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Unemployment and Inflation
• How to measure the unemployment rate?
– Labor force and the unemployment
• How to measure the inflation rate?
– Real GDP vs. nominal GDP
– Real interest rate vs. nominal interest rate
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Unemployment
• The unemployed are those who are willing and able to
work but do not have a job and are actively searching for a
job.
• The Bureau of Labor Statistics (BLS) collects monthly
survey data to compute the unemployment rate.
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How the BLS Measures Employment Status
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Unemployment
• Labor force participation rate (LFPR)
LFPR 
Labor Force
Working - age Population
• Unemployment rate =
Unemployed
Labor Force
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Problems In Measuring Unemployment
– Treatment of involuntary part-time workers
• Some economists have suggested that involuntary part-time
workers should be regarded as partially employed and partially
unemployed.
– Treatment of discouraged workers
• Individuals who would like to work but, because they feel little
hope of finding a job, have given up searching.
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Types of Unemployment
– Unemployment can arise for a variety of reasons, each
with its own policy implications
– Economists have found it useful to classify
unemployment into four different categories
–
–
–
–
Frictional unemployment
Seasonal unemployment
Structural unemployment
Cyclical unemployment
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Frictional Unemployment
• Short-term joblessness (between jobs or new entrants)
• Good match between workers and jobs
• With better suited jobs, works would be more productive.
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Seasonal Unemployment
• Joblessness related to changes in weather, tourist
patterns, or other seasonal factors.
• So, it is short-term and predictable.
• To prevent any misunderstandings, government usually
reports the seasonally-adjusted rate of unemployment.
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Structural Unemployment
• Joblessness arising from mismatches between workers’
skills and employers’ requirements.
– Coal miners, autoworkers, etc.
• Generally a stubborn, long-term problem
– Often lasting several years or more
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Cyclical Unemployment
• Business cycle – fluctuations in real GDP around its longrun trend.
• When the economy goes into a recession and total output
falls, the unemployment rate rises.
• Since it arises from conditions in the overall economy,
cyclical unemployment is a problem for macroeconomic
policy.
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Full Employment
– A situation where there is no cyclical unemployment
– Natural rate of unemployment
• Frictional+Seasonal+Structural
• In the U.S., it is between 4.5% and 5%.
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Price Level and Inflation
• Price level
– A measure of average prices of goods and services in the
economy
• Index numbers
 Series of numbers used to track the change of a variable over
time: crime index, air pollution index
 Most measures of the price level are reported in the form of an
index
Dow Jones Index, S&P 500, Consumer Price Index
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Index Numbers
• In general, an index number for any measure is
calculated as
Value of measure in current period
x 100
Value of measure in base period
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Index Numbers
• Create index numbers
Example: the number of traffic accidents in Youngstown, Ohio
Year
# of traffic
accidents
index
2000(base year)
325
100
2004
382
382
 100  117.5
325
2005
411
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The Consumer Price Index
 An index of the cost, through time, of a representative
market basket of goods and services purchased by a
typical urban family of four.
 The market basket does not include goods and services
purchased by businesses, government, and foreigners, but
include consumer goods and services currently produced
in the U.S. as well as used goods and imported goods and
services.
 An example in the textbook on page 625
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From Price Index to Inflation Rate
• Changes in price index
– Inflation when price level is rising
– Deflation when price level is falling, or negative inflation
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Inflation, Nominal and Real Values
• Purchasing power of money – amount of goods and
services
• Nominal values – measured at current year price
• Real values – measured at the base year price
• Translate nominal values into real values using the
formula
nominal value
real value 
x 100
price index
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Inflation, Nominal and Real Values
• Suppose that from December 2004 to December 2005,
your nominal wage rises from $15 to $20 per hour
– Are you better off?
• Real wage formula is as follows
Real wage in any year 
Nominal wage in that year
x 100
CPI in that year
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Inflation, Nominal and Real Values
An example:
Year
CPI
Nominal Hourly Wage
Real Wage
1983
100
8
8
 100  8
100
1995
150
12
2004
180
15
2005
200
20
12
 100  8
150
15
 100  ?
180
?
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Nominal and Real Interest Rate
• Interest rate – the cost of borrowing money, express as a
percentage of the amount borrowed.
• Nominal vs. Real interest rate
r  i -
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Redistributive Effect of Inflation
• How does inflation redistribute real income?
 Inflation hurts those who receive a fixed amount of payment
specified in nominal terms
Example: salary specified in a contract
 Inflation benefits those who make a fixed amount of payment
specified in nominal terms
Examples: mortgage payment, car loan monthly payment
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Expected vs. Unexpected Inflation
• Over any period, percentage change in a real value (%Δ
Real) is approximately equal to percentage change in
associated nominal value (%Δ Nominal) minus the rate of
inflation
%ΔReal = %ΔNominal – Rate of Inflation
• If inflation is fully anticipated, and if both parties take it into
account, then inflation will not redistribute purchasing power
• When inflation is not correctly anticipated, however, inflation
does shift purchasing power from one group to another.
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Expected vs. Unexpected Inflation
An example:
Joe borrows $100 from Mike and promises to pay
back the money plus interest in a year. Mike wants to
charge a real return of 3%. Meanwhile, Mike expects the
inflation rate to be 3% for the next year and Joe expects it
to be 5%. So, Joe happily agrees to pay Mike 6% nominal
interest rate. If the actual inflation rate is 4%, how will the
purchasing power shift between Joe and Mike?
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