Download Parkin-Bade Chapter 21

CHAPTER
11
Monitoring Jobs
and Inflation
After studying this chapter you will be able to:
 Explain why unemployment is a problem and describe
the trend and cycles in the labour market indicators
 Explain why unemployment is an imperfect measure of
underutilized labour and why it is present even at full
employment
 Explain why inflation is a problem, how we measure it
and why the official measure might be biased
© Pearson Education 2012
Each month, we chart the course of employment and
unemployment as measures of the health of the economy.
How do we measure the unemployment rate?
Is the unemployment rate a reliable vital sign for the
economy?
Having a job that pays a decent wage does not determine
the standard of living; the cost of living also matters.
We track the cost of what we buy by publishing the
Consumer Prices Index and the Retail Prices Index.
How are they calculated?
Do they provide a good guide to the cost of living?
© Pearson Education 2012
Employment and Unemployment
What kind of job market will you enter when you graduate?
Those leaving the university in 2010 had a tough time:
In May 2009, the number of people in the UK who wanted a
job but couldn’t find one past the 2.4 million mark.
Usually, unemployment is less than half that number.
The UK economy creates lots of jobs. Even in 2009, 26
million people in the UK had jobs.
But in recent years, the population has grown faster than
the number of jobs, so unemployment has become a major
problem.
© Pearson Education 2012
Employment and Unemployment
Why Unemployment is a Problem
Unemployment results in:
 Lost incomes and production
 Lost human capital
The loss of income is devastating for those who bear it.
Employment benefits create a safety net but don’t fully
replace lost wages, and not everyone receives benefits.
Prolonged unemployment permanently damages a
person’s job prospects by destroying human capital.
© Pearson Education 2012
Employment and Unemployment
Labour Force Survey
The Office for National Statistics conducts a monthly
population survey to determine the status of the UK
workforce.
The population is divided into two groups:
1 The working-age population – the number of men
aged 16 to 64 years and women aged 16 to 59 years
who are not in prison, hospital or some other form of
institutional care
2 People under 16 years or in institutional care
© Pearson Education 2012
Employment and Unemployment
The working-age population is divided into two groups:
1 People who are economically active – have a job or
are willing and able to take a job
2 People who are economically inactive – do not want a
job
The workforce is the sum of employed and unemployed
workers.
© Pearson Education 2012
Employment and Unemployment
To be counted as unemployed, a person must be in one of
the following three categories:
1 Without work, but has made specific efforts to find a job
within the previous four weeks
2 Waiting to be called back to a job from which he or she
has been laid off
3 Waiting to start a new job within 30 days
© Pearson Education 2012
Employment and Unemployment
Three Labour Market Indicators
 The unemployment rate
 The employment rate
 The economic activity rate
© Pearson Education 2012
Employment and Unemployment
The Unemployment Rate
The unemployment rate is the percentage of the
workforce that is unemployed.
The unemployment rate is
(Number of people unemployed ÷ Workforce)  100.
In 2010, the number of people employed was 28.3 million
and the number unemployed was 2.4 million.
So the unemployment rate was (2.4 ÷ 30.7)  100, or
7.8 per cent.
Figure 11.2 on the next slide shows that the
unemployment rate reaches its peaks during recessions.
© Pearson Education 2012
© Pearson Education 2012
Employment and Unemployment
The Employment Rate
The employment rate is the percentage of working-age
people who have jobs.
The employment rate equals
(Number of people employed ÷ Working-age population) 
100.
In 2010, the number of people employed was 28.3 million
and the working-age population was 40 million.
The employment rate was 70.8 per cent.
© Pearson Education 2012
Employment and Unemployment
The Economic Activity Rate
The economic activity rate is the percentage of the
working-age population who are members of the
workforce.
The economic activity rate is
(Workforce ÷ Working-age population)  100.
In 2010, the workforce was 30.7 million and the workingage population was 40 million.
The economic activity rate was 76.8 per cent.
© Pearson Education 2012
Employment and Unemployment
Figure 11.3 shows the employment rate falls during
recessions and rises in expansions, …
but the economic activity rate has no trend.
© Pearson Education 2012
Employment and Unemployment
Other Definitions of Economic Inactivity and
Unemployment
The purpose of the unemployment rate is to measure the
underutilization of labour resources.
The official measure is an imperfect measure because it
excludes:
 Discouraged workers
 Others who want a job
© Pearson Education 2012
Employment and Unemployment
Discouraged Workers
A discouraged worker is a person who is available and
willing to work but who has stopped actively looking for a
job because he or she believes that no jobs are available.
Discouraged workers often temporarily leave the
workforce during a recession and re-enter during an
expansion.
The distinction between an unemployed person and a
discouraged worker turns on whether there has been job
search activity.
© Pearson Education 2012
Employment and Unemployment
Others Who Want a Job
These people are
economically inactive,
willing to work but have
stopped actively looking
for a job because they are
not available to start a job
in the next two weeks.
Figure 11.4 shows that
discouraged workers are
a small percentage of the
economically inactive.
© Pearson Education 2012
Employment and Unemployment
Most Costly Unemployment
All unemployment is costly, but the most costly is longterm unemployment that results from job loss.
People who are unemployed for a few weeks and then
find another job bear some costs of unemployment.
But their costs are low compared to the costs borne by
people who remain unemployed for many weeks.
© Pearson Education 2012
Unemployment and Full Employment
Types of Unemployment
Unemployment can be classified into three types:
 Frictional unemployment
 Structural unemployment
 Cyclical unemployment
© Pearson Education 2012
Unemployment and Full Employment
Frictional Unemployment
Frictional unemployment is unemployment that arises
from normal labour market turnover.
The creation and destruction of jobs requires that
unemployed workers search for new jobs.
Increases in the number of people entering and reentering the workforce and increases in unemployment
benefits raise frictional unemployment.
© Pearson Education 2012
Unemployment and Full Employment
Structural Unemployment
Structural unemployment is unemployment created by
changes in technology and foreign competition that
change the skills needed to perform jobs or the locations
of jobs.
Structural unemployment lasts longer than frictional
unemployment.
© Pearson Education 2012
Unemployment and Full Employment
Cyclical Unemployment
Cyclical unemployment is the higher than normal
unemployment at a business cycle trough and lower than
normal unemployment at a business cycle peak.
A worker laid off because the economy is in a recession
and is then rehired when the expansion begins
experiences cyclical unemployment.
© Pearson Education 2012
Unemployment and Full Employment
‘Natural’ Unemployment
Natural unemployment is the unemployment that arises
from frictions and structural change when there is no
cyclical unemployment.
Natural unemployment is all frictional and structural
unemployment.
The natural unemployment rate is natural unemployment
as a percentage of workforce.
© Pearson Education 2012
Unemployment and Full Employment
Full employment occurs when there is no cyclical
unemployment or, equivalently, when all unemployment is
frictional and structural.
The unemployment rate when the economy is at full
employment is called the natural unemployment rate.
The natural unemployment rate was high during the 1980s
but has gradually decreased.
© Pearson Education 2012
Unemployment and Full Employment
The natural unemployment rate changes over time and is
influenced by many factors.
Key factors are:
 The age distribution of the population
 The scale of structural change
 The real wage rate
 Unemployment benefits
© Pearson Education 2012
Unemployment and Full Employment
Real GDP and Unemployment Over the Cycle
Potential GDP is the quantity of real GDP produced at full
employment.
Potential GDP corresponds to the capacity of the economy
to produce output on a sustained basis.
Real GDP minus potential GDP is the output gap.
Over the business cycle, the output gap fluctuates and the
unemployment rate fluctuates around the natural
unemployment rate.
© Pearson Education 2012
Unemployment and Full Employment
Figure 11.5 shows the output
gap and …
the fluctuations of the
unemployment rate around the
natural unemployment rate.
When the output gap is
negative….
The unemployment rate
exceeds the natural
unemployment rate.
© Pearson Education 2012
The Price Level, Inflation and Deflation
The price level is the average level of prices and the
value of money.
A persistently rising price level is called inflation.
A persistently falling price level is called deflation.
We are interested in the price level because we want to:
1 Measure the inflation rate or the deflation rate.
2 Distinguish between money values and real values of
economic variables.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Why Inflation and Deflation Are Problems
Low, steady, and anticipated inflation or deflation is not a
problem.
Unpredictable inflation or deflation is a problem because it:
 Redistributes income
 Redistributes wealth
 Lowers real GDP and employment
 Diverts resources from production
© Pearson Education 2012
The Price Level, Inflation and Deflation
Unpredictable changes in the inflation rate redistribute
income in arbitrary ways between employers and workers
and between borrowers and lenders.
A high inflation rate is a problem because it diverts
resources from productive activities to inflation forecasting.
From a social perspective, this waste of resources is a
cost of inflation.
At its worse, inflation becomes hyperinflation − an
inflation rate 50 per cent a month or higher that grinds the
economy to a halt and society to a collapse.
© Pearson Education 2012
The Price Level, Inflation and Deflation
The Price Indexes
Every month the Office for National Statistics calculates
the Retail Prices Index (RPI) and the Consumer Prices
Index (CPI).
Both the RPI and the CPI measure the average of the
prices paid by consumers for a ‘fixed’ basket of consumer
goods and services.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Reading the RPI and CPI
The RPI is defined to equal 100 for the reference base
period.
Currently, the reference base period is January 1987.
That is, for January 1987, the RPI equals 100.
In January 2010, the RPI was 217.9.
This number tells us that the average of the prices paid by
consumers for a fixed basket of goods was 117.9 per cent
higher in 2010 than it was in January 1987.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Constructing the RPI and CPI
Constructing the RPI and the CPI involves three stages:
 Selecting the basket
 Conducting a monthly price survey
 Calculating the price index
© Pearson Education 2012
The Price Level, Inflation and Deflation
Selecting the Basket
The RPI basket is selected to be representative of the
items bought by an average household in the UK.
The CPI basket is different from the RPI basket and
covers all expenditure on consumer good and services
made in the UK by private households, residents of
institutions and tourists.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Figure 11.6(a) illustrates
the RPI basket.
Housing and household
expenditure is the largest
component.
Travel and leisure and
food and catering are the
next largest components.
The other components
account for 20 per cent of
the basket.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Figure 11.6(b) illustrates
the CPI basket.
Transport, recreation and
culture, housing and
household services are the
largest components.
Restaurants and hotels,
and food and nonalcoholic beverages are
the next largest
components.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Conducting a Monthly Price Survey
Every month, ONS employees check 110,000 prices of
more than 550 types of goods and services.
Calculating the Price Index
1 Find the cost of the basket at base-period prices.
2 Find the cost of the basket at current-period prices.
3 Calculate the price index for the base period and for the
current period.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Let’s work an example of the RPI calculation.
In a simple economy, people consume only oranges and
haircuts. The RPI basket is 10 oranges and 5 haircuts.
The table also shows the prices in the base period.
Item
Quantity
Price
Oranges
10
£1
Haircuts
5
£8
© Pearson Education 2012
The Price Level, Inflation and Deflation
The cost of the RPI basket in the base period was £50.
Item
Quantity
Price
Cost of RPI
basket
Oranges
10
£1
£10
Haircuts
5
£8
£40
Cost of RPI basket at base period prices
© Pearson Education 2012
£50
The Price Level, Inflation and Deflation
This table shows the prices in the current period.
The cost of the RPI basket at current-period prices is £70.
Item
Quantity
Price
Cost of RPI
basket
Oranges
10
£2
£20
Haircuts
5
£10
£50
Cost of RPI basket at current-period
prices
© Pearson Education 2012
£70
The Price Level, Inflation and Deflation
The RPI is calculated using the formula:
RPI = (Cost of basket at current-period prices ÷ Cost of
basket at base-period prices)  100.
Using the numbers for the simple example:
In the base period: RPI = (£50 ÷ £50)  100 = 100.
In the current period: RPI = (£70 ÷ £50)  100 = 140.
The RPI is 40 per cent higher in the current period than it
was in the base period.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Measuring the Inflation Rate
The major purpose of the RPI is to measure inflation.
The inflation rate is the percentage change in the price
level from one year to the next.
The inflation formula is:
Inflation rate = [(RPI this year – RPI last year) ÷ RPI last
year]  100.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Distinguishing High
Inflation from a High
Price Level
Figure 11.7 shows that
the inflation rate is:
 High when the price
level is rising rapidly
and
 Low when the price
level is rising slowly.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Biased Price Indexes
The main sources of bias in a price index are:
 New goods bias
 Quality change bias
 Substitution bias
© Pearson Education 2012
The Price Level, Inflation and Deflation
New Goods Bias
New goods that were not available in the base period
appear and, if they are more expensive than the goods
they replace, they put an upward bias into the price index.
Quality Change Bias
Quality improvements occur every year. Part of the rise in
the price is payment for improved quality and is not
inflation.
The price index counts all the price rise as inflation.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Substitution Bias
The market basket of goods used in calculating the price
index is fixed and does not take into account substitutions
that consumers make away from goods whose relative
prices rise.
As the structure of retailing changes, people switch to
buying from cheaper sources, but the price index, as
measured, does not take account of this switch in where
people shop.
© Pearson Education 2012
The Price Level, Inflation and Deflation
Some Consequences of the Bias in the RPI and CPI
The bias
 Distorts private contracts
 Increases government outlays
 Might lead to inappropriate monetary policy decisions
© Pearson Education 2012
The Price Level, Inflation and Deflation
Alternative Price Indexes
One of the alternative measures of the price level is the
GPD deflator.
The GDP deflator is an index of the prices of all the items
in GDP.
The GDP deflator = (Nominal GDP ÷ Real GDP) × 100.
The GDP deflator, a broader price index, is appropriate for
macroeconomics because it is a comprehensive measure
of the cost of the real GDP basket of goods and services.
© Pearson Education 2012
The Price Level, Inflation and Deflation
The Alternatives
Compared
Figure 11.8 compares the
three measures of inflation.
These measures give
different average values and
different fluctuations.
RPI fluctuates more than
CPI, …
but GDP deflator is the least
volatile.
© Pearson Education 2012
The Price Level, Inflation and Deflation
The Real Variables in Macroeconomics
We can use the GPD deflator to deflate nominal variables to
find their real values.
For example,
Real wage rate = (Nominal wage rate ÷ GDP deflator)  100
But not the real interest rate! It is different.
© Pearson Education 2012