Download Chapter 10 - The Citadel

Chapter 10
Unemployment,
Inflation, and the
Business Cycle
Did You Know That...
• Trying to understand and better forecast
labor employment and the overall
performance of the national economy is a
central objective of macroeconomics?
• This branch of economics seeks to explain
and predict movements in unemployment,
the average level of prices, and the total
production of goods and services?
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7-2
Unemployment
• Unemployment
 Total number of adults (aged 16 years or
older) willing and able to work and who are
actively looking for work and have not
found a job
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7-3
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
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7-4
Unemployment (cont'd)
• Question
 What are the costs of unemployment?
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7-5
Unemployment (cont'd)
• Answers
 Lost output
 During
early 2000s, unemployment rate rose
by 2 percentage points
 Factory
output was 80% of potential
 Lost
output was $200 billion of goods and
services that could have been produced
 Personal psychological impact
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7-6
Figure 7-1 More Than a Century
of Unemployment
Source: U.S. Department of Labor, Bureau of Labor Statistics
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7-7
Figure 7-2 Adult Population
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Unemployment (cont'd)
• The unemployment rate is the
percentage of the measured labor
force that is unemployed.
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7-9
Unemployment (cont'd)
Labor force = The employed + The unemployed
152.7*
=
145.4
+
Unemployed
Unemployment rate =
Labor force
7.3
x 100
7.3
x 100 = 4.8%
=
152.7
*U.S., millions of people; as of 2007
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7-10
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
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7-11
Unemployment (cont'd)
• Categories of individuals without work
 Job loser
 Reentrant
 Job leaver
 New entrant
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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
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7-13
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
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7-14
Unemployment (cont'd)
• Job Leaver
 An individual who voluntarily quit
 10
to 15% of the unemployed
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7-15
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
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7-16
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.
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7-17
Figure 7-3 The Logic of the
Unemployment Rate
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7-18
Unemployment (cont'd)
• Question
 What is likely to happen to the duration
of unemployment during a downturn in
the economy?
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7-19
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?
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7-20
Unemployment (cont'd)
• Labor Force Participation Rate
 The proportion of noninstitutionalized
working-age individuals who are employed
or seeking employment
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7-21
The Major Types of Unemployment
• The major types of unemployment
 Frictional
 Structural
 Cyclical
 Seasonal
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7-22
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
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7-23
The Major Types
of Unemployment (cont'd)
• Structural Unemployment
 Results from a poor match of workers’
abilities and skills with current
requirements of employers
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7-24
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
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7-25
The Major Types
of Unemployment (cont'd)
• Seasonal Unemployment
 Results from the seasonal pattern of work
in specific industries
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7-26
International Example:
Challenges of Measuring the
Unemployment Rate in China
• Measurement of China’s labor force and
unemployment rate fails to encompass all of
the roughly 115 million people who migrate
from rural areas.
• In addition, China’s government has not
yet developed a way to determine how
many millions of people laid off from stateowned firms have obtained positions with
private firms.
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7-27
Full Employment and the Natural
Rate of Unemployment
• Question
 Does full employment mean that
everybody has a job?
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7-28
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
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7-29
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.
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7-30
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
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7-31
Inflation and Deflation (cont'd)
• Purchasing Power
 The value of money for buying goods
and services
 Varies with prices and income
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7-32
Inflation and Deflation (cont'd)
• Nominal value
 Price expressed in today’s dollars
• Real value
 Value expressed in purchasing power,
adjusted for inflation
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7-33
Inflation and Deflation (cont'd)
• Measuring the rate of inflation
 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
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7-34
Inflation and Deflation (cont'd)
• Market Basket
 Representative bundle of goods
and services
• Base Year
 The point of reference for comparison of
prices in other years
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7-35
Table 7-1 Calculating a Price Index
for a Two-Good Market Basket
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7-36
Inflation and Deflation (cont'd)
• Real-world price indexes
 Consumer Price Index (CPI)
 Producer Price Index (PPI)
 GDP deflator
 Personal Consumption Expenditure (PCE)
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7-37
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
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7-38
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
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7-39
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
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7-40
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
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7-41
Figure 7-4 Inflation and Deflation
in U.S. History
Source: U.S. Department of Labor, Bureau of Labor Statistics
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7-42
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.
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7-43
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
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7-44
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
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7-45
Anticipated versus
Unanticipated Inflation (cont'd)
• Real interest rate
 Nominal interest rate = 10%
 Expected inflation rate = 6%
 Real rate = 10% – 6% = 4%
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7-46
Anticipated versus
Unanticipated Inflation (cont'd)
• Does inflation necessarily hurt
everyone?
 Inflation affects people differently
• Unanticipated inflation
 Creditors lose
 Debtors gain
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7-47
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
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7-48
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
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7-49
Policy Example: How Pervasive Is
“Inflation Inequality” in the United States?
• Inequality based on consumption of
fuel, education, and health care
• Households facing higher inflation do so
for a short period of time.
• To the extent inflation inequality exits,
it is neither pervasive nor persistent.
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7-50
Changing Inflation and Unemployment:
Business Fluctuations
• Business Fluctuations
 The ups and downs in business activity
throughout the economy
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7-51
Changing Inflation and Unemployment:
Business Fluctuations (cont'd)
• Expansion
 A business fluctuation in which the pace of
national economic activity is speeding up
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7-52
Changing Inflation and Unemployment:
Business Fluctuations (cont'd)
• Contraction
 A business fluctuation during which the
pace of national economic activity is
slowing down
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7-53
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
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7-54
Figure 7-5 The Idealized Course of
Business Fluctuations
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7-55
Figure 7-6 National Business
Activity, 1880 to the Present
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7-56
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
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7-57
Issues and Applications:
Wal-Mart, Product Quality, and the CPI
• Wal-Mart offers lower prices on most
food items.
• The Bureau of Labor Statistics (BLS) uses
prices charged at a nearby Kroger.
• As far as the BLS is concerned, lower WalMart prices must reflect lower quality.
• BLS quality adjustments may result in an
upward bias in the rate of CPI inflation.
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7-58
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
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7-59
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
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7-60
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
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7-61
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.
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7-62
Summary Discussion
of Learning Objectives (cont'd)
• Losers and gainers from inflation
 Creditors lose as a result of
unanticipated inflation.
 Borrowers gain.
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7-63
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
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7-64
Key Terms and Concepts
• anticipated inflation
• business fluctuations
• consumer price index
• cyclical unemployment
• discouraged workers
• expansions
• frictional unemployment
• inflation
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
• labor force participation
rate
• nominal rate of interest
• purchasing power
• real rate of interest
• recession
• seasonal
unemployment
• structural
unemployment
• unanticipated inflation
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