Download Chap23

Chapter 23
Unemployment and Inflation
© 2006 Thomson/South-Western
1
Costs of Unemployment
Personal Cost
Loss of paycheck
Loss of self-esteem
Increase in stress related psychological
problems
Increase in incidence of crime, suicide, and
mental illness
Economic Cost
Loss in output
2
Measuring Unemployment
Civilian Noninstitutional Adult Population
All civilians 16 years of age and older
Excludes institutionalized in prisons or mental
hospitals
Excludes those in military
Labor force
Those in the adult population who are either working
or looking for work
3
Measuring Unemployment
Unemployed
Those with no job who are looking for work
Unemployment rate
Measures the percentage of those in the labor force
who are unemployed
Equals the number unemployed divided by the
number in the labor force
Does not include discouraged workers
Discouraged workers
Those who are no longer looking for work but are
unemployed
4
Exhibit 1: The Adult Population Sums the Employed,
the Unemployed, and Those Not in the Labor Force
5
Labor Force Participation Rate
The number in the labor force divided by the
adult population
On average, two out of three adults are in the
labor force
Increased from about 60% in 1970 to
approximately 67% in 1990 and has remained
relatively constant since
Convergence of the participation rates of men
and women over last 40 years as more women
enter the labor force
6
Trend of Unemployment Rate
Decline in the unemployment rate over last 20
years
Overall growth in the economy
Relatively fewer teenagers in the work force
Unemployment rate says nothing about who is
unemployed or for how long – differs across
Race
Gender
Age
Geographical area
Occupational group
7
Exhibit 2: The U.S. Unemployment Rate
Since 1900
8
Exhibit 3: Unemployment Rates for
Various Groups
9
Exhibit 3: Unemployment Rates for
Various Groups
10
Exhibit 4: Unemployment Rates Differ
Across U.S. Metropolitan Areas
11
Sources of Unemployment
Frictional
Seasonal
Structural
Cyclical
12
Frictional Unemployment
Caused by time required to bring together
labor suppliers and labor demanders
Employers need time to learn about the talent
available
Job seekers need time to learn about employment
opportunities
Generally short-term and voluntary
13
Seasonal Unemployment
Caused by seasonal changes in labor demand
during the year
To eliminate the impact of such changes,
monthly unemployment statistics are seasonally
adjusted, which smoothes out these factors
14
Structural Unemployment
Exists because unemployed workers often
Do not have the skills demanded by employers, or
Do not live where their skills are in demand
Occurs because changes in tastes, technology,
taxes, or competition reduce the demand for
certain skills and increase the demand for other
skills
15
Cyclical Unemployment
Fluctuates with the business cycle,
increasing during contractions and
decreasing during expansions
Means the economy is operating inside its
PPF
Government policies to stimulate
aggregate demand recessions is aimed at
reducing this type of unemployment
16
Full Employment
Occurs only if there is no cyclical
unemployment
Occurs when the only unemployment is
frictional, structural, or seasonal
Does not mean zero unemployment
Frictional, seasonal, and structural
unemployment can still occur
Occurs when from 4% to 6% of the labor
force is unemployed
17
Unemployment Compensation
Cash transfers for those who lose their jobs
and actively seek employment
Applies to unemployed workers who meet
certain qualifications
Problems with unemployment
compensation:
Workers who receive benefits tend to search
less actively than those who don’t
May reduce the urgency of finding work
18
International Comparisons
Why are unemployment rates so high in
Europe?
Ratio of unemployment benefits to average pay is
higher
Unemployment benefits last longer, sometimes
years, so workers have less incentive to find new
jobs
Government regulations make employers in Europe
reluctant to hire new workers because firing them is
difficult
19
Exhibit 5: In the Last Two Decades, Unemployment
Rates Fell in the United States, Rose in Japan, and
Remained High in Europe
20
Problems with Unemployment Figures
Understate the actual amount of
unemployment because they do not
include discouraged workers and
underemployed
Underemployment occurs when
people are counted as employed even if they
can find only part-time jobs or
Are vastly overqualified for their job
21
Problems with Unemployment Figures
Tend to overstate unemployment because
Employment insurance and most welfare programs
require recipients to seek employment
Some who would prefer to work part time can find
only full-time work
Some are forced to work overtime and weekends, but
would prefer to work fewer hours
People in the underground economy may not readily
acknowledge such jobs because their intent is to evade
taxes
22
Inflation
Inflation: a sustained increase in the
average price level
Hyperinflation: extremely high inflation
Deflation: a sustained decline in the
average price level
Disinflation: a reduction in the rate of
inflation
23
Inflation
Inflation is typically measured annually
Annual inflation rate is the percentage
increase in the average price level from
one year to the next
Two sources of inflation
Demand-pull inflation
Cost-push inflation
24
Exhibit 6a: Inflation Caused by Shifts of
AD and AS Curves
Increase in the AD curve pulls up
the price level. To generate
continuous demand-pull inflation,
the AD curve must keep shifting
outward along a given AS curve
Increase in costs of production push
up the price level. To generate
continuous cost-push inflation, the AS
curve must keep shifting to the left
along a given AD curve.
25
Exhibit 7a: Consumer Price Index Since 1913
26
Exhibit 7b: CPI Since 1913 – Annual
Percentage Change
27
Anticipated versus Unanticipated Inflation
Unanticipated inflation creates more problems
for the economy than does anticipated inflation
To the extent that inflation is higher or lower
than anticipated, it arbitrarily creates winners
and losers
If it is higher than expected, the winners are all
those who had contracted to pay a price that
anticipates lower inflation
The losers are all those who agreed to sell at that
price
If inflation is lower is lower than expected, the
situation is reversed
28
Transaction Costs of Inflation
When prices are stable, people correctly believe
they can predict future prices and can plan
accordingly
But, if inflation changes unexpectedly, planning gets
harder which undermines the ability of money to serve
as a link between the present and the future
When dealing with the rest of the world, they
must also anticipate how the value of the dollar
might change relative to foreign currencies
29
Obscures Relative Price Changes
Relative prices describe the exchange
rate between goods—how much one good
costs compared to another
Inflation does not necessarily cause the
change in relative prices, but it can
obscure them
Occurs because of the greater
uncertainty about the price of one good
relative to another
30
Inflation Across Metropolitan Areas
Inflation rates differ across regions
mostly because of differences in housing
prices, which grow faster in some places
than in others
Federal government tracks separate CPIs
for each of 26 metropolitan areas.
31
Exhibit 8: Average Annual Inflation from 1994 to
2004 Differed Across U.S. Metropolitan Areas
32
Inflation Across Countries
Exhibit 9: Inflation Rates in Major Economies Have Trended
Lower Over the Past Two Decades
33
Inflation and Interest Rates
Interest is the dollar amount paid by borrowers
to lenders because lenders must be rewarded
for forgoing present consumption
The interest rate is the interest per year as a
percentage of the amount loaned
34
Exhibit 10: The Market for Loanable Funds
Greater the interest rate,
the greater the reward for
loaning money: supply
curve slopes downward
The higher the interest
rate, the higher cost of
borrowing – the quantity of
loanable funds demanded
decreases as the interest rate
increases, other things
constant: demand curve for
loanable funds is downward
sloping
Equilibrium interest rate
is at the intersection of the
supply of and demand for
loanable funds
35
Interest Rates
Nominal interest rate
Measures interest in terms of the current dollars
paid
The interest rate that appears on the borrowing
agreement
The rate quoted in the news media
Real interest rate
Equals the nominal rate of interest minus the
inflation rate
Expressed in dollars of constant purchasing power
36
Interest Rates
With no inflation, the nominal and real interest
rates would be identical
With inflation, the nominal interest rate
exceeds the real interest rate
If the inflation rate is high enough, the real interest
rate can actually be negative
The nominal interest would not even offset the loss
in spending power because of inflation – lenders
would lose purchasing power
Why lenders and borrowers are concerned more
about the real interest rate than the nominal interest
rate
37
Interest Rates
The higher the expected rate of inflation,
the higher the nominal rate of interest
that lenders require and that borrowers
are willing to pay
Expected real interest rate equals the
nominal rate of interest minus the
expected inflation rate
38
Why is Inflation Unpopular?
Problems with unanticipated inflation
Hits those whose incomes are fixed in
nominal terms
Arbitrarily redistributes income and wealth
from one group to another
Reduces the ability to make long-term plans
Forces buyers and sellers to pay more
attention to prices - less time for production overall productivity of economy falls
39
COLA
Cost of Living Adjustment: the increase
in a transfer payment or wage that
reflects the increase in the price level
40