Download Chapter7 - QC Economics

Chapter 7
The Macroeconomy:
Unemployment and Inflation
Learning Objectives
• Explain how the U.S. government calculates
the official unemployment rate
• Discuss the types of unemployment
• Describe how price indexes are calculated
and define the key types of price indexes
7-2
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Learning Objectives (cont'd)
• Distinguish between nominal and real
interest rates
• Evaluate who looses and who gains from
inflation
• Understand key features of business
fluctuations
7-3
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Chapter Outline
• Unemployment
• The Major Types of Unemployment
• Full Employment and the Natural Rate of
Unemployment
• Inflation and Deflation
• Anticipated versus Unanticipated Inflation
• Changing Inflation and Unemployment:
Business Fluctuations
7-4
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Did You Know That...
• Estimates indicate that each year, discount pricing
by retailers such as Wal-Mart, K-Mart, and Target,
helps to keep the overall U.S. inflation rate about
0.4% lower?
• Additionally, every year discount pricing by food
superstores holds the annual rate of increase in
average U.S, food prices 0.75% below the rate it
otherwise would reach?
• Trying to understand and better measure inflation
and the overall performance of the national
economy is a central objective of macroeconomics.
7-5
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Unemployment
• Unemployment
– Total number of adults (aged 16 years or older)
willing and able to work and who are actively
looking for work but have not found a job.
– Unemployment creates a cost to the entire
economy in terms of lost output – often ranging
in the billions of dollars.
7-6
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Unemployment (cont'd)
• Labor Force
– Individuals aged 16 years or older who either
have jobs or who are looking and available for
jobs; the number of employed plus the number
of unemployed
• The unemployment rate is the percentage of
the measured labor force that is
unemployed.
7-7
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Unemployment (cont'd)
• Question
– What are the costs of unemployment?
7-8
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Unemployment (cont'd)
• Answers
– Lost output
• During early 2000s, unemployment rate rose by 2
percentage points
• Firm output was 80% of potential
• Lost output was $200 billion of goods and services that
could have been produced
– Personal psychological impact
7-9
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Figure 7-1 More Than a Century of
Unemployment
Source: U.S. Department of Labor, Bureau of Labor Statistics
7-10
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Figure 7-2 Adult Population
Source: U.S. Department of Labor, Bureau of Labor Statistics.
7-11
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Unemployment (cont'd)
Labor force = The employed + The unemployed
155.7*
=
145.3
+
Unemployed
Unemployment rate =
Labor force
10.4
x 100
10.4
x 100 = 6.7%
=
155.7
*U.S., millions of people; as of 2009
7-12
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Unemployment (cont'd)
• Stock
– The quantity of something, measured at a given
point in time—for example, an inventory of
goods
• Flow
– A quantity measured over time, such as the
income you make per year, or the number of
individuals fired every month
7-13
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Unemployment (cont'd)
• Categories of individuals without work
– Job loser
– Reentrant
– Job leaver
– New entrant
7-14
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Unemployment (cont'd)
• Job Loser
– An individual whose employment was
involuntarily terminated or who was laid off
• 40–60% of the unemployed
7-15
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Unemployment (cont'd)
• Reentrant
– An individual who has worked a full-time job
before but left the labor force and has now
reentered it looking for a job
• 20–30% of the unemployed
7-16
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Unemployment (cont'd)
• Job Leaver
– An individual who voluntarily quit
• 10 to 15% of the unemployed
7-17
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Unemployment (cont'd)
• New Entrant
– An individual who has never worked a full-time
job for two weeks or longer
• 10 to 15% of the unemployed
7-18
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Figure 7-3 The Logic of the
Unemployment Rate
7-19
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Unemployment (cont’d)
• Duration of unemployment
– More than a third of job seekers find work within
one month.
– Approximately another third find employment
within a second month.
– About a sixth are still unemployed after six
months.
– Average duration is just over 15 weeks
throughout the last 15 years.
7-20
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Unemployment (cont'd)
• Question
– What is likely to happen to the duration of
unemployment during a downturn in the
economy?
7-21
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Unemployment (cont'd)
• Discouraged Workers
– Individuals who have stopped looking for a job
because they are convinced they will not find a
suitable one
• Question
– How does the existence of discouraged workers
bias the unemployment rate?
7-22
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Unemployment (cont'd)
• Labor Force Participation Rate
– The proportion of non-institutionalized workingage individuals who are employed or seeking
employment
7-23
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The Major Types of
Unemployment
• The major types of unemployment
– Frictional
– Structural
– Cyclical
– Seasonal
7-24
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The Major Types of
Unemployment (cont'd)
• Frictional Unemployment
– Results from the fact that workers must search
for appropriate job offers
– This takes time, so they remain temporarily
unemployed
7-25
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The Major Types of
Unemployment (cont'd)
• Structural Unemployment
– Results from a poor match of workers’ abilities
and skills with current requirements of
employers
– Considerable evidence shows that government
labor market policies influence how many jobs
businesses wish to create, thereby affecting
structural unemployment.
7-26
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The Major Types of Unemployment
(cont'd)
• Cyclical Unemployment
– Results from business recessions that occur when
aggregate (total) demand is insufficient to create
full employment
7-27
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International Example: How Illegal Aliens
Affect Measured Cyclical U.S.
Unemployment
• In 2007, home-building activity fell by
more than 25%. Yet, cyclical
unemployment increased by only 4%.
• What was different about this particular
housing slump was that construction firms
had hired large numbers of illegalimmigrant workers alongside U.S. residents.
7-28
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The Major Types of Unemployment
(cont'd)
• Seasonal Unemployment
– Results from the seasonal pattern of work in
specific industries
7-29
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Full Employment and the Natural
Rate of Unemployment
• Questions
– Does full employment mean that everybody has
a job?
– Is it always possible for everyone who is looking
for a job to find one?
7-30
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Full Employment and the Natural
Rate of Unemployment (cont'd)
• Full Employment
– An arbitrary level of unemployment that
corresponds to “normal” friction in the labor
market
7-31
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Full Employment and the Natural
Rate of Unemployment (cont'd)
• Natural Rate of Unemployment
– The unemployment rate that is estimated to
prevail in the long-run macroeconomic
equilibrium
– Should not reflect cyclical unemployment
– When seasonally adjusted, the natural rate
should include only frictional and structural
unemployment.
7-32
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Inflation and Deflation
• Inflation
– A sustained increase in the average of all prices
of goods and services in an economy
• Deflation
– A sustained decrease in the average of all prices
of goods and services in an economy
7-33
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Inflation and Deflation (cont'd)
• Purchasing Power
– The value of money for buying goods and
services
– Varies with prices and income
7-34
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Inflation and Deflation (cont'd)
• Nominal value
– Price expressed in today’s dollars
• Real value
– Value expressed in purchasing power, adjusted
for inflation
7-35
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Inflation and Deflation (cont'd)
Measuring the Rate of Inflation
• Market Basket
– Representative bundle of goods and services
• Base Year
– The point of reference for comparison of prices in
other years
7-36
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Inflation and Deflation (cont'd)
– Price Index
• The cost of today’s market basket of goods expressed
as a percentage of the cost of the same market basket
during a base year
Cost today of market basket
Price index =

100
Cost of market basket in base year
7-37
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Example: Why are Women Confronting
Higher Inflation Than Men
• The price index for the market basket of a
typical U.S. female resident has increased at
a rate at least 1% higher than her male
counterpart.
• Compared to years past, more women are
employed. They are also marrying and
having children later in life. Higher-income
single women tend to spend more of their
income than men.
7-38
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Table 7-1 Calculating a Price Index for a
Two-Good Market Basket
7-39
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Inflation and Deflation (cont'd)
• Real-world price indexes
– Consumer Price Index (CPI)
– Producer Price Index (PPI)
– GDP deflator
– Personal Consumption Expenditure (PCE)
7-40
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Inflation and Deflation (cont'd)
• Consumer Price Index (CPI)
– A statistical measure of a weighted average of
prices of a specified set of goods and services
purchased by wage earners in urban areas
– Market basket of goods and services of typical
consumer
7-41
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Inflation and Deflation (cont'd)
• Producer Price Index (PPI)
– A statistical measure of a weighted average of prices of
goods and services that firms produce and sell
– Used as a short-run leading indicator (before CPI)
– PPIs for
• Foodstuffs
• Intermediate goods
• Finished goods
7-42
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Inflation and Deflation (cont'd)
• GDP Deflator
– A price index measuring the changes in prices of
all new goods and services produced in the
economy
– Broadest measure of prices; reflects both price
changes and the public’s market responses to
those price changes
7-43
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Inflation and Deflation (cont'd)
• Personal Consumption Expenditure (PCE)
Index
– A statistical measure of average price using
annually updated weights based on consumer
spending
– Primary inflation index used by the Federal
Reserve
7-44
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Figure 7-4 Inflation and Deflation
in U.S. History
Source: U.S. Department of Labor, Bureau of Labor Statistics
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7-45
Anticipated versus Unanticipated
Inflation
• Anticipated versus unanticipated inflation
– To determine who is hurt by inflation we
distinguish between the two types.
– The effects of inflation on individuals depend
upon which type of inflation exists.
7-46
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Anticipated versus Unanticipated
Inflation (cont'd)
• Anticipated Inflation
– The inflation rate that we believe will occur
• Unanticipated Inflation
– Inflation at a rate that comes as a surprise
7-47
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Anticipated versus Unanticipated
Inflation (cont'd)
• Inflation and interest rates
– Nominal Rate of Interest
• The market rate of interest expressed in today’s dollars
– Real Rate of Interest
• The nominal rate of interest minus the anticipated rate
of inflation
7-48
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Anticipated versus Unanticipated
Inflation (cont'd)
• Real interest rate
– Nominal interest rate = 10%
– Expected inflation rate = 6%
– Real rate = 10% – 6% = 4%
7-49
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Anticipated versus Unanticipated
Inflation (cont'd)
• Does inflation necessarily hurt everyone?
– Inflation affects people differently
• Unanticipated inflation
– Creditors lose
– Debtors gain
7-50
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Anticipated versus Unanticipated
Inflation (cont'd)
• Protecting against inflation
– Cost-Of-Living Adjustments (COLAs)
• Clauses in contracts that allow for increases in specified
nominal values to take account of changes in the cost
of living
7-51
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Anticipated versus Unanticipated
Inflation (cont'd)
• The resource cost of inflation
– Repricing or Menu Cost of Inflation
• The cost associated with recalculating prices and
printing new price lists when there is inflation
7-52
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Changing Inflation and Unemployment:
Business Fluctuations
• Business Fluctuations
– The ups and downs in business activity
throughout the economy
7-53
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Changing Inflation and Unemployment:
Business Fluctuations (cont'd)
• Expansion
– A business fluctuation in which the pace of
national economic activity is speeding up
7-54
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Changing Inflation and Unemployment:
Business Fluctuations (cont'd)
• Contraction
– A business fluctuation during which the pace of
national economic activity is slowing down
7-55
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Changing Inflation and Unemployment:
Business Fluctuations (cont'd)
• Recession
– A period of time during which the rate of growth
of business activity is consistently less than its
long-term trend or is negative
• Depression
– An extremely severe recession
7-56
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Figure 7-5 The Idealized Course of
Business Fluctuations
7-57
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Figure 7-6 National Business
Activity, 1880 to the Present
Sources: American Business Activity from 1790 to Today, 67th ed., AmeriTrust Co.,
January 1996, plus author’s estimates.
7-58
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Changing Inflation and Unemployment:
Business Fluctuations (cont'd)
• Leading Indicators
– Events that have been found to occur before
changes in business activity
• Economic downturns often follow
– Reduction in the average workweek
– Rise in unemployment insurance claims
– Decrease in prices of raw materials
– Drop in the quantity of money circulating
7-59
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Issues and Applications: Explaining the
Downtrend in Labor Force Participation
• The U.S. labor force participation rate is several
percentage points higher today than it was a halfcentury ago.
• In recent years, however, labor force participation
has fallen.
• What accounts for the decrease in U.S. labor force
participation?
• Several factors have contributed to the decline in
the labor force participation rate.
7-60
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Issues and Applications: Explaining the
Downtrend in Labor Force Participation
(cont’d)
• One is that the number of new female entrants has been
insufficient to replace women who have departed the labor
force.
• Another factor is a dip in the labor force participation rate
among teenagers.
• In addition, a number of people between the ages of 25 and
54 have dropped out of the labor force, many of whom have
not graduated from high school or are high school graduates
without college.
7-61
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Issues and Applications: Explaining the
Downtrend in Labor Force Participation
(cont’d)
• Finally, altered legal rules have made it
easier for all workers to receive disability
benefits, and these changes help account
for the decreases in labor force participation
among men and women under the age of
55.
7-62
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Figure 7-7 The U.S. Labor Force
Participation Rate Since 1995
Source: U.S. Department of Labor, Bureau of Labor Statistics; author’s estimates
7-63
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Summary Discussion of Learning
Objectives
• How the U.S. government calculates the
official unemployment rate
– Percentage of the total number of adults willing
and able to work who are actively looking for
work but have not found a job
• The major types of unemployment
–
–
–
–
Frictional
Structural
Cyclical
Seasonal
7-64
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Summary Discussion of Learning
Objectives (cont'd)
• Full employment
– Arbitrary level of unemployment
• Corresponds to “normal” friction in labor market
• Natural rate of unemployment
– Estimated to prevail in the long-run
macroeconomic equilibrium
• All workers and employers adjust to any changes in
economy
7-65
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Summary Discussion of Learning
Objectives (cont'd)
• How price indexes are calculated and key
price indexes
– Multiply 100 times the ratio of the cost of a
market basket of goods in the current year to
the cost of the same basket in a base year
– Key price indexes
•
•
•
•
CPI
PPI
GDP deflator
PCE
7-66
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Summary Discussion of Learning
Objectives (cont'd)
• Nominal versus real interest rates
– Nominal rate is the market rate expressed in
current dollars.
– Real rate is net of inflation.
– Hence the real interest rate equals the nominal
interest rate minus the expected inflation rate.
7-67
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Summary Discussion of Learning
Objectives (cont'd)
• Losers and gainers from inflation
– Creditors lose as a result of unanticipated
inflation.
– Borrowers gain.
7-68
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Summary Discussion of Learning
Objectives (cont'd)
• Key features of business fluctuations
– Increases and decreases in business activity
• Expansion from previous trough to new peak
• Contraction from previous peak to new trough
7-69
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