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Chapter 7
Part 2
Unemployment
(One Result of Economic
Downturns)
The population is divided into three groups:
• Those under age 16: “not potential
members of the labor force”
• Adults not looking for work: not in the labor
force.
• Labor force: includes those in age 16 and
over who are willing and able to work, and
actively seeking work.
•
The unemployment rate is defined as the
percentage of the labor force (not of
population) that is not employed.
Unemployment
rate
unemployed
=
labor force
x 100
• In USA the unemployment rate is calculated by
random survey of 60,000 households nationwide.
• Two factors cause the official unemployment rate
to understate actual unemployment:
a. Part-time workers are counted as “employed.”
b. who want a job, but are not actively seeking one,
are not counted as being in the labor force, so they
are not part of unemployment statistic.
Types of unemployment
1. Frictional unemployment: Workers between
jobs. Consists of those searching for jobs or
waiting to take jobs soon; it is regarded as
somewhat desirable, because it indicates that
there is mobility as people change or seek jobs.
Types:
• Voluntarily moving from one job to another
• Fired and seeking another job
• Housewives who decided to work
• New graduates looking for jobs for the first time
Note: this type of unemployment is unavoidable
2. Structural unemployment is due to
changes in the structure of demand for
labor; e.g., when certain skills become
obsolete (out-dated) or geographic
distribution of jobs changes.
•
Difference between frictional and structural
is that frictional unemployed have salable
skills. Structurally unemployed will find it
difficult to find a job
3. Cyclical unemployment is caused by the
recession phase of the business cycle,
which is sometimes called deficient
demand unemployment.
•
When demand for goods and services falls,
employment falls and unemployment
increases.
Definition of “Full
Employment”
Frictional and structural unemployment is .1
unavoidable, hence, full employment is
something less than 100%. Full employment
does not mean zero unemployment.
The unemployment rate consistent with .2
full-employment is equal to the total of
frictional and structural unemployment.
The “full-employment” rate of unemployment 3.
is also referred to as the natural rate of
unemployment NRU.
4.The natural rate is achieved when labor
markets are in balance; the number of job
seekers equals the number of job vacancies.
• Hence at NRU
• The economy is producing its potential
output
Note:
• It is not necessary that the economy will
work at NRU. At times of recession
unemployment will be greater than NRU.
• The natural rate of unemployment is not fixed, but
depends on the demographic makeup of the labor
force and the laws and customs of the nations.
• Recently in USA the natural rate has dropped from
6% to 4 or 5%. This is attributed to:
a. The aging of the work force as the baby
boomers approach retirement.
b. Improved job information through the Internet
and temporary-help agencies.
c. The doubling of the U.S. prison population
since 1985.
Economic cost of
unemployment
1. Foregone output. Failure to create enough jobs
leads to loss of potential output (NRU). This is
measured by GDP gap: the difference between
potential and actual GDP.
GDP gap = Actual GDP - Potential GDP
•
GDP gap and Okun’s Law: Economist Arthur
Okun quantified the relationship between
unemployment and GDP as follows: For every 1
percent of unemployment above the natural rate,
a negative GDP gap of 2 percent occurs. This is
known as “Okun’s law.”
2. Unequal Burdens: Burden of
unemployment is unequally distributed.
• Occupations: workers in lower skilled
occupations have higher unemployment
rates
• Age: teenagers have much higher
unemployment rates than adults (less skills
and less experience).
• Race and ethnicity: rate is high among
African-Americans and Hispanics.
• Education: rate is higher among less
educated.
GLOBAL PERSPECTIVE
Unemployment Rates 5 Industrial Nations
1992 - 2002
15
France
U.K.
10
Germany
U.S.
Japan
5
0
1992
1997
2002
Source: Economic Report of the President, 2003
Inflation: Defined and
Measured
Definition: Inflation is continuous rise in
the general level of prices.
- A continuous rise: a one shot rise in the price
level is not inflation (price rise).
- The general price level: it is not necessary
that all prices must increase at the same
time. During inflation some prices can go
down.
• The main index used to measure inflation is the
Consumer Price Index (CPI).
• Measuring Inflation: the percentage change in CPI
 2002 CPI = 123
 2003 CPI – 127
 Inflation = ((127-123)/123)% = 3.25%
• The “rule of 70” permits quick calculation of the
time it takes the price level to double: Divide 70 by
the percentage rate of inflation and the result is the
approximate number of years for the price level to
double. If the inflation rate is 7 percent, then it will
take about ten years for prices to double.
GLOBAL PERSPECTIVE
Inflation Rates in Five Industrial Nations
1992 - 2002
10
Italy
5
Germany
U.S.
France
Japan
0
1992
1997
2002
Source: Bureau of Labor Statistics
Types of inflation
Demand-pull inflation:
• When resources are already fully
employed, businesses cannot respond to
excess demand by expanding output.
• So excess demand bids up the prices of
the limited output.
• Spending increases faster than
production.
Cost-Push inflation:
• Prices rise because of a rise in per-unit
production costs.
• Per unit cost = total input cost/units of
output.
• Rising costs squeeze profits and reduce
output firms are willing to produce at current
prices.
• Supply of goods decreases and prices go up
Note
a.Output and employment decline while the
price level is rising.
b.Supply shocks (due to higher cost of
inputs) have been the major source of costpush inflation. These typically occur with
dramatic increases in the price of raw
materials or energy.
Redistributive effects of inflation
•
Nominal and real income
•
Nominal income is the number of KDs received
as wages, rent, interest and profits
•
Real income is a measure of the amounts of
goods and services income can buy. Therefore;
Real income = nominal income / price level
•
% change in real income = % change in nominal
income – percentage change
in price
level
• surprising inflation has stronger impacts;
those expecting inflation may be able to
adjust their work or spending activities to
avoid or lessen the effects.
Who is hurt by inflation?
Fixed income receivers: People whose
incomes are fixed see their real incomes fall
when inflation occurs.
Savers
• will be hurt by unexpected inflation, because
interest rate returns may not cover the cost
of inflation. Their savings will lose
purchasing power.
e.g.,
- A 1000 CD with a 6% interest and inflation
13%, after one year
- Nominal value = 1060
- Real value = (1060/1.13) = 938
•
•
•
Creditors:
They can be harmed by unexpected
inflation. Interest payments may be less
than the inflation rate.
Borrowers are paying back money that
have less purchasing power for the lender.
If inflation is predictable, the effects of
inflation may be less severe, since wage
and pension contracts may have inflation
clauses built in, and interest rates will be
high enough to cover the cost of inflation to
savers and lenders.
Who is Unaffected by inflation?
• Flexible-Income receivers: they can avoid
inflation’s harm or even benefit from it.
• They benefit more from unexpected inflation.
Debtors: they pay back less valuable money
whose purchasing power has been eroded by
inflation.
• Real income is redistributed away from
creditors to debtors.
• The government, as a debtor, benefits as it
pays back its debt with money that has less
purchasing power than the original money it
borrowed.
•
•
expected Inflation
Redistribution effects of inflation are less severe
if inflation was expected.
People can adjust their nominal incomes to
reflect the expected rise in the price level.
•
“Inflation premium” is amount that the interest
rate is raised to cover effects of expected
inflation.
•
“Real interest rate” is defined as nominal rate
minus inflation premium.
ANTICIPATED INFLATION
11%
=
+
5%
Nominal
Interest
Rate
Real
Interest
Rate
6%
Inflation
Premium
Output Effects of Inflation
A. Cost-push inflation, where resource prices rise
unexpectedly, could cause both output and
employment to decline. Real income falls.
B. Mild inflation (<3%) has uncertain effects. It may
be a healthy by-product of a wealthy economy, or it
may have an undesirable impact on real income.
C.
Danger of creeping inflation turning into
hyperinflation, which can cause speculation, out of
control spending, and more inflation