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Lecture 5: UNEMPLOYMENT
AND INFLATION
Unemployment and Inflation

The two key concepts of Macroeconomics
Either can destabilize the economy.
When
BOTH happen together – REALLY,
REALLY BAD.
STAGFLATION
Unemployment

People who are looking for work but have no
jobs.
 ACTIVELY
LOOKING is critical to the definition.
Definitions for Unemployment



Labor Force = Employed + unemployed
Unemployment Rate = number of unemployed /
total labor force
Labor Force Participation Rate = labor force /
population 16 and over
Definitions of Unemployment

Discouraged Workers
 People
who left the labor force because
they could not find jobs.

Underemployed
 Workers
holding part-time work, but prefer
full-time work OR hold jobs that are far
below their capabilities.
The reasons for unemployment

Frictional Unemployment

Structural Unemployment

Seasonal Unemployment

Cyclical Unemployment
Cyclical Unemployment

When GDP fluctuates,
demand in the
economy is not
sufficient to provide
jobs for all those who
seek work.
– Recession
– Depression
Frictional Unemployment

People in between jobs.

Short period of time while changing jobs.

3% - 4% frictional employment is
considered normal.
Structural Unemployment

When changes in market supply or demand
conditions affect major industries or regions.
 The part of unemployment that results from the
mismatch of skills and jobs.
Causes of Structural Unemployment

Decline in demand for a product

Increased foreign competition

Automation of production

Increased raw material costs

Lack of labor mobility between occupations or regions.
Seasonal Unemployment

Most seasonal unemployment tends to
occur in certain industries.
–
–
–
–
Hotel and catering
Tourism
Fruit picking
Christmas
Unemployment Statistics

Natural Rate of Unemployment
 Level
of unemployment at which there is no
cyclical unemployment.

Full Employment
 Level
of employment that occurs when the
unemployment rate is at the “natural rate.”
The Natural Rate of Unemployment

Depending on whom you talk to …

4% to 5% is considered the natural rate.
 Consists
of only structural and frictional
unemployment.
Historic Unemployment Rates




1933 during the Great
Depression – 25%
1998 – Unemployment
fell to 3.9%
October 2009 – 10.2%
- highest in 26 years!
March 2010 – 9.7%
3.9% Unemployment

Why wouldn’t this be
good for the
economy?
Wage Inflation

How do employers attract or keep employees
if there is not enough workers?
 Higher
Wages
 More Benefits
 1999,
Amigos was paying $9 per hour and
McDonalds offered $500 signing bonuses.
Why would that be bad?



Costs go up (labour), so prices have to rise
to cover labour.
Higher prices make workers demand more
money.
Cost – Push Inflation
Current Data on Unemployment for
the US


According to the Bureau of Labour Statistics
(www.bls.gov)
Currently wages are stagnant to negative.
Unemployment Data



Previously: 303,000
new jobless claims were
filed in March 2009.
Currently: 448000 in
the week ending April
24, 2010
168000 people
reported getting jobs in
March 2010
Comparison of key countries December 09
BRIC Country Unemployment




Brazil – 9.7% (est.)
Russia – 6.4% (est.)
India – 6.8%
(DOWN)
China – 4.0%
BTW:

Top 3 of
unemployment:
 Nauru
 Liberia
 Zimbabwe
Countries with the lowest
unemployment 
Countries with the
lowest unemployment
 Andorra
 Monaco
 Qatar
Review




How do economists measure the unemployed?
Previously unemployed individuals who have
stopped looking for work are called ____ workers.
What are the types of unemployment?
The natural rate of unemployment consists solely of
frictional and structural unemployment.
THE CONSUMER PRICE INDEX
AND THE COST OF LIVING
The INFLATION Indicators
What do you think?



1976: Starting salary
for an economics
professor was $15,000
2001: Starting salary
for an econ. prof. was
$55,000.
Considering the REALITY
PRINCIPLE, who had a
better life?
Reality Principle

What matters to
people is the real
value of money – its
PURCHASING
POWER – not the
nominal or face value
of money.
CPI:


Consumer Price Index
A price index that
measures the cost of a
fixed basket of goods
chosen to represent
the consumption
pattern of individuals.
 Tracks
the cost of
living over time.
What is in the “market basket”?








Food and Beverages
Housing
Apparel
Transportation
Medical Care
Recreation
Education
Other goods and
services
Food and Beverages







Breakfast Cereal
Milk
Chicken
Wine
Coffee
Service meals
Snacks
Housing




Rent for primary
residences
Owners equivalent
rent
Fuel Oil (home
heating)
Bedroom furniture
Apparel



Men’s shirts and
sweaters
Women’s dresses
Jewellery
Transportation




New cars
Airline fares
Gasoline
Car insurance
Medical Care






Prescription drugs
Medical supplies
Doctor services
Eyeglasses
Eyeglass services
Hospital care
Recreation





Television
Pets
Pet products
Sports equipment
Admissions
Education and Communication





College Tuition
Postage
Telephone Services
Computer Software
Computer accessories
Other Goods and Services




Tobacco and smoking
products
Haircuts
Other personal
services
Funeral Expenses
CPI

Used by both
government and the
private sector to
measure changes in
prices facing
consumers.
CPI versus GDP


CPI measures goods
produced in prior years
(older cars) as well as
imported goods.
Chained GDP does not
measure either of these.
ONLY new goods and
those produced in the
country.
CPI vs GDP

Because consumers
will cut back on goods
that cost more – the
CPI will tend to
overstate true
changes in cost of
living.
 If
chicken goes up in
price, we switch to
hamburger.
CPI Problems


Does not “cut back”
on higher priced
goods like consumers
do.
Would still count the
same share of chicken
as it did before the
price index.
What Economists THINK


CPI may be
overestimated by
0.5% to 1.5% each
year.
BIG argument among
the econ community.
Cost of Living Adjustments


Automatic increases in
wages or other
payments that are
tied to a price index.
For Future Reference
on contract
negotiations: Called
COLA.
COLA and CPI

As CPI goes up, our
wages or Social
Security makes
adjustments to keep
up with the cost of
living.
INFLATION

Inflation Rate:
 The
percentage rate
of change of the price
level of the economy.
Calculating Inflation Rates


Inflation Rate = percentage rate of change of a
price index.
See page 124 for more on how to calculate!
INFLATION
– The trade-off with
more employment.
Types of Inflation





Demand-Pull Inflation
Cost-Push Inflation
Monetary Inflation
Stagflation
Hyperinflation
Demand-Pull Inflation

When the demand for
goods and services
exceeds the production
capacity.
– Prices rising because
of shortages.
Cost-Push Inflation

Inflation can arise from
changes in the costs of
production of goods and
services.
– Increase in the price of raw
materials
– Increase in the price of
labor
– Increase in the cost of
capital.
Cost-Push v. Demand Pull

They push and pull
prices up.
– Labour contracts
containing COLA
clauses.
 Cost-Of-Living
Adjustments.
Monetary Inflation

Inflation caused by
excessive growth in
the money supply.
– Value of money
decreases if it isn’t that
“rare.”
Rule for Monetary Inflation:
VELOCITY

Quantity Equation
– MxV=TxP
– Money supply times
the velocity at which it
changes hands equals
the number of
transactions times the
average level of prices.
MxV=TxP

Direct relationship
between the money
supply and the price
level.
What happens when the
quantity equation is “off”?

Hyperinflation
 Money supply
increases much, much
faster than an
economy’s output of
goods and services.
– THINK RUSSIA in
1990s.
– Zimbabwe in 2000s
– Germany post WWI
Phillips Curve: The
relationship between
unemployment and inflation.
INVERSE relationship.
Unemployment goes
UP, then inflation goes
DOWN.
Stagflation: When things
REALLY go wrong on the
Phillips Curve

Inflation and
unemployment were at
higher levels.
– Combination of
stagnation and
inflation.
– Both were increasing.
1970s: What caused
Stagflation?

Spending on the Vietnam War PLUS
spending on domestic social programs.
 Inflationary expectations
 Rise in energy costs caused by OPEC
 Monopolistic pricing
What is wrong with Inflation?

Inflation reduces
REAL INCOME of
those whose incomes
do not rise as fast as
the price level.
 Hurts:
– People holding assets
in MONEY
– Lenders
Special Note: Phillips Curve
International
– Europe 1970s had higher
inflation and
unemployment.
– Worse because:



Labour union practices
Tax structures
Government economic
policies
Consequences of
Unemployment

Real Output Effects
– Each 1% of unemployment
results in a reduction of
$100-billion in output.
– Lower real investment
means less growth and
reduced future output.
– OKUN’S LAW!
Consequences of Unemployment

Income Effects
 Loss of income and
benefits (Health
insurance)
 Loss of income to
others because of
reduced purchasing
power
 Reduced tax income
and increased outlays
of government.
Consequences of
Unemployment

Social Effects
– Health Problems
– Increased suicides
– Break up of families
– Increased child abuse
– Increased crime
Consequences of INFLATION

Income Effects:
– Reduced purchasing
power of the dollar
– Reduced real income
for fixed income
receivers
– Reduced real wealth of
savings
Income Effects of Inflation
(cont.)

Benefits those whose
incomes rise faster
than the inflation rate.
 Benefits owners of
real assets (real estate,
precious metals
(kinda!))
 Benefits debtors
How Inflation effects Real
Output

Inflation initially
stimulates output
 Near full employment,
there arise bottlenecks in
supplies
 Costs begin rising faster
than prices
 Interest rates accelerate,
discouraging new
investment.
Helpful Reading
Economics. Samuelson, & Nordhaus (2005) Ch. 29-30