Download WHAT ARE THE TWO EVILS OF EVERY ECONOMY?

Unemployment and
Inflation
i.e. two evils of the
economy will be
discussed.
Component Parts GDP
Consumption
Investment
Government Spending
Exports- Imports (Net Exports)
C+I+G+(X-M) = GDP
GDP 2007 to 2010
Unemployment to August 2011
Now- was that a bad recession????
Why does growth matter?
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Allows wages and incomes to rise.
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Standard of living increases

Takes the pressure of scarce
resources… (why?)
Main Sources of Growth
Two ways that society can increase its
real output and income:
1) increase inputs of resources
2) increase productivity of those inputs
BLS Latest Numbers
Macroeconomic Problems
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High inflation rate
High unemployment rate
High interest rates
Low economic growth or stagnation
Macroeconomic Policies
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Fiscal Policy deals with
changes in government
expenditures and/or taxes.
to achieve particular
macroeconomic goals.
Monetary Policy deals with.
changes in the money
supply, or the rate of
growth of the money
supply, to achieve
particular macroeconomic
goals.
What really is macroeconomics?
Is the study of the aggregate economic
behavior of the economy as a whole to
determine what causes the swings in the
business cycle.
Example: imagine everyone is paid on the same
day. With incomes in hand, people enter the
product market.
The question is: How much will people buy?
Answer is: we have to know something about
prices. (if cheap, we buy more) vice-versa…
We are not talking about prices of a single good,
but rather the average price level.
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The Idealized Course of Business
Fluctuations
What are component parts of GDP?
?
What will we focus on?
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This will focuses on economic growth,
the business cycle, unemployment
and inflation.
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When is a person “unemployed”?
What are the costs of unemployment?
-When will money not buy as much?
Unemployment since 1990
Current Unemployment Rate today is????????
9.2
What is the labor force?
The labor force includes all persons over
age sixteen who are either working for
pay or actively seeking paid employment.
 People who are not employed or are not
actively seeking work are not considered
part of the labor force.
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When is a person “unemployed”?
What are the costs of unemployment?
How is unemployment measured?
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U.S. Census Bureau surveys about 60,000
households a month to determine how many
people are actually unemployed.
This translates into approximately
110,000 individuals, a large sample
compared to public opinion surveys which
usually cover fewer than 2,000 people.
number of unemployed people
Unemployment rate =
labor force
Sampling for unemployment
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Every month, one-fourth of the households in the
sample are changed, so that no household is
interviewed more than 4 consecutive months.
Similarly, interviewers do not decide the
respondents' labor force classification. They
simply ask the questions in the prescribed way
and record the answers. Based on information
collected in the survey and definitions
programmed into the computer, individuals are
then classified as employed, unemployed, or not
in the labor force.
Bureau Labor Statistics determines
perimeters for unemployment.
Persons over 16 are considered
employed IF:
 They worked at all for pay or
profit even if for an hour
 Worked 15 hours or more w/out
pay in a family-operated
enterprise.
 Have a job which they did not
work during (survey week) due
to illness, vacation, industrial
disputes, bad weather, time off
or personal reasons.
BLS Continued
Persons are considered
unemployed IF: (during the
survey week)
 Do not have a job
 Are available for work
 Have actively looked & looked
for work during past four
weeks (this requirement is
very weak…)
Reason for unemployment
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How long a person remains unemployed is
affected by the nature of the joblessness.
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Job leavers
Job losers
Re-entrants
New entrants
What happens if you can’t find
work…….
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If unemployment persists… workers often give-up
looking.
Discouraged workers are not counted as part of
the unemployment problem after they give up
looking for a job.
Some people are forced to take any job available
which means…no longer unemployed, but now
“underemployed.”
How could one be underemployed?
Underemployment exists when people
seeking full-time paid employment, work
only part time, or are employed at jobs
below their capability.
Underemployed workers represent labor
resources that are not being fully utilized.
Unemployment Cont.
Seasonal unemployment is the
unemployment due to seasonal changes in
employment or labor supply. What would
be an example?
At the end of each season, thousands of
workers must go searching for new jobs,
experiencing seasonal unemployment in
the process.
Three basic kinds of unemployment:
1. Frictional Unemployment
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Frictional unemployment is the brief
periods of unemployment experienced by
people moving between jobs or into the labor
market.
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Frictional unemployment differs from other
unemployment in three ways:
Demand is there
Frictionally unemployed have the skills
required
Job search relatively short
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3 Kinds of Unemployment Cont.
2. Structural Unemployment
 Structural unemployment is the
unemployment caused by a mismatch between
the skills (or location) of job seekers and the
requirements (or location) of available jobs.
Periods between jobs will be lengthened when the
unemployed lack the skills that employers
require.
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3 Kinds of Unemployment Cont.
3. Cyclical Unemployment
 Cyclical unemployment is the
unemployment attributable to the lack of
job vacancies – i.e., to an inadequate
level of aggregate demand.
 Cyclical unemployment occurs when there
are simply not enough jobs to go around.
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More Than a Century of
Unemployment
Source: U.S. Department of Labor, Bureau of Labor Statistics
OKUN’S Law
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Okun’s Law
Arthur Okun quantified the relationship between
the shortfall in real output and unemployment.
High unemployment in 1992 left the U.S. $240
billion short of its production possibilities — a loss
of $920 of goods and services for every
American.
Labor Force? Okun’s Law
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Slow Growth….
The economy must grow at least as fast as the
labor force to avoid cyclical unemployment.
Relationship between the shortfall in
output and unemployment.
When you have unemployment of any
significance, your economy will have reduced
output. Ratio accepted today is 1% of
unemployment yields 2% less output.
A 2/1ratio then allows economists to put a $$$
amount on the cost of unemployment to the
economy.
Think about this!
Unemployment = 5% (NARU)
Unemployment = 8% (x 2 = 16% less
production)
Unemployment = 25% (depression era x
2) = 50% less production!
Today (2010) = 9.2 x 2 =18.4% less
So… what is full employment?
Full employment is not the same as zero
unemployment.
The economy strives to reach its potential
which means that full employment is
essential.
When the actual rate of unemployment
exceeds the natural rate, the actual output
of the economy will fall below its potential.
Resources are underutilized (inside production
possibility curve.)
Full Employment

The condition that
exists when the
unemployment rate
is equal to the
natural
unemployment rate.
Image Cylinder= Economy…
Businesses, factories, economy
not working at full capacity
Full Employment
AD
AS
LRAS
Full Employment Act of 1946
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The Full-Employment Goal
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In the Employment Act of 1946, Congress
committed the federal government to pursue a
goal of “maximum” employment.
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Congress didn’t specify what the rate of
unemployment should be.
Congress creates confusion
First attempt to define “full employment” came
about 1960- Council of Advisors decided that
full employment meant “watching prices” …..
Rising prices they said would signal that full
employment was being reached.*** believed
inverse relationship unemployment/inflation
In 1970-80 Full employment potential was
considered overly optimistic.
Unemployment rates stayed far above 4% even
when the economy expanded.
Inflation began to accelerate at higher levels of
unemployment.
Confusion Continued
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The redefinition of full employment goal
needed to be addressed.
Needed to realize more youth and women in
the labor force
Needed to acknowledge the increased transfer
payments
Needed to acknowledge the structural changes
in demand (for such things as technology and
trade) old industries were not in such demand
(steel, textiles, auto)\
Most economists say 5% today
Humphrey-Hawkins Act of 1978
This Act was passed to require the Federal
Reserve to maintain a 4% rate of
unemployment without inflation while
holding the inflation to a goal of 3% by
implementing monetary policy where
needed.
 Fiscal policy might undo this law, but it is
still a focus of the Fed and the Fed has to
report to Congress twice a year on the
health of the American economy.
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Natural Rate of Unemployment
NARU
NARU = the difference between full
employment and 100% employment.
A level of unemployment that will not trigger
inflation. i.e. this figure will not bid up
wages.
The natural rate of unemployment is not a
temporary high or low… it is a rate that is
sustainable into the future.
Depression Unemployment
Our greatest failure occurred during the Great
Depression, when as much as one-fourth of
the labor force was unemployed.
The Historical Record
 Unemployment rates fell dramatically during
World War II — the civilian unemployment
rate reached a rock bottom 1.2 percent.
 Since 1950, unemployment rate has fluctuated
from a low of 2.8 percent during the Korean
War (1953) to a high of 10.8 percent during
the 1981-82 recession.
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From 1982 to 1989, unemployment fell, but shot up again
in the 1990-91 recession.
In…2002…unemployment was circa 5.7%
In…2004…unemployment was circa 6.5%
February, 2005… 5.4%
September, 2005….5.1%
February, 2006….. 4.8%
January, 2007…….4.6%
October, 2007…….4.7%
October, 2008…….6.1%
February, 2009 …..7.6%
July, 2009 ………. 9.5%
September 2009….9.7%
October, 2009 – 10.1
February. 2010 – 9.7
May, 2010 – 9.3
June, 2010- 9.7
October, 2010 9.6
New Jobs
 The new jobs of tomorrow will require increasing
levels of education and skill.
 And, new type skills no doubt.
Old Skills
 As the skills gap widens, structural
unemployment increases.
 The skills gap is the gap between skills required
for emerging jobs and the skills of workers.
What about the other evil?
Inflation and Deflation
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Inflation
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A sustained increase in the average of all
prices of goods and services in an economy
Deflation
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A sustained decrease in the average of all
prices of goods and services in an economy
Looking at the past
In 1923, prices in Germany rose a trillion
times over.
 Prices in Russia, Bulgaria, and some other
nations have witnessed a tenfold increase
in a year.
 In the 1990’s the U.S. inflation rate has
risen 1 to 4 percent a year.
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Inflation…is bad…is bad..is bad!
What is inflation?
A continuing rise in the average level of
prices.(it costs more to purchase the
typical “bundle” of goods and services that
is produced or consumed or both.)
Bottom line: Too many $$$$ chasing too
few goods.
The CPI is based on what it costs an
average family to live.
 Just think… Inflation enables us to live
in more expensive neighborhoods
without having to move
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Inflation is bad… see???
Shortened Time Horizons
 During the German hyperinflation, workers
were paid two or three times a day so that
they could buy goods in the morning before
prices increased in the afternoon.
Speculation
People may be encouraged to withhold resources
from the production process, hoping to sell
them later at higher prices.
Bracket Creep
 Under our progressive tax system, taxes go up
when prices rise.
 Savings, investment, and work effort decline.
Inflation discussion
Notice we said an increase in the Average Level of prices. Not a
change in any specific price…
Statisticians calculate the average then look for changes in the
average. The Consumer Price Index for All Urban Consumers (CPIU) decreased 0.4 percent in August, before seasonal adjustment, the
Bureau of Labor Statistics of the U.S. Department of Labor reported
today. The August level of 219.086 (1982-84=100) was 5.4 percent
higher than in August 2007.
 A decline in average prices = deflation.
Relative price means an increase in the price of apples (relative to
other fruits) apples cost more than pears.
Inflation does not make ALL persons worse off.
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Nominal Income vs. Real Income
What is the difference between nominal income
and real income.
Nominal = income you receive in a particular
period
Real income = what you can use for
purchasing stuff.
***If you nominal income does not change
and there is an increase in the average level
of prices….. You cannot buy as much “stuff.”
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If the number of dollars you receive every
year is always the same, your nominal
income doesn’t change- but your real
income will rise or fall with price changes.
Another rule:
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If you put your money into savings and
keep it there rather than spending it,
and inflation comes along…
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your money in savings will not buy as
much as it would prior to the wave of
inflation that hit.
Uncertainty and Misconception
Money Illusion
 Even people whose nominal incomes keep up
with inflation often feel oppressed by rising
prices.
 They feel cheated when they discover that
their higher nominal wages don’t buy
additional goods.
Uncertainty
 One of the most immediate consequences of
inflation is uncertainty.
 Uncertainties created by changing price levels
affect consumption and production decisions.
Inflation discussion
Uncertainty on the part of
the consumer in trying to
outguess the price of
goods and services.
If consumers or producers
postpone or cancel their
expenditure plans, the
demand for g & s will fall.
Eventually production
falls, and unemployment
occurs…
What Causes
Inflation?
 Nearly all
economists
believe that
rapid expansion
in the supply of
money is the
cause of
inflation.
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What happens if incomes go up to
keep pace with inflation?
Bracket creep is the movement of
taxpayers into higher tax brackets
(rates) as nominal incomes grow.
Deflation Dangers
 Deflation — a falling price level —
might not make people happy either.
 Deflation reverses the redistributions
caused by inflation. (Example: people
today – upside down on their houses.)

Speculations from consumption and
production
If you expect prices to rise, it makes
sense to buy things now for resale
later.
 People may be encouraged to withhold
resources from the production process,
hoping to sell them later at higher price
 As such behavior becomes widespread,
production declines and unemployment
rises.
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Measuring Inflation
Measuring inflation serves two purposes:
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Gauges the average rate of inflation.
Identifies its principal victims.
Consumer Price Index (CPI)
 The CPI is the most common measure of
inflation.
 The consumer price index (CPI) is a
measure (index) of changes in the
average price of consumer goods and
services.
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Macroeconomic Measures - Prices
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Price Level - A weighted average of the
prices of all goods and services.
Price Index - A measure of the price level.
Consumer Price Index (CPI) - A widely
cited index number for the price level; the
weighted average of prices of a specific set of
goods and services purchased by a typical
household.
How to measure rate of inflation
Measuring the Rate of Inflation
 Market Basket
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Representative bundle of goods and services
Base Year
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The point of reference for comparison of prices
in other years
Macroeconomic Measures - Prices

Base Year - The year chosen as a point
of reference or basis of comparison for
prices in other years; a benchmark year.
Computing the Consumer Price Index
Consumer Price Index (CPI)

By observing the extent of price increases,
we can calculate the inflation rate.
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The inflation rate is the annual percentage
rate of increase in the average price level.
Changes in Prices
Percentage change in prices = Current year - later year
later year
x100
In 2005 the CPI was 195.3; in 2006 the index was
201.6. What was the percentage change in prices
from 2005-2006?
Click below for answer.
3.22 %
Here’s a little hint if you forget…C-L/L
CPI determined
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Calculates the inflation rate
Market basket of goods
and services (same each
year.)
Bureau of Labor Statistics
determines cost in 85 cities
by shopping 184 items.
19,000 stores visited and
60,000 landlords,renters and
homeowners surveyed each
month
Statistics released each
month.
Yearly average compiled.
CPI expressed in
base year ’82-84
Constructing the CPI
 The base period is
the time period used
for comparative
analysis — the basis
of indexing, for
example, of price
changes.
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Shopping for CPI
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CPI is constructed by identifying a typical
bundle of goods that the average consumer
buys. This bundle stays the same each year.
The base year is changed periodically. The
base year used is ’82-’84 and prior to that it
was ’63.The price level in the base period is
designated as 100.
The market basket (bundle) can be changed if
BLS research shows that the “average”
consumer no longer is purchasing that good or
service.
Each item in the bundle is weighted percentwise in the market basket figures.
The Market Basket
Transportation
19.0%
Housing
32.6%
Food
13.6%
Insurance and pensions 9.3%
Clothing 4.7%
Entertainment 5.1%
Miscellaneous 10.5%
Health care 5.3%
What is the difference?
So………if it cost you $225 in 2002 to buy the
same bundle of goods that you bought in
1983, you would be paying 225% more
for the same “stuff.”
Look at the inflationary costs of: cars,
health care, housing, (house 4 bedrooms,
2 baths, in Highland Park in 1960 cost
approximately $30,000.) (Today?????)
Calculations
Rate of Inflation = %
of PI(price index)
from one year to the next.
When prices are rising, on average, the price
index will rise.
i = This year’s PI – Last year’s PI
Last year’s PI x100
If price index this year was 220 compared to
200 last year, the inflation rate would equal
10%
220 – 200
200
x 100 = 10
Formula hint: c-l/l x 100 (current-last/last x
100)
Let’s try another calculation
In 2008 – CPI measured 215.3
In 2004 – CPI measured 188.9
What was the rate of inflation from 04 – 08?
Ans. 13.9
Is there a safety shield against inflation?
Answer: not much!!!
But Congress has passed the Cost-ofliving adjustment (COLA) provision for
those receiving Social Security Checks.
Checks are indexed each January…in the
amount equal to inflation the previous
year.
If inflation was 3% then the checks are
adjusted accordingly.
Unions also negotiate for this COLA in
their pay proposals…
Bankers in business to make a profit.
Some bankers build in that same philosophyAdjustable-rate mortgage (ARM) stipulates an
interest rate that changes during the term of
the loan.
Actually, banks build the inflation factor into all
their loans…the number of points depends on
many variables we will discuss later.
 The real interest rate is the nominal interest
rate minus the anticipated inflation rate.
Inflation and Deflation (cont'd)
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Real-world price indexes
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Consumer Price Index (CPI)
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Producer Price Index (PPI)
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GDP deflator
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Personal Consumption Expenditure (PCE)
What is stagflation?
High inflation and high
unemployment….
A period during which an economy is
experiencing both substantial inflation
and either declining or slow growth in
output.
Economists used to say this would and
could never happen… it did in the 80’s
Paul Volker entered the scene as Fed
chairman and held court on monetary
policy.. More of this story later…
CAUSES of inflation
1. Demand pull (too much aggregate
demand and not enough aggregate
supply.
 Cost Push (production costs rise) supply
decreases…
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S
D
S1
S
D1
D
Explanations
Demand pull:
 Economy producing at capacity
 Consumers willing and able to buy more goods
 Can buy goods because of accumulated
savings or easy access to credit (refinancing
the house, second mortgages in Texas, low
interest loans, credit card interest rates low,
prime rate very low.)
 Pull to have more goods and only limited
amount of goods available… causes prices to
rise!
 Hence, a demand-driven rise in average prices
or demand-pull
Explanations Continued
Cost Push:
 When producers have to pay more for inputs
(resources for production), the price of the
good produced increases.
OPEC- prices of crude escalates any product
dependent on crude (including heating costs,
increases).-News Flash! Winter of 2007-2008
heating home costs rose 22%
Explanation of Dollars in Cost-push
Labor has generally been the most
expensive of inputs for production up till
now in our economy.
If wage rates are pushed upward…. The
good or service would have an increase in
price (longshoreman’s union, pilots,)
Note that most of these are union
connected. Tech industry workers took
about a 50% cut to get jobs in 2002 as
opposed to their salaries in 1999.
If the Fed releases too much money in the
economy (continually pushing down
interest rates, the value of that money is
not as solid as if there were less
circulating… more later on that) 
Check the current inflation rate………..
http://inflationdata.com/inflation/
Bureau of Labor Statistics
Another way to measure U.S.
economic health
Producer Price Index:
 The PPIs keep track of average prices received
by producers.
 October 20, 2005….PPI up highest in 15 years.
 3 indices…crude materials, intermediate
goods, finished goods.
 Identified in monthly surveys just like CPI is.
 In SR, PPI increases before CPI (takes a little
while for the prices to be reflected in products
we buy.
Is the Growth of GDP real or inflated?
This is the real test!!!!!!!
Was there actual increase in production
and services or did the prices just skew
the GDP statistics when C+I+G was
added?
Have to correct GDP for price changes so
we can measure actual production.
CPI tells the consumer if they have to
spend more dollars to get that loaf of
bread… but other measures have to be
evaluated.
Still another way to test the health of the
U.S. economy
The GDP Deflator…. The broadest price index
and covers all output including consumer
goods, investment goods and government
services. (C+I+G)
The GDP deflator isn’t a pure measure of price
change. Its value reflects both price
changes AND market responses to those
price changes as reflected in new
expenditure patterns.
The GDP deflator typically registers a lower
inflation rate than CPI and the
government watchdogs use this
barometer more readily than current CPI
Year
Price of good Quantity
(base
GDP
Real GDP
1
$10
100
$1,000
$1,000
2
$12
120
12x120
10 x 120
= $1,440 = $1,200
3
$14
140
14 x 140 10 x 140
= $1,960 = $1,400
Bottom Line
CPI is designed to measure the impact of price
changes on the cost of a typical bundle of
goods purchased by households(remember,
market basket and only for urban purchasers.)
GDP deflator is a broader price index and is
designed to measure the change in the
average price of the market basket of goods
included in GDP (in addition to consumer
goods it includes capital goods, & g & s by
government.)
CPI measures money income of consumers in
relation to rising prices (only consumer
goods.)
GDP deflator measures economy wide inflationmore g & s included in measurement.
Personal Consumption Expenditure
CPE
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More accurate than CPI
Quantifies changing expenditure patterns
for consumers.
Is a weighted measure
Doesn’t always have same items
calculated
BEA uses continually updated surveys of
consumer purchases to determine index
Federal Reserve uses this measure for
their predictions and assessments.
Historical Record Graph
20
Inflation
16
A
12
8
4
B
0
4
8
Deflation
12
1920
1930
1940
1950
1960
1970
1980
1990
2000
What really is the goal of fiscal and
monetary planners?
The CPI’s market basket of goods and services
was overhauled in 1998.
Price Stability…..
 Major changes in the general level of prices
indicate upsets in the economic system.
 Prices act as allocators of economic goods,
they are the mechanism that determines the
answer to the three basic questions, What,
How and For Whom.
 Prices act as the basic force in a capitalistic
economy 
What does a pair of Nike shoes cost
compared to a pair of Keds?