjustment

Employment and Unemployment

• Employed individuals: those who are 14 years and over, engaged in some economic activity for at least one hour in the week before the survey
• Categories of employment:
  • Paid employment: working for a wage or salary
  • Paid self-employment: working for profit or family gain
  • Unpaid workers: working without pay in an economic enterprise
• Unemployed individuals: those who are 14 years and over, without work, available for work, and seeking work
• Unemployment rate: the percentage of the unemployed to the total labour force (employed and unemployed)

Labour Force and Labour Market

• Labour force: the sum of the employed and unemployed
• Labour force participation rate: the proportion of the working-age population actively engaged in the labour market
• Labour market indicators: unemployment rate, labour force participation rate, employment to population ratio

Types of Unemployment

• Frictional unemployment: due to normal turnover in the labour market, e.g. people moving between jobs or changing occupations
• Structural unemployment: due to workers being displaced by automation, or their skills no longer being in demand
• Cyclical unemployment: due to a decline in the economy's total production
• Seasonal unemployment: due to changes in seasons, e.g. agricultural or tourism-related work

Macroeconomic Policy and Unemployment

• One of the aims of macroeconomic policy is to keep cyclical unemployment to a minimum
• Full employment: the condition where the unemployment rate is equal to the natural rate of unemployment
• Natural rate of unemployment: the unemployment rate that exists when the labour market is in equilibrium, with supply and demand for labour equal

Impact of High Unemployment

• Loss of output, crime, and violence, anxiety, and depression, suicide, decline in health levels, loss of human capital, and loss of revenue and increase in expenditure for the government

Methods to Alleviate High Unemployment

• Unemployment insurance, social welfare programs, increase in government spending, reduction in tax rates, and increasing exports

Labour Productivity

• Labour productivity: the amount of output a worker produces in an hour, measured by GDP per hour of work
• Labour productivity per hour = GDP / Total Hours worked
• Output per Worker = GDP / Employed Labour

Okun's Law

• Okun's law: a 1% increase in cyclical unemployment is associated with a 2.5% loss of full employment output
• Inverse relationship between unemployment rate and GDP

Phillips Curve

• Phillips curve: the statistical relationship between inflation and unemployment
• Inverse relationship between unemployment and inflation rate in the short-run
• No trade-off between unemployment and inflation in the long-run

Inflation

• Inflation: an increase in overall price levels
• Inflation rate: the percentage change in the price level
• Measured by calculating the average increase in the prices of a large number of goods during a period of time
• Types of inflation: creeping, hyper, stagflation, and anticipated/unanticipated inflation

Output Gap

• Output gap: the difference between the level of actual output and potential output
• When actual output exceeds potential output, there is a positive output gap and inflation tends to rise
• When actual output falls below potential output, there is a negative output gap and downward pressure on inflation

Real and Nominal Interest Rates

• Real rate of interest: the percentage increase in purchasing power that the borrower pays to the lender
• Nominal rate of interest: the percentage by which the money the borrower pays back exceeds the money borrowed, making no adjustment for inflation

Deflating

• Deflating: the process of finding the real value of some monetary magnitude by dividing by a price index (CPI)
• Deflating monetary figures: Real spending = Nominal spending x 100 / CPI
• Deflating the real wage: Real wage = Nominal wage x 100 / CPI

Business Cycles

• A business cycle is the cycle of short-term ups and downs in the economy, including recession, expansion, contraction, peak, trough, and recovery stages.
• Recession: a period during which aggregate output declines, conventionally for two consecutive quarters.
• Depression: a prolonged and deep recession.
• Expansion or Boom: a general increase in output and employment.
• Contraction, Recession or Slump: a period from a peak down to a trough during which output and employment fall.
• Peak: a period when aggregate demand reaches a peak and the economy's output is growing faster than its long-term trend, making it unsustainable.
• Trough: the phase when the level of economic activity is at its lowest point in the business cycle.
• Recovery stage: the phase after the trough, when the economy starts growing, but it is below the recent peak.

Causes of Business Cycles

• Political factors: associated with pre-election spending increases and tax cuts by governments, and a reversal of these policies after an election.
• International economic factors: focus on the international transmission of economic activity, including globalization of product and financial markets.
• Domestic economic factors: the multiplier-accelerator model is central to an explanation of the business cycle, with emphasis on stock (inventory) adjustment.

Employment and Labour Force

• An employed person is defined as someone 14 years and over who is engaged in some economic activity for at least one hour in the week before the survey.
• The employed are classified into three categories: paid employment, paid self-employment, and unpaid workers.
• The labour force is defined as the sum of the employed and the unemployed, including those who are:
  • Employed in any form of economic activity for one hour or more during the survey week.
  • Had jobs but were absent from work during the reference period.
  • Had no job, or worked less than one hour during the survey week, but were looking for work.
  • Did not look for work, but wanted work and were in a position to accept work during the survey week.

Labour Force Participation Rate

• The labour force participation rate is a measure of the proportion of the working-age population that is actively engaged in the labour market, either by working or looking for work.
• It is defined as the ratio of the total labour force to the working-age population and is expressed as a percentage.

Unemployment

• An unemployed person is defined as someone 14 years and over who satisfies three conditions simultaneously:
  • Without work, i.e., not in paid employment or self-employment.
  • Currently available for work, i.e., available for paid employment or self-employment during the reference period.
  • Seeking work, i.e., had taken specific steps in a specified recent period to seek paid employment or self-employment.
• The 'relaxed' definition of unemployment is used in Jamaica, where a person is defined as unemployed if they are 'without work', 'currently available for work', but have not taken any step to seek work.

Unemployment Rate

• The unemployment rate is the percentage of the unemployed to the total labour force (sum of the employed and unemployed).
• It is a key labour market indicator and a good measure of current economic activity.