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“A recession is when your neighbour is out or work. A depression is when you are out of work.” – Harry S. Truman
Business Cycle- defined as the diffusion of fluctuations in aggregate economic activities all over the economy and not just
on a single industry.
Phases of Business Cycle
Peak/Prosperity- phase where business activities are in temporary maximum, there’s full employment and the level
of real output is at its full capacity and there is a tendency for price level to rise.
Recession- phase characterized by decline in real output, income, trade, and ultimately, employment. Therefore,
unemployment is induced.
Trough/Depression- turning point of recession when economic activity is at its lowest. In this phase, unemployment is
so severe.
Expansion- recovery in the economy wherein income, output, trade, interest rate, wages, and employment are
rising. Therefore, unemployment is low.
Three Business Cycles in the Philippines
insufficient power supply
Asian financial crisis
lingering political instability
Classical Theories Explaining Business Cycles
Endogenous Theories- explain the causes of business cycles within rather than outside the economy.
Real Structural Hypothesis (RSH)- 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. This results to a period of low growth as investment is supressed, and large price adjustments
affect the economy. Investment is stimulated as foreign credit is re-established and a new cycle begins.
Innovation Theory- 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 the enhancement of existing
production system that leads to new and better products. This innovation will bring higher profits to
producers as prices are reduced because of a more efficient production. Higher profitability attracts more
producers in the industry. Too many players reduce individual profit, making others withdraw especially
those who are unable to meet with efficiency, making the industry profitable again.
Self-Generating Theory- according to Wesley Mitchell, one phase of the business cycle grows out of the
preceding phrase. These different phases of the business cycle are series of cumulative changes by which
one condition is a product of another.
Underconsumption Theory- comprises the oldest explanations of business cycle. Economists subscribing to
underconsumption view attribute the deficiency of purchasing power, because it typifies all business
contractions, and if in some fashion, society could sustain the demand for goods, then prosperity could
endure. Underconsumptionists brood excessively over the role of savings. A downward turn of production
could conceivably result in accumulated savings of the society were not invested, or if, through savings, the
demand for consumer goods were forced below a level of profitable production.
Exogenous Theories- explain the causes of business cycles as disturbances outside the economy.
Country’s economy is so dependent on the demand of the United States for our products
Philippines relies heavily in Middle East for our oil supplies
Unemployed- those who are 15 years old as of their last birthday and during the reference period and reported as
without work, currently available for work, and seeking for work.
Unemployment Rate- proportion in percent of the total number of unemployed persons to the total persons in the labor
Unemployment Rate= (Unemployed/Labor Force) x 100
Labor Force- 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.
Labor Force= Employed + Unemployed
Labor Force Participation Rate- percentage of total number of persons in the labor force to the total population of 15
years old and over.
Labor Force Participation Rate= (Total Number of Persons in the Labor Force/Total Population 15 years old
and above) x 100
Types of Unemployment
Unavoidable Employment
Frictional Unemployment- temporary unemployment associated with the changes in the economy
Structural Unemployment- occurs when the location and qualifications of the labor force do not match the
available jobs.
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
Avoidable Unemployment- associated with insufficient demand for workers caused by many factors such as poor
performance of the economy.
Full Employment- does not mean that unemployment rate is 0%. It is unavoidable unemployment or if cyclical
unemployment is zero.
Full employment rate of unemployment- referred to as the natural rate of unemployment.
Underemployment- 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.
Invisibly Underemployed- a person considered invisibly underemployed if the person already worked 40 hours
during the reference week but still want additional hours of work
Visibly Underemployed- a person considered visibly underemployed if the person worked less than 40 hours
during the reference week and wanted additional hours of work
Okun’s Law- developed by Arthur Okun. For every 2-3% movement in GDP, unemployment changes by 1% in both
opposite directions.
Inflation- rate on increase in the average prices of goods and services typically purchased by consumers.
Inflation Rate= [(CPI current – CPI previous)/CPI previous] x 100
Consumer Price Index- indicator of the change in the average price of a fixed standard basket of goods and services
commonly purchased by households relative to the base year
Headline Inflation- calculated as the change in the weighted overall average prices of all goods and services in
the CPI basket.
Core Inflation- alternative measure of inflation that is calculated as the rate of change in the CPI that excludes all
the items that have transitory effects on the CPI
Causes of Inflation
Demand-Pull Inflation- characterized by “too much spending chasing too few goods.” Pressures on inflation are
caused by relatively higher demand compared to the available supply of goods and services. Excess demand
pulls the general price level.
Supply Shocks to Inflation- there are pressures on inflation resulting from shortages in supply and increases in the
cost of production without a corresponding expansion in output.
Profit-Push Inflation- there are pressures on inflation resulting to higher markups by businesses. Markup is the
difference between the original price and the selling price.
Redistributive Effects- effects of inflation are redistributed to different individuals, as such, there are gainers and losers
Loser and Winners in Inflation
Fixed income earners
Holders of securities
Fixed asset owners
Deflation- sustained decrease in the average price level
Hyperinflation- refers to a period of extremely high inflation reaching 100,000% and above
Phillips Curve- if aggregate supply is constant, a high rate of inflation is accompanied by high rate of employment (or low
unemployment) because output expands
Stagflation- economy is experiencing increasing inflation and unemployment at the same time