Chapter 12 Business Cycle

REPORTERS:
PANIMDIM, CELINE
PAYOS, RANNIE
PELENIO, WOWIE
Business Cycle
 Is defined as the diffusion of
fluctuations in aggregate
economic activities all over the
economy and not just on a single
industry.
 It is a characteristics of
industrialized developing
capitalistic economies; economic
fluctuations occurred long before
modern economies.
Phases of Business Cycle
1. Peak/Prosperity - This is a phase
where business activities are in
their temporary maximum. The
economy at this phase is at full
employment and the level of real
output is at its full capacity,
and there is the tendency for the
price level to rise.
2. Recession – A phase in business
cycle that is characterized by a
decline in total output, income,
trade, and ultimately employment.
3. Trough/Depression – It is the
turning point of recession, or
when economic activity is at
its lowest. In this phase of
the business cycle,
unemployment is so severe.
4. Expansion – In this phase,
there is a recovery in the
economy wherein income, output,
trade, interest rate, wage an
employment are rising, meaning,
unemployment is low.
Phases of Business Cycle
GDP
PEAK
RECESSION
EXPANSION
TROUGH
TIME
Business Cycle in the Philippines
During the early times, the
business cycle was already
operating. Primitive communities
had periods of goods and bad
harvests, and their hunting and
farming were greatly affected by
the weather. A good amount of
rain and sunshine improved their
farming and hunting outputs, while
vagaries of weather depressed
their output.
Selected Classical Theories Explaining
Business Cycles
Endogenous Theories – These theories
explain the causes of business
cycles within rather than outside
the economy.
The following are specific explanations of
the business cycle:
1. Real structural hypothesis (RSH).
This hypothesis is based on the
explanation that aggressive
investment plans, together with
import dependence, attain a normal
frontier in the weak (structural)
ability to bring in foreign
exchange.
2.Innovation theory. This theory
was based on the ideas put forward
by Joseph Schumpeter. This theory
holds that innovation is a
fundamental cause of business
cycle.
 Innovation is defined as
enhancement of an existing
production system that leads to
new and better products. This
innovation will bring higher
profit for producers as prices are
reduced because of a more
efficient production.
3. Self-generating theory. According
to Wesley Mitchell, one phase of
the business cycle grows out of
the preceding phase.
4. Under consumption theory. This
theory comprises the oldest
explanations of the business
cycle. Economists subscribing to
the under consumption view
attribute the deficiency in
purchasing power.
5. Monetary theory. In inflation is
threatening the economy, the
Central Bank (CB) should slow the
rate of growth of money supply.
Exogenous Theories – This theories
explain the causes of business
cycle as disturbances outside the
economy.
UNEMPLOYMENT
 Unemploymentrepresents sheer
waste – the Philippines society
loses the goods and services which
might have been produced by those
out of work.
Unemployed is usually defined as
all those who are 15 years old as
of their last birthday and during
the reference period, and are
reported as:
1. Without work, i.e., had no job or
business during the basic survey
reference period;
2. Currently available for work,
i.e., were available and willing
to take up work in paid
employment or self-employment
during the basic survey reference
period, and/or would be available
and willing to take up work in paid
employment or self-employment
within two weeks after the
interview date; and
3. Seeking work, i.e., had taken
specific steps to look for a job
or establish a business during the
basic survey reference period; or
not seeking work due to the
following reasons.
Unemployment Rate is the
proportion in percent of the total
number of unemployed persons to
the total persons in the labor
force.
Unemployed
Unemployment Rate = ──────────── x100
Labor Force
Labor force includes all persons
15 years old and over as of their
last birthday who contribute to
the production of goods and
services in the country whether
employed or unemployed.
Mathematically:
Labor Force = Employed + Unemployed

8.2
7.8
7.6
7.4
7.2
6.8
6.9%
6.6
6.4
6.2
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
2008 2009 2010

Fiure 12.2 Unemployment Rate in the
Philippines (in percent)
Labor Force Participation Rate
is the percentage of the total
number of persons in the labor
force to the total population of
15 years old and over.
Mathematically:
Labor Force Participation Rate
𝐭𝐨𝐭𝐚𝐥 𝐧𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐏𝐞𝐫𝐬𝐨𝐧𝐬 𝐢𝐧 𝐭𝐡𝐞 𝐋𝐚𝐛𝐨𝐫 𝐅𝐨𝐫𝐜𝐞

= × 𝟏𝟎𝟎
𝐓𝐨𝐭𝐚𝐥 𝐏𝐨𝐩𝐮𝐥𝐚𝐭𝐢𝐨𝐧 𝟏𝟓 𝐲𝐞𝐚𝐫𝐬 𝐨𝐥𝐝 𝐚𝐧𝐝 𝐨𝐯𝐞𝐫
Types of Unemployment
1. Unavoidable Unemployment
There are 3 types of unavoidable
unemployment:
a. Frictional Unemployment. It is a
temporary unemployment associated
with the changes in the economy.
b. Structural Unemployment. It
occurs when the location and
qualifications of the labor force
do not much the available jobs.
c. Cyclical Unemployment.
Unemployment caused by the
recession phase of the business
cycle. It is caused by inadequate
total spending. As the overall
demand for goods and services
decreases, unemployment rises.
2. Avoidable Unemployment. This
refers to unemployment usually
associated with insufficient
demand for workers caused by many
factors such as poor performance
of the economy.
Underemployment
There are persons who are already
employed but they express the
desire to have additional hours of
work in their present job or in an
additional job, or to have a new
job with longer working hours.
Those persons are called
Underemployed
There are two classifications of
Underemployed Persons:
1. Invisibly Underemployed. A
person is considered invisibly
underemployed if the person
already worked 40 hours during
the reference week but still want
additional hours for work; and
2. Visibly Underemployed. A person
is considered visibly
underemployed if the person
worked less than 40 hours during
the reference week and wanted
additional hours for work.
22
21
20
19
17.9%
18
17
16
15
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
2008 2009 2010
Figure 12.3 Underemployment Rate in the Philippines
(in percent)
Okun’s Law
 This was developed by Arthur Okun
who was a macroeconomist and
served in the economic council of
President Lyndon Johnson. He
developed the relationship between
GDP and unemployment. As a result
of this findings, he concluded
that for every 2-3% movement in
GDP,unemployment changes by 1% in
both opposite directions.
Inflation
 Refers to the rate of increase in
the average prices of goods and
services typically purchased by the
consumers. Mathematically, it is
expressed as follows:
CPI current – CPI previous

Inflation Rate= ────────────────────── X 100
CPI previous
Where: CPI = consumer price index
 Headline Inflation. Is calculated
as the change in the weighted
overall average prices of all
goods and services in the CPI
basket.
 Core Inflation. Is an alternative
measure of inflation that is
calculated as the rate of change
in the CPI that includes the item
that have transitory effects on
the CPI.
CAUSES OF INFLATION
1. Demand Pull Inflation. This inflation is

characterized by “too much spending
chasing too few goods”. Pressures on
inflation are caused by relatively higher
demand compared to the available supply
goods and services. Excess demand pulls
the general price level.
2. Supply Shocks to Inflation. These are
pressures on inflation resulting from
shortages in supply and increases in the cost
of production without a corresponding
expansion in output.
3. Profit-Push Inflation. These are pressures
on inflation resulting to higher markups by
businesses.
Markup is the difference between the original
price and the selling price.
EFFECTS OF INFLATION
Inflation has an effect on the real income of
individuals in the economy. It may reduce the
real income (purchasing power) of an
individual or individuals but does not
necessarily follow that it reduces the real
income of the whole economy. Inflation results
to redistributive effects, meaning, the effects of
inflation are redistributed to different
individuals, and as such, there will be gainers
and losers. The primary assumption of this
redistributive effect is that, inflation is
unanticipated.
LOSERS AND WINNERS IN
INFLATION
Losers during inflation are individuals who
are hurt when prices are increasing. Those
are:
1. Fixed income earners (including
pensioners). Laborers and office workers
who are getting a fixed amount of money
monthly cannot keep up with the high
prices because their nominal income does
not rise with prices.
2. Savers. The interest rate of savings
deposits may not cover the cost of
inflation. If the amount of money that
was saved will be withdrawn during the
time when the prices are high, that
money will lose purchasing power.
3. Creditors. Creditors are hurt by the
time they will receive the payment, the
amount of goods and services that can
be bought by the sum of money has less
purchasing power during inflationary
times.
4. Holders of securities. People who
have investment in bonds and or stocks
lose during the time on inflation because
the value of their money invested in
securities depreciates in terms of
purchasing power.
Gainers during inflation are the groups of
individuals that are helped by unanticipated
inflation.
1. Debtors. They are paying back “cheap”
pesos to their creditors that have less
purchasing power.
2. Fixed Asset Owners. Land owners
gain during inflation as the value of land
and other fixed assets appreciate.
3. Producers. The income of producers
increases when inflation takes place. As
the price of commodities increases,
business firms gain higher returns.
Is deflation better than inflation?
Deflation is a sustained decrease in the
average price level. Is deflation good for the
economy? NO. if there is deflation in the
economy, producers will lose and eventually
shut down their businesses, because a
substantial decrease in price will adversely affect
their incomes. The obvious reaction they will
take when losing profits is to cut down their
labor cost. The effect will be higher
unemployment, lower output, taxes, and national
output. An inflation rate of 2 – 3% is good for
both consumers and producers.
HYPERINFLATION
 Refers to a period of extremely high inflation
reaching 100,00% and above.
An example of this is the case of Germany after WWI
where the Deutschmark (currency of Germany) lost its
value due to the increase in its circulation from 50 billion
to 500 billion in just four years. Because money was so
plentiful, people rushed to spend it because it was
practically worthless. Inflation reached 116,00% in Bolivia
in the early 80’s where a sack of money could only
purchase a bag of grocery, or a bar of chocolate cost
50,000 Bolivian pesos. The cause of this hyperinflation is
the planeload of printed money that arrived in that
country from Germany and Britain every month.
Phillips Curve and Stagflation
Trade-Offs
Inflation and unemployment have an existing
short-run trade-off, and there is policy
implication on this. According to this concept,
full employment cannot be attained without
the existence of inflation.
Phillips Curve
INFLATION (%)
UNEMPLOYMENT (%)
As seen in the figure, there is an inverse
relationship between inflation and
unemployment. A low level of unemployment
rate will accompany a high level of inflation
rate; the inverse relationship connotes trade-
offs between the two.
Stagflation
Stagflation comes from two different words,
stagnant and inflation. The word “stagnant”
is used to depict the democracy of the
economy with the simultaneous occurrence
of inflation. This simply means that the
economy is experiencing increasing inflation
and unemployment at the same time as
shown in the figure.
Stagflation
INFLATION (%)
UNEMPLOYMENT (%)

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REPORTERS:

Labor Force = Employed + Unemployed

2008 2009 2010

Labor Force Participation Rate

𝐭𝐨𝐭𝐚𝐥 𝐧𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐏𝐞𝐫𝐬𝐨𝐧𝐬 𝐢𝐧 𝐭𝐡𝐞 𝐋𝐚𝐛𝐨𝐫 𝐅𝐨𝐫𝐜𝐞

CPI current – CPI previous

1. Demand Pull Inflation. This inflation is

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