Assignment:
Create a 2-page paper describing how the published unemployment rate is derived. What is the relationship between the labor participation rate and the unemployment rate? How can the published unemployment rate actually be misleading vis-a-vis economic conditions? Unemployment
Now that we have delved into how a nation records what it produces and the market value of those goods and services it produces, we are going to analyze how cycles and price fluctuations within an economy can affect either positively or negatively GDP and economic growth and expansion.
• Since the early 1900's, the U.S.' GDP has on average consistently grown, and its economy expanded. During the last 100 years, however, there have been cyclical downturns accompanying the growth.
Some the extremes in cycles occurred during the 1930's and 1940's, with severe negative growth occurring during the Great Depression to extensive growth after World War II in the 1940's and 1950's. Business cycles occur naturally and will occur despite any government intervention or market failure. The four phases of business cycles are expansion, peak, contraction, and recession.
During an expansion, aggregate output is increasing, and depending upon whether aggregate demand or aggregate supply or both shift, prices may be rising too. A increase in the general level of prices in the economy is defines the term inflation.
• Although in most cases inflation can be harmful to the economy due to distortive effects it has on prices and economic expectations, during an expansion, inflation may signify positive events occurring.
• If aggregate demand, for example, is shifting more and faster than aggregate supply but yet the economy is not at long-run aggregate supply equilibrium and/or full employment, inflation actually indicates growth and expansion.
Once the economy has reached a peak and maximum productive point, if aggregate demand continues to grow and aggregate output and supply cannot accommodate, that is when the economy will begin to cool itself and possibly when government actions in the forms of fiscal and monetary restraints will take effect.
Contraction ensues in which output falls, real unemployment starts to rise, and deflationary pressures begin to take effect. Eventually, after continued contraction, a recession can occur in which two consecutive quarters of negative GDP growth hits the economy. Prolonged recessions can turn into a depression and end up severely hurting the recovery and overall health of the country.
• Additionally to business cycles affecting GDP, unemployment affects the productivity of a nation. Structural, frictional, seasonal, and cyclical are the four types of unemployment. Depending upon which type, each can be a symptom and affect GDP and economic growth.
Structural unemployment normally is the result of something structurally occurring and affecting workers. When labor costs rise, for example, firms may seek cheaper labor overseas to counteract the rise in its marginal resource costs. The firm may close operations, merge, or replace workers with computers or robots. All of these examples represent structural unemployment.
Frictional unemployment occurs when a person according to their volition may choose to be unemployed. Firms may not be aware of the level of expertise or options that may exist at the time, and so over time people of certain experience and skill levels may be hired. Another example may be someone in school looking to get more qualified and decides to defer employment.
Seasonal unemployment simply is one who is seasonally unemployed due to circumstances occurring in nature and/or markets. A lawn cutter in Maine in January is likely not going to be cutting grass during that period of time, but on the other hand, a snow-plow job will be idled there in the middle of July. Retailers often use additional labor for periods such as holidays, and once the holiday is over, often times extra labor will be eliminated.
Cyclical unemployment is directly related to business cycles. During periods of contraction and recession, real unemployment rises as firms cut back on output and lay people off. During periods of expansion, workers may be added. It is ultimately only when the economy reaches full employment that cyclical unemployment is considered to be zero or at its lowest.
In summary, GDP and economic output of the economy are directly related to business cycles, and unemployment can negatively affect GDP.
• There four phases of a business cycle - expansion, peak, contraction, and recession - and they occur naturally and will occur; how long each phase transpires will be key, because prolonged periods of contraction and recession can lead to depression. Periods of unexpected inflation can distort economic activity too.
Ultimately, unemployment is affected by business cycles. There are four types of unemployment - structural, frictional, seasonal, and cyclical - with cyclical having the closest ties to business cycles
Real Interest Rates
We will examine what constitutes long-run equilibrium in the aggregate economy, as well as interest rates and how inflation can affect real interest rates. When we look at the aggregate economy, we inherently deal with aggregate demand and aggregate supply.
Aggregate demand is simply the overall demand in the economy, and the aggregate demand curve is downward sloping due to the law of demand; aggregate supply is simply the overall supply in the economy, and the short-run aggregate supply curve is upward sloping due to the law of supply. The long-run aggregate supply curve is a perfectly vertical line which represents the total economy at capacity.
• What represents an economy in long-run equilibrium?
When an economy is in long-run equilibrium, it is at full capacity. Aggregate demand, short-run aggregate supply, and long-run aggregate supply are in equilibrium. Aggregate demand and/or short-run aggregate supply can shift any time, either leftward or rightward, causing long-run disequilibrium.
• However, either through natural business cycles or fiscal/monetary policies implemented by government, the aggregate demand and/or short-run aggregate supply curves may shift and the system resumes long-run equilibrium, either at a higher or lower level potentially. In long-run equilibrium, the economy is at potential GDP and full employment (no cyclical unemployment).
What about interest rates?
• Interest rates are what a borrower pays to a bank for borrowing funds, and it is going to be made up of a pure interest rate, a premium for credit risk, a premium for long-term holding, a premium for default risk, and a premium of inflation. Interest is simply a price.
The natural rate of interest is going to be the result of the quantity demanded for funds and quantity supplied of funds being in equilibrium.
The Loanable Funds theory of interest rates applies. Interest rates are the result, thus, of the demand for credit; the price of credit, as it were.
The interest payment one pays back to a bank will entail that natural rate of interest plus those other additional costs in the aforementioned above. Lenders will demand in return the premiums, such as credit risk, long-term holding, default, and inflation as a way of compensation for the risk taken on by lending.
• So, the natural rate of interest + the premiums comprises the money interest rate. As inflation, for example, rises, so does the nominal rate of interest as lenders increase the premiums. Borrowers are not all alike, and borrowers will end up paying different amounts in interest due to the credit risk and default risk of the specific borrower.
In summary, the aggregate economy moves to long-run equilibrium by coming into equilibrium between aggregate demand and short-run aggregate supply and long-run aggregate supply. The economy reaches potential GDP there, and full employment is achieved. The economy is at capacity.
The natural rate of interest is similar, as the demand for loanable funds and supply of loanable funds come together in equilibrium. Lenders demand additional returns through premiums to be compensated for risk and default; the money interest rate is the natural rate of interest + premiums. Ultimately, inflation can affect whether the money rate of interest rises or falls, as higher premiums are required when inflation rises, and lower premiums are required when inflation falls.
Attachment:- Economic Fluctuations.rar