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© 2010 Jane Himarios, Ph.D.
Lecture 6
Chapter 6: Measuring Inflation and Unemployment
I.
Aggregate price level
The price of all the goods and services produced in the economy. One of the
macro goals is to keep the aggregate price level at a constant level. That is, we
don’t want inflation, deflation, disinflation, or hyperinflation.
Inflation
A general rise in prices throughout the economy.
Disinflation
Inflation at a declining rate.
Deflation
A general decline in overall prices throughout the economy.
Hyperinflation
An extremely high rate of inflation of at least 50% per month.
II.
It’s hard to measure the aggregate price level
It’s hard to measure the aggregate price level, so policymakers spend taxpayer
dollars to estimate it. The Bureau of Labor Statistics is in charge of constructing
various price indexes with which to estimate the aggregate price level.
III.
Price index
A measure of prices that is used to measure inflation (that is, to estimate
changes in the aggregate price level). Important price indexes include the CPI,
the PCE, the PPI, and the GDP deflator.
Consumer Price Index (CPI)
A measure of the average prices paid by urban consumers for a typical market
basket of consumer goods and services.
Personal Consumption Expenditure Index (PCE)
A measure of consumer prices that focuses on consumer expenditures in the
GDP accounts.
Producer Price Index (PPI)
A measure of the prices received by domestic producers for their output.
GDP deflator
A measure of the prices of the components of GDP (includes prices of the goods
and services bought by consumers, firms, the government, and foreigners).
© 2010 Jane Himarios, Ph.D.
IV.
Important Stuff about the CPI
The CPI measures the prices of 80,000 consumer goods and services each
month out of the 10s of millions of consumer goods and services that are actually
available.
The CPI is a cost-of-goods index: it always measures the price of a fixed market
basket of goods.
Problem: The fixed market basket of goods actually changes over time, as new
goods become widespread and as old goods are discontinued.
The CPI = (cost of the market basket in the current period ÷ cost of the market
basket of goods in the base period)x100
The base year of a price index gives a price level against which prices in other
years can be compared. The price index in the base year is 100. This is because
it is found using the formula cost of the market basket in the current period ÷ cost
of the market basket of goods in the base period)x100, where the current year is
the base year. Therefore the numerator and the denominator have the same
value.
To find actual CPI numbers, go to www.bls.gov/cpi, click on “CPI Tables” and
then click on “Table Containing History of CPI . . .” Look at the numbers under
the column titled “Avg.” to find the annual average CPI index number.
Year
2006
2007
2008
2009
CPI
201.6
207.342
Inflation Rate
----
V.
Three useful things that you can do with the CPI or GDP deflator
1.
Use the CPI to measure the inflation rate:
The inflation rate = ((current year index – original year index) ÷ original year
index) x 100
Exercise 1: Find the inflation rate from 2006 to 2007.
Answer: ((207.342 – 201.6) ÷ 201.6) x 100 = 2.8%
Exercise 2: Complete column 3 in the table above.
© 2010 Jane Himarios, Ph.D.
Exercise 3: Complete this table.
Year
GDP
Inflation Rate
Deflator
Since Previous
Year
1
212
Not available
2
215
3
222
4
212
5
215
6
216
7
216
8
213
9
204
2.
((215 –
212)/212)x100 =
1.415%
Is this economy experiencing
inflation, disinflation, deflation, or
price level stability?
We can’t tell since we don’t have
information for Year 0
Inflation
Use the CPI to adjust your salary for inflation:
New salary = Original salary x (current year index ÷ original year index)
Exercise 1: If you earned $32,000 in 2007 when the CPI equaled 207.342 how
much did you need to earn in 2008 when the CPI equaled 215.303 in order to
keep up with inflation?
Answer: $32,000 x (215.303 ÷ 207.342) = $33,228.66
Exercise 2: Use the table on the previous page to find how much you need to
earn now to maintain your purchasing power if you earned $33,000 in 2008.
Answer:
© 2010 Jane Himarios, Ph.D.
3.
Use the CPI to compare wages or income or prices or the GDP
deflator to compare output across time:
Comparing wages/income/prices across time
To do this you must calculate real (or constant dollar) income and real (or
constant dollar) prices for the two periods in question:
Real income in Year X = (Nominal income in Year X ÷ CPI in Year X) x 100
Inflation erodes the purchasing power of our incomes. Real (constant) income is
nominal income adjusted for price level changes. It allows us to see how our
purchasing power compares with the purchasing power we had in the past.
Exercise 1: If someone earned $100,000 in 1998 and their boss offers them
$125,000 in 2008, will their purchasing power rise? To find out, calculate their
real income for each period, and then compare those figures to see if real income
rose:
Real income in 1998 =
Real income in 2008 =
Exercise 2: How big a raise does this person need to get the same purchasing
power they had back in 1998? Use the escalation formula:
New income = original income x (current year index ÷ original year index)
Raise necessary to maintain standard of living = new income – actual income
Exercise 3: Go to http://www.dol.gov/whd/minwage/chart.htm and use the CPI to
calculate the real (constant) value of the minimum wage rate in July 2008 and
July 2009. Did people earning the minimum wage rate see their purchasing
power rise?
Real minimum wage in July 2008 =
Real minimum wage in July 2009 =
© 2010 Jane Himarios, Ph.D.
You use real figures for comparison purposes across time periods. Nominal
figures do not allow for comparison across time periods. Here is a chart to help
you see this.
If
A person’s real income rose
over time
A person’s real income
stayed the same over time
A person’s real income fell
over time
An item’s real price rose over
time
An item’s real price stayed
the same over time
An item’s real price fell over
time
Then we know
The person has more purchasing power now
than they had in the past
The person has the same amount of purchasing
power now than they had in the past
The person has less purchasing power now than
they had in the past
The item is relatively more expensive than it was
in the past
The item costs relatively the same as it cost in
the past
The item is relatively less expensive than it was
in the past
If
A person’s income (also called
nominal income) rose over time
A person’s income (also called
nominal income) stayed the same
over time
A person’s income (also called
nominal income) fell over time
An item’s price (also called
nominal price) rose over time
An item’s price (also called
nominal price) stayed the same
over time
An item’s price (also called
nominal price) fell over time
Then we
Cannot tell from the information given
whether their purchasing power rose, fell, or
stayed the same
Cannot tell from the information given
whether their purchasing power rose, fell, or
stayed the same
Cannot tell from the information given
whether their purchasing power rose, fell, or
stayed the same
Cannot tell from the information given
whether cost more, less, or the same as it
did in the past
Cannot tell from the information given
whether cost more, less, or the same as it
did in the past
Cannot tell from the information given
whether cost more, less, or the same as it
did in the past
© 2010 Jane Himarios, Ph.D.
VI.
Real GDP
Formula: Real GDP = (Nominal GDP ÷ the GDP deflator) x 100
Go to http://www.bea.gov/national/nipaweb/Index.asp and choose “List of
Selected NIPA tables” then table 1.1.6 to review the most recent real GDP
figures. Real GDP figures can be compared to see whether an economy has
grown because they have been adjusted to take price changes into account.
Here is an example where we can see that the US economy grew from 2007 to
2008 but shrank in 2009 (note: these figures are subject to revision so they may
be slightly different in the future). I pulled them on 2/5/2010.
Line
1
Gross domestic product
2
Personal consumption expenditures
3
Goods
4
Durable goods
5
Nondurable goods
6
Services
7
Gross private domestic investment
8
Fixed investment
9
Nonresidential
10
Structures
11
Equipment and software
12
Residential
13
Change in private inventories
14 Net exports of goods and services
15
Exports
16
Goods
17
Services
18
Imports
19
Goods
20
Services
Government consumption expenditures
21
and gross investment
22
Federal
23
National defense
24
Nondefense
25
State and local
26 Residual
2007
2008
2009
13,254.1 13,312.2 12,988.7
9,313.9 9,290.9 9,237.3
3,273.7 3,206.0 3,143.7
1,199.9 1,146.3 1,100.5
2,074.8 2,057.3 2,037.3
6,040.8 6,083.1 6,090.5
2,146.2 1,989.4 1,522.8
2,126.3 2,018.4 1,646.7
1,544.3 1,569.7 1,289.1
441.4
486.8
391.0
1,097.0 1,068.6
887.9
585.0
451.1
359.1
19.5
-25.9 -111.7
-647.7 -494.3 -353.8
1,546.1 1,629.3 1,468.6
1,064.8 1,127.5
987.0
481.3
501.7
480.6
2,193.8 2,123.5 1,822.5
1,839.6 1,767.3 1,479.1
354.2
356.5
342.9
2,443.1 2,518.1 2,566.4
906.4
975.9 1,026.7
611.5
659.4
695.1
294.9
316.4
331.4
1,536.7 1,543.7 1,542.8
0.3
20.0
19.2
© 2010 Jane Himarios, Ph.D.
VII.
Calculating Economic Growth Rates
Economic growth rate = ((Real GDPlatest period – Real GDPearlier period )/Real
GDP earlier period) x 100
Economic growth has occurred if real GDP is higher in one year than it was in the
previous year. Later on we will address the issue of whether a particular growth
rate is good “enough.”
VIII.
Problems with inflation and deflation, or, why we want price stability
A.
Problems with inflation
Inflation hurts people on fixed incomes, savers, and lenders
Web Activity:
According to the Associated Press, 3/31/2001, New York firefighters
tearing down a fire-damaged ceiling found nearly $30,000 in cash believed
to have been stored in a Brooklyn apartment for at least 20 years. They
found the money wrapped in foil inside six envelopes marked with
handwritten dates from the 1970s and 1980s.
Go to www.minneapolisfed.org and click on inflation calculator to find what
goods worth $30,000 in 1980 would cost today.
How can savers protect themselves from inflation? By demanding an
inflation premium on the money they save.
Nominal interest rate = real interest rate+ expected inflation rate
Inflation hurts economic growth
Inflation makes it harder for businesses to plan, because it is hard to predict how
much demand there will be at higher prices.
Inflation and international competitiveness
Inflation reduces a country’s ability to sell its products abroad.
B.
Problems with Deflation
Deflation hurts borrowers
They have to pay back dollars that are “more dear” than when they got
them. (Example: farmers during the Great Depression, mortgage holders
these days.)
Deflation makes it harder for the Fed to help our economy
Ongoing, expected deflation creates difficulties for monetary policy. The
Fed can lower its Federal Funds rate target all the way to 0%--but it can't
use open market operations or any of its other tools to make the Federal
Funds rate fall BELOW 0%.
© 2010 Jane Himarios, Ph.D.
(As we will see in later chapters, the Fed will want to use open market
operations to reduce interest rates so that consumers and firms will spend
more money, in order to help the economy grow. If the Federal Funds rate
is 0%, the Fed won't be able to stimulate spending.) Therefore, ongoing,
expected deflation potentially limits the Fed’s ability to affect our economy
with monetary policy.
Notes: "ongoing" means more than a one-time occurrence, "expected"
means that the public expects deflation to occur--that it isn't a surprise.
IX. Unemployment
A.
Some Basic Definitions
The government puts all of us into one of three categories: “employed,”
“unemployed,” or “not in the labor force.”
Who is “employed”?
1. Everyone who is at least 16 years old, not institutionalized or on active duty in
the armed forces, and who did any work for pay or profit during the survey week
2. Everyone who is at least 16 years old, not institutionalized or on active duty in
the armed forces, and who did at least 15 hours of unpaid work in a familyoperated enterprise
3. Everyone who is at least 16 years old, not institutionalized or on active duty in
the armed forces, and who was temporarily absent from their regular jobs
because of illness, vacation, bad weather, strike, or various personal reasons
Who is “unemployed”?
1. Everyone who is at least 16 years old, not institutionalized or on active duty in
the armed forces, and who did not have a job at all during the survey week but
made specific active efforts to find a job during the prior 4 weeks, and was
available for work (unless temporarily ill)
2. Everyone who is at least 16 years old, not institutionalized or on active duty in
the armed forces, and who was waiting to be called back to a job from which they
had been temporarily laid off
Who is “not in the labor force”?
1.
Everyone who is under 16
2.
Everyone who is institutionalized
3.
Everyone who is a member of the armed forces on active duty
4.
Everyone else who is not employed or unemployed
© 2010 Jane Himarios, Ph.D.
B.
How the Government Tracks the Unemployment Rate
See http://www.bls.gov/cps/cps_htgm.htm for How the Government Measures
Unemployment and http://www.bls.gov/opub/hom/homch1_itc.htm for the BLS
Handbook of Methods
The government conducts a monthly survey called the Current Population Survey
(CPS) to measure unemployment. There are about 60,000 households in the
sample for this survey. Interviewers collect information only about household
members who are at least 16 years old who are not in an institution such as a
prison or mental hospital or on active duty in the armed forces.
A CPS surveyor asks the following questions for each household member who is
at least 16 years old and who is not institutionalized or on active duty in the
armed forces.
1.
Did you do any work for pay or profit during the survey week?
If the answer is yes the person is employed.
If the answer is no the surveyor asks the next question.
2.
Did you do at least 15 hours of unpaid work in a family-operated
enterprise?
If the answer is yes the person is employed. (People who work 15
hours or more per week without pay in a family-operated business
are considered employed, and fall into a group called “unpaid family
workers”.)
If the answer is no the researcher asks the next question.
3.
Do you have a regular job that you were temporarily absent from due to
illness, vacation, bad weather, strike, or various personal reasons?
If the answer is yes the person is employed.
If the answer is no, the person is NOT counted as employed,
because they did not have a job at all during the survey week. The
researcher asks the next question.
4.
Did you make specific active efforts to find a job during the prior 4 weeks,
and were you available for work (unless temporarily ill)?
If the answer is yes the person is unemployed.
If the answer is no the researcher asks the next question.
5.
Were you waiting to be called back to a job from which you had been
temporarily laid off?
If the answer is yes the person is unemployed.
If the answer is no then the person is not in the labor force.
© 2010 Jane Himarios, Ph.D.
For 2007:
69,754,157
146,047,000
78,743,000
7,078,000
2007
Total U.S. Population
301,627,157
- Under 16, on active duty in the armed 69,754,157
forces, or institutionalized
= Civilian noninstitutional population
231,867,000
- employed
146,047,000
- unemployed
7,078,000
= everyone else who is not in the labor 78,743,000
force (retirees, college students who
don’t work, housewives and
househusbands, etc.)
Sources: http://stats.bls.gov/cps/cpsaat1.pdf;
http://factfinder.census.gov/servlet/SAFFPopulation?_submenuId=population_0&_sse=on
The unemployment rate = unemployed/civilian labor force =
7,078,000/(146,047,000 + 7,078,000) = 4.6% for 2007
C.
Problems with Unemployment Statistics
The presence of discouraged workers and underemployment mask weaknesses
in the economy.
Discouraged workers
Discouraged workers are people who aren’t actively seeking work but would take
a job if one were offered. They are “not in the labor force”, but their existence is
an indicator of the strength or weakness of the economy. See
http://stats.bls.gov/cps/cpsaat35.pdf.
Underemployment
Underemployment occurs when people take jobs that do not fully exploit their
education, background, or skills.
© 2010 Jane Himarios, Ph.D.
D.
The Types of Unemployment
1.
Frictional Unemployment
This type of unemployment occurs when qualified people with transferable
skills change jobs or enter the labor force, due to “frictions” in the
economy.
2.
Structural Unemployment
This type of unemployment occurs when people do not have the skills
necessary to qualify for the jobs that exist, due to “structural changes” in
the economy.
3.
Cyclical Unemployment
= Total Unemployment – Frictional Unemployment – Structural
Unemployment. This type of unemployment occurs when there is
insufficient spending in the economy.
E.
The Natural Unemployment Rate = Frictional Unemployment Rate +
Structural Unemployment Rate
Notice that the natural unemployment rate
is composed of two of the three types of
unemployment. The economy achieves
the natural rate when there is no cyclical
unemployment.
F.
Full Employment occurs when there is no cyclical unemployment. This is
when our economy is at the natural unemployment rate. Full employment is a
useful concept for macroeconomic policy-makers. In terms of achieving the three
macroeconomic goals, they worry only about eliminating cyclical unemployment,
but they do not worry about eliminating frictional and structural unemployment.
Therefore, as soon as they eliminate cyclical unemployment, they declare that
the economy has achieved "full employment," then they shake hands, exchange
"high fives," and go home happy.
Question: Is the unemployment rate 0 when our economy is at full employment?
© 2010 Jane Himarios, Ph.D.
Answer:_____. Explanation:________________________________________.
Go to http://stats.bls.gov/eag/eag.us.htm to see total unemployment rates.