Quiz 8: Economic Fluctuations, Unemployment, and Inflation


Business cycle is a diagram indicating change in real GDP over a time period in an economy. If a diagram is drawn on the basis of time series data of an economy, then it will be observed that the curve is rising and then falling. This rise and fall will happen continuously in sequence. This continuous undulation in the time series data is known as business cycle. Business cycle has four different phases as stated below- 1. Peak or boom 2. Contraction or recession 3. Recessionary trough and 4. Recovery or expansion phase These four phases are shown in the diagram below- img The above diagram is showing business cycle. It is indicating fluctuation in real GDP during a time period. Note that the curve has a rising trend. But it is moving up. Then after reaching a peak, it has started decreasing again. After reaching a lowest level again recovery starts. Thus phases are continuing in sequence. Explanation of different phases of business cycle: 1. Peak or Boom: It is the highest point of the cycle. Here all manufacturers are using their capacity to the optimum level for increasing real GDP. Manufacturer wants to supply more. But due to non availability of unused resources, it is not possible to increase real GDP further. Thus economy is said to have GDP very close to potential full employment level. Due to a very high demand, all workers in the labor force are effectively employed. Unemployment rate is well below the normal unemployment rate. Unemployment observed is inevitable due to frictional and structural causes. Production is very much profitable and business risk is minimized. 2. Contraction or depression: After attaining the peak economy will experience a down turn in the activities. This phase is known as contraction and depression. Following points will be observed here- a. Real GNP will start decreasing. Initially rate of decrease will be slow. Then it will gather momentum. b. Fall in GDP will mean less resource will be needed to manufacture them. So many worker will be laid off at least on temporary basis. New worker will find it hard to get a job. Actual unemployment rate will start moving upward. Involuntary unemployment is added with normal unemployment rate. c. Investment will decrease as the production is now less profitable and more risky. d. Interest rate will decrease. With low interest rate people will invest less and will prefer to hold more money as liquid cash. Holding of cash is made with the expectation that they will be invested when situation improve. e. There will be lots of excess capacity remaining unutilized in the industries. Capital goods and durable goods industries will be the worst sufferer. 3. Trough / Slump: It is the lowest level of business cycle. In other words, it is the extreme end of depression. Following points will be observed here- a. Real GDP will be to the lowest possible limit. Further fall in GDP under existing situation will be impossible. b. Investment is almost zero. Most of the industries have been closed. It is very risky for investor to produce and sell. c. Unemployment rate will be as high as possible. Largest possible gap will be observed between actual unemployment and natural unemployment. Involuntary unemployment will appear in largest possible scale. d. Interest rate will be at its lowest possible level. People have adequate cash in their hand. They want to consume, but commodities are scarce in the market. 4. Expansion / prosperity: Once the economy has reached trough, people have enough money as well as demand to consume, but no commodity is available for consumption. Thus atmosphere of economy has now become less risky to start production again. Some entrepreneur will take the risk and start production again. In fact government will first initiate manufacturing of the product. Whoever takes the initiative, he will make profit. It will encourage others to come forward and take the risk. Gradually economy will start moving upward. Prosperity will set in. Following points will be observed now- a. Real GDP will start moving upward. Initially, the rate of upward movement will be slow. But it will gradually gather momentum. b. Investment will rise. More and more new entrepreneur will enter the business. Existing entrepreneurs will expand their business. Risk will be low. c. Due to increase in investment, demand of labor will rise. Employment will go up. Involuntary unemployment will decrease. Gap between actual unemployment and normal unemployment will synchronize. d. Due to confident market demand the investment demand for loanable fund will rise. So interest rate will go up. And hence encourages people to save more. These four phases should come in sequence. But when they will come or what will be their duration, etc., cannot be predicted with accuracy. Time period of business cycle: There is no hard and fast rule for the time period of occurrence of business cycle. A business cycle may get completed within two to three years. Sometimes it may also take as long as eight to nine years to get complete. Duration of phases: Similarly there is no hard and fast rule for duration of different phases of a business cycle. Boom period may last for few days while trough period of the same trade cycle may continue for few months or even for a year. Thus it is not necessary that duration of each phase will be equal.

Production and consumption are two important activities of an economy. Production means creation of goods and services for the satisfaction of wants. It requires introduction of different factors of production. There are four such factors. They are land, labor, capital and organization. These factors are scarce. But human needs are unlimited. So it is the function of an economy to allocate those factors in such a manner that maximum welfare is achieved. Hence, an efficient economy ensures such allocation of scarce factors. Not only proper allocation is needed it is also necessary that these scarce resources remain utilized. In other words no unemployment should exist. Classical economist has named this situation as full employment. According to them an ideal economy will exist only when full employment is found. Let us consider the following reasons for which unemployment to some extent should always be there- 1. Unemployment causing from adoption of new technology: Innovation is the fundamental requirement for the growth of an economy. New technology may be innovated which will take the place of old one. Industries using new technology will create employment opportunities. At the same time industries using old technology and are unable to convert them into new one will close down. So labor and other factors of old industries will get unemployed. It has happened after invention of computer. When computerized accounting systems was introduced in industries many new job opening was created. But at the same time employees maintaining accounts manually, passing the bills and doing other accounting job have lost their job and get unemployed. 2. Temporary unemployment for new entrants: Some new entrants in the labor force will always exist in the economy. They have just completed their schooling and now are searching for a job. Even if they are appointed, company has to give them necessary training to make them fit for the productive work. Thus a gap period will always be observed between entering in the labor force and getting properly employed in a job. During this period they have to remain unemployed. 3. Temporary unemployment for getting better job: Further there may be found some persons who have left the existing job on their own. They think that their skill is better suited for some other high level job. So by quitting the job they are searching a very appropriate job for them. Until the search process is over they have to remain unemployed. This type of unemployment is good for the economy, since it will make the best possible use of the capacity of a labor after he get reemployed in a better suited job. It is making effective allocation scarce factors possible. 4. Temporary unemployment for acquiring better skill: A company adopting new technology may retrench its laborers on temporary basis. Then proper training is provided to make them fit for new technology. Once they acquire the required skill, they get reappointed again. During this period they have to remain temporarily unemployed. This unemployment also will be effective in improving future productivity of the economy. Thus it can be safely concluded that for efficient functioning of the economy some unemployment is inevitable.

In the economy persons above 16 years of age are eligible for the work. Out of them some people are not included in labor force. It may be due to their old age, illness, not yet completed study or may be physically disable. Persons who are included in labor force either employed or unemployed. Thus any person above 16 years of age but not working voluntarily will not be considered as unemployed. No distinction is made between full time and part time employment. Following cases are to be evaluated on the basis of this idea. a. Br is a person who is not currently working. She has applied for a job in W-M and is waiting for the result. Here Br appears to have recently completed his schooling and has joined in the labor force. He is new entrant in the labor force. He has applied for the job and is expected to get it very soon. So he will be considered as unemployed. b. Mar was an employee of GM. Company has decided to change the model. So company has decided to lay off some employees including Mar. Here Mar very much belongs to labor force. He is not in any way incapable of doing work. The company when adopt new technique or wants to introduce some major changes in the production system, Existing workers have to remain idle until new set off has been completed. During this period they can save labor cost through lay off existing work force temporarily for some days. During this period existing employees can be trained to make them fit for the new technology. Same thing has happened here. Mar has been temporarily laid off. He is now unemployed. He is expected to get employed very soon. c. Gre is included in labor force. He is not getting appropriate job. It may happen when there is structural or cyclical factors persist in the economy. Sometimes there may be some major structural change in the economy. It may be due to change in technology or product. With such change existing skill of a labor may be inappropriate unless he acquires some new skill to make him fit for the changed situation. Another reason may be the general down turn in the economy. It will reduce demand of labor. They will remain either unemployed or will be forced to work at less wage rate. It is known as cyclical unemployment. Any one of the above two reasons may be responsible for his unemployment. Whatever be the reason, the unemployment period is expected to continue for a long period. d. When somebody works for her family, she is not considered as included in the civilian labor force. Therefore she will not be considered in the employment data. Here West is working for seventy two hours in a week in her family. She is doing work as a homemaker. But she will not be considered as employed. Also she will not be included in the labor force. e. Cars is 17 years old. Since he has crossed 16 years of age, therefore he should be included in the labor force. He is working only part time basis in a week. He is employed for only six hours per week in the morning for distributing newspaper. No distinction is made between full time and part time employment. Therefore He will be considered as employed. f. Exact age of Cha has not been mentioned in the problem. It may be assumed that he has crossed sixteen years. So he is included in the labor force. He is employed partly for only three hours in the morning. He is searching for better job in the afternoon. He may be considered as a new entrant in the labor force. Although he is not fully employed, yet he will be considered as employed.

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