Unemployment, Inflation,

and the Business Cycle

Unemployment

• Unemployment is the inability of those who are in

the labor force to find a job.
• The labor force consists of those who have attained
16 years of age and older who are either employed
or are actively looking for employment.
Types of Unemployment
• No matter how one examines unemployment, it costs the
economy.
• Economists categorize unemployment into four basic
types:
• Frictional
• Structural
• Cyclical and
• Seasonal
Frictional Unemployment

• We live in a dynamic economy. Some people are fired

or laid off and have to look for a job. Others just want
to change occupations.

• All of the ins and outs in the labor market result in

frictional unemployment, defined as the continuous
flow of individuals from job to job and in and out of
employment.
Structural Unemployment
• Structural changes in our economy cause some
workers to become unemployed permanently or for
very long periods, because they cannot find jobs that
use their particular skills. This is called structural
unemployment. Structural unemployment occurs for a
number of reasons – workers may lack the requisite job
skills, or they may live far from regions where jobs are
available but are unable to move there.
Cyclical Unemployment
• Cyclical unemployment happens as the business fluctuations
cycle through good times and bad times. When overall economic
activity slows down, there will be cyclical unemployment.
• One way to reduce cyclical unemployment is to reduce the
intensity, duration, and frequency of the ups and downs of
nationwide business activity. The normal up and down
movements in the economy as it cycles through booms and
recessions over time.
Seasonal Unemployment
• Seasonal unemployment varies with seasons of the year in which the demand
for particular jobs rises and falls.

• Seasonal unemployment is the unemployment created from seasonal variations

in demand for goods and services.

• In an economy there will be certain times of year when the demand for goods
and services are lower than normal. In these periods, firms will sell fewer goods
and services and as a result they may decide to reduce their workforce.
However, once these periods have past firms will start to employ people again
as demand increases.
To explain this concept more clearly, let’s take an example. In the summer,

employment in the ice cream market is high due to the number of people

purchasing ice creams. However, during the winter months, demand for ice cream

falls due to the cold weather. Consequently, ice cream manufacturers and

retailers employ fewer workers because they aren’t selling as many products. The

unemployment created from this situation is called seasonal unemployment.

10-8
 Measuring the
Unemployment Rate
• To determine the rate of unemployment, the
government first adds up the employed and the
unemployed, to obtain the measured labor force. Then
it divides the unemployed by that total.
• For example, if the number of unemployed is 10 million
and the number of employed is 140 million, then the
labor force is 150 million, and the measured rate of
unemployment is 0.067 or 6.7 percent.
 Inflation

• We define inflation as a sustained rise in the

general price level of goods and services.

• The value of a dollar does not stay constant when

there is inflation. The value of money is usually
referred to in terms of its purchasing power.
There are several variations on inflation:
Deflation is when the general level of prices is falling. This is the opposite of


inflation.
Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to


the breakdown of a nation's monetary system. One of the most notable

examples of hyperinflation occurred in Germany in 1923, when prices rose
2,500% in one month!
Stagflation is the combination of high unemployment and economic


stagnation with inflation. This happened in industrialized countries during the

1970s, when a bad economy was combined with OPEC raising oil prices.
 Purchasing Power
Purchasing power is the value of a currency
expressed in terms of the amount of goods or
services that one unit of money can buy. Purchasing
power is important because, all else being
equal, inflation decreases the amount of goods or
services you would be able to purchase.
The faster the rate of inflation, the greater the rate
of decline in the purchasing power of money.
 How We Measure the Rate
of Inflation
Inflation Rate = [(Current Year CPI Value - Past CPI Value) / Past Year CPI Value] x 100

Government statisticians use price indexes to

measure inflation.

•Two of these price indexes are:

• The CPI or Consumer Price Index, and

• The GDP Deflator.

 Computing a Price Index

• A price index is defined as the cost of a market

basket of goods and services today, expressed as a
percentage of the cost of that identical market
basket of goods and services in some starting year,
known as the base year.

Cost today of market basket

Price = 100
Cost in base year of market basket
The Consumer Price Index
(CPI)
• The CPI attempts to measure changes only in the
level of prices of all goods and services purchased
by all urban consumers.

• The Pakistan Bureau of Statistics has the task of

identifying CPI in Pakistan
Example of CPI

Market Basket of Goods

The Pakistan Bureau of Statistics takes a market basket of 374

items in ten major groups; food & beverages, clothing, textile
and footwear, house rent, fuel and lighting, household,
furniture & equipment, transport and communication,
recreation and entertainment, education, cleaning, laundry
and Medicare. The diversified list of items in the basket is an
attempt to include different income groups to calculate
consumer price index.
Item Group Weight

Food and Beverages: 40.34

Apparel, Footwear and Textile: 6.10

House Rent: 23.40

Fuel and Lighting: 7.29

Household, Furniture and Equipments: 3.29

Transport and Communication:

7.32

Recreation and Entertainment:

0.83

Education:
3.45

Cleaning, Laundry and Personal Appearance:

5.88

Medicare

2.07
Total:

100
Data Collection

The PBS has stationed its employees in 35 districts to collect

price data of different items for the basket in different dates of
the month. Data about apparel, fuel, lighting, footwear and
textile is collected from 1st to 3rd of every month. During the
next three days, the data about Household, Furniture &
Equipment etc. and Transport & Communication is calculated.
From 7th to 10th of every month, the data about Recreation,
Entertainment & Education Cleaning, Laundry & Personal
Appearance & Medicare is collected. The employees of the PBS
go to market and purchase food and beverages from 11th to
14th of every month.
The price collectors get four quotations of each item from
different shops in the market. The average price of these four
quotations is taken as representative price of that item in a
particular market. An average price of that item in all selected
markets is considered as national level price. The data
collection operation is supervised by the senior officers in each
selected District. The national level analysis is done at the
headquarters and in case of any doubt or confusion the price
collectors are contacted directly.
Use of Laspeyres' Formula

The Pakistan Bureau of Statistics (PBS), applies Laspeyre’s formula to

calculate consumer price index (CPI)

Where ln = CPI for the nth period

Pn = price of an item in the nth period
Po = price of an item in the base period

Qo = quantity in base period

ln = (Σ Pn XQ0/ Σ P0 XQ0)x100
 The GDP Deflator

• The GDP deflator measures the changes in prices of all

new goods and services produced in the economy.

• The basket on which it is based is allowed to change

with people’s consumption and businesses’ investment
patterns.

• Usually, the GDP deflator is used to create measures of

real GDP.
Price Index using Laspeyres Price Index Formula and calculation of inflation

Commodity 2016 2017 2018

Price Quantity Price Quantity Price
Wheat 315 10 345 10 385
Mutton 780 1 814 1 854
Hi Speed Diesel 65 1 71 1 90
Cooking Oil 457 2.5 462 2.5 469

Index= (Σ Pn XQ0/ Σ P0 XQ0)x100

Inflation Rate = [(Current Year CPI Value - Past CPI Value)

Past Year CPI Value] x 100

 Index (2017)

2016 2017
Commodity PnXQ0 P0XQ0
Price (P0) Quantity (Q0) Price (Pn)
Wheat 315 10 345 3450 3150
Mutton 780 1 814 814 780
Hi Speed
65 1 71 71 65
Diesel
Cooking Oil 457 2.5 462 1155 1142.5
5490 5137.5

Index= (Σ Pn XQ0/ Σ P0 XQ0)x100

In(2017) = (5490/5137.5)*100

106.86

10-23
 Index (2018)
2017 2018
Commodity PnXQ0 P0XQ0
Price (P0) Quantity (Q0) Price (Pn)
Wheat 345 10 385 3850 3450
Mutton 814 1 854 854 814
Hi Speed
71 1 90 90 71
Diesel
Cooking Oil 462 2.5 469 1172.5 1155
5966.5 5490

Index= (Σ PnXQ0/ Σ P0 XQ0)x100

In(2018) = (5966.5/5490)*100

108.68

10-24
Inflation Rate = [(Current Year CPI Value - Past CPI Value) / Past Year CPI Value] x 100

[(108.68-106.86)/106.86]*100

(1.82/106.86)*100

0.017*100

1.70%

10-25
 Gross domestic product (GDP)

The gross domestic product (GDP) is one of the

primary indicators used to gauge the health of a
country's economy. It represents the total dollar
value of all goods and services produced over a
specific time period; you can think of it as the size of
the economy.
Anticipated versus
Unanticipated Inflation
• Anticipated inflation is the rate of inflation that is
generally expected by individuals in the economy.

• Unanticipated inflation is inflation that comes as a

surprise to individuals in the economy.
Anticipated versus
Unanticipated Inflation
(cont.)
• Some of the issues caused by inflation arise when it
is unanticipated. In contrast, when inflation is
anticipated, many people are able to protect
themselves from disadvantageous contracts, for
example.
Business Fluctuations and
Business Cycles
• Nationwide economic activity does not just go up at a
steady pace every year.

• Business fluctuations used to be called business cycles,

but that term no longer seems appropriate because
cycle implies regular or automatic recurrence, and we
normally don’t observe automatic recurrent
fluctuations in general business and economic activity.
Expansions and
Contractions
• The ups and downs in economy-wide economic activity
are sometimes called business fluctuations.
• When business fluctuations are positive, they are called
expansions—speedups in the pace of national
economic activity. The opposite of an expansion is a
contraction. The top of an expansion is usually called
its peak, and the bottom of a contraction is usually
called its trough.
Recessions and
Depressions
• If the contractionary phase of business fluctuations
becomes severe enough, we call it a recession. An
extremely severe recession is called a depression.

• The Great Depression lasted throughout most of the

1930s. By 1932, 13 million people were unemployed.
By 1933, actual output was at least 35 percent below
the nation’s productive capacity.
The Typical Course of
Business Fluctuations
A Typical Business Cycle

• Business fluctuations occur around a growth trend in

overall business activity. A straight upward-sloping line
shows this growth trend.

• Starting out at a peak, the economy goes into a

contraction. Then an expansion, moves up to its peak,
and the sequence starts over again. That is where the
term cycle comes from in business cycle.
The Expansion is between the trough and the peak. That's when economy is
growing. Gross domestic product, which measures economic output, is positive.
Ideally it is in the healthy 2-3 percent range.

The Peak is the second phase of Business Cycle. It is the time when the expansion
transitions into the contraction phase.

The third phase is Contraction. It starts at the peak and ends at the trough. Economic
growth weakens. GDP growth falls and when it turns negative, it becomes a recession.
Businesses wait to hire new workers until they are sure the recession is over.

The Trough is the fourth phase. That's the month when the economy transitions from
the contraction phase to the expansion phase. It's when the economy hits bottom.