Download Chapter 11: Unemployment and Inflation

CHAPTER
11
Unemployment and
Inflation
Prepared by: Jamal Husein
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
What Is Unemployment?



The unemployed are those
individuals who do not currently
have a job but who are actively
looking for work.
The employed are individuals who
currently have jobs.
Together, the employed and
unemployed comprise the labor
force.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
2
Unemployment Measures
Labor Force = employed + unemployed

The unemployment rate is the percentage
of people in the labor force who are
unemployed.
Unemployment
Rate
© 2005 Prentice Hall Business Publishing
=
Number of Unemployed
Survey of Economics, 2/e
Labor Force
O’Sullivan & Sheffrin
3
Unemployment Measures

The working age population includes
individuals 16 years of age and older
who can legally work in the U.S.

The labor force participation rate is
the ratio of people in the labor force to
the working-age population.
Labor Force
Participation
Rate
© 2005 Prentice Hall Business Publishing
Labor Force
=
Survey of Economics, 2/e
Population 16 and
over
O’Sullivan & Sheffrin
4
Unemployment Measures

For example, suppose an economy consists of:



200,000 individuals 16 years and older.
122,000 employed.
8,000 unemployed.
Labor Force = (122,0000 + 8,000) = 130,000
Labor Force
Participation
Rate
Unemployment
Rate
© 2005 Prentice Hall Business Publishing
=
=
130,000
= 65%
200,000
8,000
130,000
Survey of Economics, 2/e
O’Sullivan & Sheffrin
= 6.15%
5
Unemployment Data, January 2003
U.S. civilian population over 16 years of age
219,897,000
Labor force
Not in the labor
145,838,000
force
Employed
Unemployed
74,059,000
137,536,000
8,302,000
Labor force participation rate
Unemployment rate
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
64.12%
5.7%
6
Unemployment Rates (2003)
Country
United States
Belgium
Sweden
France
Italy
Spain
United Kingdom
Netherlands
Japan
Australia
© 2005 Prentice Hall Business Publishing
Unemployment Rate (%)
5.7
10.8
5.1
9.1
8.9
12.1
5.1
4.3
5.5
6.1
Survey of Economics, 2/e
O’Sullivan & Sheffrin
7
Who Are the Unemployed?


The Bureau of Labor Statistics conducts
a monthly survey of households to
determine who is employed, unemployed, or
not in the labor force.
It is difficult to determine if someone is
truly looking for work, therefore, to
distinguish between those people who are
unemployed and those who are not in the
labor force.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
8
Who Are the Unemployed?

People who were looking for work in
the recent past but did not find work
and stopped looking are considered
discouraged workers.

Discouraged workers are not
counted as unemployed, but
considered to have dropped out of
the labor force.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
9
Who Are the Unemployed?

Workers who hold part-time jobs
but would prefer to have full-time
jobs, and workers holding jobs far
below their capabilities are called
the underemployed.

It is also difficult to distinguish
between employed and
underemployed workers.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
10
Unemployment Rates
Selected Unemployment Rates, January
2003 (in percent)
Total
5.7
Males 20 years and older
Female, 20 years and older
Both sexes, 16-19 years
White
African American
White, 16-19 years
African American, 16-19 years
Married men
Married women
Women maintaining families
5.4
4.7
16.8
5.1
10.3
15.2
30.4
3.5
3.8
8.0
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
11
Types of Unemployment

Cyclical unemployment is the result
of fluctuations in real GDP.
Unemployment rises when real GDP
falls, and falls when the economy
improves.
 Frictional
unemployment occurs
naturally in the economy. It refers to
the time it takes to find an
appropriate job.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
12
Types of Unemployment

Structural unemployment refers to
the mismatch between job openings
and the skills of workers seeking
jobs.

It is difficult to draw the line between
frictional and structural
unemployment. Are workers from the
“old economy” able to find jobs in the
“new economy”?
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
13
The Natural Rate of Unemployment

When the economy is at full
employment, the unemployment
rate is not zero, but equal to the
natural rate of unemployment.

The natural rate of unemployment
consists of frictional and structural
unemployment. It is the unemployment
that exists when actual GDP is equal to
potential GDP—there is no cyclical
unemployment.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
14
The Natural Rate of Unemployment

In the United States, economists
estimate that the natural rate of
unemployment is between 4.0%
and 5.5%. In Europe it is
between 7% and 10%.

The economy needs some
frictional unemployment to
operate efficiently.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
15
The Natural Rate of Unemployment

When the growth rate of real GDP slows
down relative to its long-run trend, the
actual unemployment rate exceeds the
natural rate of unemployment—cyclical
unemployment rises.

On the other hand, if economic growth is
too rapid, the economy will “overheat”
and cyclical unemployment will be
negative.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
16
The Costs of Unemployment

Excess unemployment cause both society and
individuals to suffer:


Excess unemployment means the economy is no
longer producing at its potential, i.e., some of
society’s resources are being wasted;
Lower employment translates into reduced income
and immediate hardship for individuals, especially
those with fixed obligations;

Unemployment cost can also linger into the
future. Some skills are likely to be lost as a
result of prolonged unemployment;

Unemployment can impose psychological
costs, i.e., divorce, crime, suicide, … etc.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
17
Unemployment and Inflation

When the economy is “overheated,”
and unemployment rates are low,
firms will find it difficult to recruit
workers, and competition among firms
will lead to increases in wages.

As wages increase, increases in prices
soon follow. The sign of overheating
will be a general rise in prices for the
entire economy, or inflation.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
18
The Consumer Price Index

The Consumer Price Index (CPI) is an index
that measures changes in a fixed “basket of
goods” which contains items purchased by the
typical consumer.

The CPI is a measure of the value of money
over time.

Reality PRINCIPLE
What matters to people is the real
value or purchasing power of money
or income, not its face value.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
19
The Consumer Price Index

The CPI index for a given year, say
year K, is defined as:
CPI in
Year K
© 2005 Prentice Hall Business Publishing
=
Cost of Basket in Year K
× 100
Cost of Basket in base Year
Survey of Economics, 2/e
O’Sullivan & Sheffrin
20
The Consumer Price Index
Example:
 Cost of basket in 1992, the base year = $200
 Cost of same basket in 1997 = $250
$200
CPI in 1992 =
x 100 = 100
$200
$250
CPI in 1997 =
x 100 = 125
$200
Prices increased an average of 25% over this
five-year period.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
21
The CPI and the Standard of Living

Suppose you have $300 in 1992. How
much would you need to be able to have
the same standard of living in 1997?

Using the ratio of the CPI in 1997 to the
CPI in 1992:
125
300 x
= 375
100
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e

You need $375 in 1997
just to maintain what
was your standard of
living in1992.
O’Sullivan & Sheffrin
22
Components of the CPI, 1992
Components of the CPI
Medical (5.00%)
Transportation (7.00%)
Other services (7.00%)
Household services
(9.00%)
Food & beverage (18.00%)
Apparel (6.00%)
Rent (26.00%)
Non-durables (11.00%)
Durables (11.00%)
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
23
The CPI Versus the GDP Deflator


Both the CPI and the GDP deflator
(including the more recent chain
price for GDP) are measures of the
average prices for the economy.
The CPI includes goods produced in
prior years, as well as imported
goods, while the GDP deflator does
not.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
24
Problems in Measuring Changes in Prices

The CPI tends to overstate true
changes in the cost of living because it
does not allow for the share of the
goods whose prices have risen to
decline in the typical basket of goods
used by the Commerce Department.

In reality, all indexes tend to overstate actual
price changes, primarily because we have a
difficult time measuring quality
improvements in goods and services.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
25
The CPI Tends to Overstate Price Changes

Economists believe that the
inflation rate is overstated by
between 0.5% and 1.5% each year.

This means that cost-of-living
adjustments to wages and social
security payments based on changes
in the CPI tend to be larger than
they should be.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
26
Inflation


The percentage rate of change of a price
index is the inflation rate.
Example:


Price index in a country in 1998 = 200
Price index in 1999 = 210
(210 - 200)
Inflation rate =
= .05 = 5%
200
Conclusion: the country experienced a 5% inflation
rate.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
27
Inflation



Inflation refers not to the level of prices,
whether they are high or low, but to their
percentage change from one year to another.
If prices are high but remain the same from
one year to another, there would be no
inflation during that time.
Historically, the price level did not have a
trend prior to the 1940s. After 1940, the
price level increased sharply.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
28
U.S. Inflation Rate, 1950-2000
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
29
Deflation



Deflation is a period during which the
average level of prices falls.
During the Great Depression, between
1929 and 1933, average prices fell
33%.
As the average level of prices falls,
wages tend to fall. Therefore, deflation
is a problem because people may not
be able to pay their debts.
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
30
The Costs of Inflation

Costs associated with anticipated
inflation;

Menu costs or costs associated with
physically changing prices;
Shoe-leather costs that results from holding
less cash or the additional wear and tear
necessary to hold less cash (more frequent
trips to Banks and ATMs);
 Tax system and financial system do not
always fully adjust to anticipated inflation.

© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
31
The Costs of Inflation

When there is an unanticipated
inflation, there are winners & losers ;

It causes unfair redistributions or transfers
of income between parties, i.e, when
inflation is higher than everyone expected,
buyer with fixed dollar contracts would
gain and sellers making a contract in
dollar terms would lose;

It also imposes real costs on the economy.
When people take actions based on beating
inflation, the economy becomes less efficient .
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
32