The Business Cycle

Below is a basic diagram of the business cycle (Figure 1).

Figure 1 adapted from Krugman & Wells, 2013, P. 171

In the diagram, four separate elements of the business cycle can be seen. The first element is the expansion, where growth is positive. The cycle then reaches a peak where the growth turns from positive to negative. The business cycle then enters a period of contraction, which is illustrated in this diagram by the purple bars. During contraction the size of the economy is shrinking. These times of shrinkage are called recessions, which are two or more quarters of consecutive shrinkage. It is possible to have a shorter contraction that is not a recession, but that is not illustrated in the graph. The shrinkage then stops, and then growth begins again. This local minimum on the diagram is known as a business cycle trough. Overall, despite the cyclical nature of the ups and downs in the business cycle, the upward trend is illustrated with the orange line, a mean with which to revert to.

There are certain economic phenomena related with each segment. For periods of growth in the expansionary phase, the biggest worry is that people might have too much money to spend. Though counter-intuitive, when there is too much money in the economy, the risk of inflation rises as there is too much money chasing too few goods, and the price level rose. Conversely, during times of contraction and especially those that are long enough to be called during recessions, the risk of unemployment is present, as companies lay off workers in reaction to less consumption.

Though there are recessions shown on the diagram, there is one final rare business cycle phenomenon that is not shown on the chart. That would be the potential for depression, which is an extended slump such as happened globally in the 1930s. Through the use of both fiscal and monetary policy, governments were able to make sure that the most recent fiscal downturn was just a deep recession instead of another replay of the Great Depression (Krugman & Wells, 2013, p. 168).  

References

Krugman, P. & Wells, R. (2013). Macroeconomics. New York, NY : Worth Publishers

 

On Unemployment

To be unemployed has a strict technical meaning of people who do not have a job but are actively looking for a job. In the United States, the BLS tracks the number of people who are in the labor force but do not have a job, in a report issued every month (Krugman & Wells, 2013, p. 215).

There are multiple ways to get to that point. Even in a growing economy, people are leaving jobs all the time. There is a transition period between the time a worker leaves a job and the time they enter a new job. For example, if a worker wants job in another state, and they quit one position but the new position is not immediately forthcoming, the time the worker is in transition from the old job to the new job is a time they are technically unemployed. This is called frictional unemployment (Krugman & Wells, 2013, p. 221). Frictional unemployment is always present in the economy and not necessary and bad thing. It can mean that people are finding positions that are better fits for their skill sets.

There is more pernicious way for a worker to be unemployed. The economy works through cycles, where there are periods of growth and periods of contraction. The number of jobs available at times of growth increase and the number of jobs available as the economy shrinks decreases. Workers caught up in this “cyclical unemployment” are why the unemployment rate increase is recessions. They are jobless through the workings of firm-level responses to the business cycle. Fortunately, for the effected workers, a safety net exists to soften the blow of the job loss for those affected. For example, federal unemployment insurance was increased to 99 weeks of benefits in some states during the peak of joblessness during the most recent recession. They were able to re-enter the workforce when as the economy once again found itself on a growth track.

The worst form of unemployment is when there is a surplus of workers even during the peaks in the business cycle. This surplus is called “structural unemployment,” and can have multiple causes. The main factor is that the wage rate for whatever reason is above the equilibrium rate so that the quantity demanded of jobs is less than the quantity supplied of jobs, and there is a gap where people who would be willing workers are locked out of work. Examples of this include a minimum wage, where businesses would hire more workers at a lower rate but the statutory minimum means those potential workers find themselves without. Another example is labor unions, where in the same mechanism the negotiated rate is higher than the clearing rate, and the price floor protects the incumbents who hold the jobs at the expense of the surplus workers who would work the positions in the simple supply and demand framework (Krugman & Wells, 2013, p. 168).  

References

Krugman, P. & Wells, R. (2013). Macroeconomics. New York, NY : Worth Publishers

 

Comparing GDP

The GDP calculation discussed in the previous post is a fine way to compare different areas at the same point in time. It does, however, have two weaknesses.

The first weakness is that the value of the unit of account changes. Anyone living long enough knows that over time the dollar bill can purchase less as time passes. The nominal price level increases, so that makes it difficult to compare one year to another and less useful the more time that passes. If economists wanted to look at growth in one country that had a GDP of one trillion in 1995 and ten trillion in 2014, does it make sense for her to say that in the intervening years, the economy of that country had grown ten times? The answer is “no” because we do not have a measure of the inflation between those years. First, the economist would have to find the rate of inflation so that those two numbers are being compared in terms of dollars that have the same value. Once this adjustment is made, then the economist can compare the overall size of the economy more accurately. This measurement of calculating the GDP as if prices did not change is the Real GDP (Krugman & Wells, 2013, p. 199). Stating measurement of GDP in terms of Real GDP allows measurement of the same country across time.

The second weakness of the nominal GDP obtained from addition of the inputs is that it is not easily used to compare across countries. A good example of the comparison is that between the United States and China. China recently passed Japan to become the world’s second largest economy in terms of the nominal GDP, and they are closing in on the United States in pure dollars. Politicians have raised the specter of a rising China as a competitor to the US. The problem is that such comparisons rely on the innumeracy of the electorate. Though the China is approaching the US in terms of overall size, the population of the country is roughly four times that of the United States. That means that if you took the final value of the goods and services that accrued to China and divided it by the population of China, and made the same calculation for the United States, the value of these goods and services per each individual would be almost four times higher for those in the United States. This measurement is the GDP per Capita measurement (Krugman & Wells, 2013, p. 199). Looking at GDP in this manner allows economists to compare countries of different population size. If the measurement is then put in constant dollars, economist can then look at countries at a point in time and then across time. A big drawback of this method is that it assumes that growth accumulated to all the individuals in a country at the same rate, though it is easy shorthand for looking at the overall rate of a country’s growth concerning how it is experienced by the population.

References

Krugman, P. & Wells, R. (2013). Macroeconomics. New York, NY : Worth Publishers