Economics - Macro - Inflation, Unemployment and Business Cycles

Start - 12:30 pm

Inflation vs. price level

• Inflation is persistent increase in price level over time; erodes purchasing power
• Prices of almost all goods are increasing

Demand pull inflation vs. cost push inflation

• Demand pull
• Caused by anything that increases demand
• Rising real wages mean that SAS will decrease and P will increase
• If government tries to stop it, it will just repeat the process
• Cost push
• Caused by an initial decrease in SAS - e.g if energy becomes expensive
• This decreases real output below the LRAS level
• If this brings about a policy response to increase demand, demand rises as well as price
• This happened in the 1970s oil crisis

Costs of inflation

• Costs of high inflation can be high even when anticipated properly
• Diverts resources to deal with inflation's effects/uncertainty
• Decreases value of currency used in transactions and as store of value
• Reduces real returns of investments (taxed on nominal basis)

Nominal rate of interest is the eq rate in the market for savings/investment

• Higher inflation = business will expect greater returns
• Higher rates of growth of money supply = higher inflation, expected inflation, interest rates

Inflation and unemployment - more inflation, overemployment in short term

• If expected and actual are equal, economy is at full employment
• If inflation (increase in agg demand) greater than expected:
• Price increases more than expected
• Unemployment decreases to level below natural rate
• You move at a point along the downward sloping Philips Curve
• Philips curve shifts when expectations shift

Changes in natural rate of unemployment are caused by:

• Size and makeup of labor force changes
• Changes in labor mobility
• Advances in tech
• Increase in natural rate = shift Philips to the right

Business cycle - fluctuations in economic activity

• Two phases - expansion and contraction/recession
• Turning points are peak and trough
• Recession - significant decline in economic activity lasting more than a few months
• Expansion - growth positive, unemployment down, inflation up
• Reverse true in recession

Theories on why business cycles happen

• Mainstream view - caused by variability in aggregate demand around true LRAS
• Keynes - swings are due to swings in level of optimism of business owners
• Monetarists - swings are due to money supply errors
• New Classical - only unexpected changes in demand lead to cycles
• Real business cycle theory
• Emphasizes effect of real economic variables
• Technology a key driver - changes productivity
• Real GDP can thus fluctuate, different that assumption that GDP is steady

End

1:15 pm

0.75 hours