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345 C h a p t e r 05 MONITORING CYCLES, JOBS, AND THE PRICE LEVEL Outline Vital Signs A. A recession started in March 2001. What defines a recession, who makes the decision that we are in one, and how? B. How do we measure unemployment and what other data do we use to monitor the labor market? C. Being employed alone does not determine standard of living; the cost of living also matters, so we also need to know what the Consumer Price Index is, and how that is measured and used. I. The Business Cycle A. The business cycle is the periodic but irregular up-and-down movement in production and jobs. 1. The NBER defines the phases – recession and expansion – and turning points – peak and trough – of the cycle. 2. Its Business Cycle Dating Committee identifies and dates them for the United States. B. Business Cycle Dates 1. The 16 cycles since 1920 are briefly described. 2. Table 20.1 (page 454/108) lists the months of troughs and peaks for each. C. The 2001–2002 Recession 1. The 2001-2002 recession, as seen from early 2002, is described with alternative visions of how it would evolve. 2. Figure 20.1 (page 455/109) shows business cycle patterns with a stylized graph of annual percentage change in real GDP against time, 1921 through 2000. II. Jobs and Wages A. Population Survey 1. The U.S. Census Bureau conducts monthly surveys to determine the status of the labor force in the United States. 2. United States population is divided into two groups: a) The working-age population, which is the number of people aged 16 years and older who are not in jail, hospital, or other institution (in 2001, the working-age population was 211.8 million). b) People too young to work (less than 16 years of age) or in institutional care. 3. The working-age population is people in the labor force and force. In 2001, 142.3 million force and 69.5 million people force. divided into two groups: people not in the labor people were in the labor were not in the labor 3. The labor force is the sum of employed and unemployed workers. To be considered unemployed, a person must be: a) without work and have made specific efforts to find a job within the past four weeks, or b) waiting to be called back to a job from which he or she was laid off, or c) waiting to start a new job within 30 days. 4. Figure 20.2 (page 110) shows the population labor force categories for 2001. B. Three Labor Market Indicators 1. The unemployment rate is the percentage of the labor force that is unemployed. a) The unemployment rate is (Number of people unemployed/Labor force) 100. b) The unemployment rate reaches its peaks during recessions. 2. The labor force participation rate is the percentage of the working-age population that is in the labor force. a) The labor force participation rate is (Labor force/Working-age population) 100. b) Overall, the labor force participation rate has increased from 59 percent in the 1960s to 67 percent in the 1990s. The labor force participation rate for men has declined, but for women has increased. c) The labor force participation rate falls during recessions as discouraged workers —people available and willing to work but who have not made an effort to find work within the last four weeks —leave the labor force. 3. The employment-to-population ratio is the percentage of working-age people who have jobs. a) The employment-to-population ratio is (Number of people employed/Working-age population) 100. b) The employment-to-population ratio from 55 percent in the early 1960s 2000. The employment-to-population declined for men and increased for has increased to 67 percent in ratio has women. 4. Figure 20.3 (page 457/111) shows the labor force participation rate, employment to population ratio, and unemployment rate, 1961–2001. 5. Figure 20.4 (page 458/112) shows the changing face of the labor market, 1961–2001, by time series line graphs of labor force participation rates and employment-to-population ratios for males and females separately. C. Aggregate Hours 1. Aggregate hours are the total number of hours worked by all workers during a year. 2. Aggregate hours have increased since 1960 but less rapidly than the total number of workers because the average workweek has shortened. 3. Figure 20.5 (page 113) shows aggregate hours and average weekly hours per person, 1961–2001. D. Real Wage Rate 1. The real wage rate is the quantity of goods and services that can be purchased with an hour’s work. 2. The real wage rate equals the money wage rate divided by the price level and three measures are discussed. a) hourly earnings in manufacturing deflated by the GDP deflator b) wages and salaries, deflated by the GDP deflator and divided by aggregate hours c) total labor compensation, from the national income accounts, deflated by the GDP deflator and divided by aggregate hours 3. The growth rate of the average real wage rate slowed during the 1970s and early 1980s, a reflection of the productivity growth slowdown. a) The real wage rate of private manufacturing nonsupervisory workers peaked in 1973 and has trended downward since then. b) The growth of the real wage rate, measured by total wages and salaries divided by total hours, slowed substantially after 1973. c) The real wage rate, measured by total labor compensation (which includes fringe benefits) divided by total hours, also grew more slowly after 1973, but the slowdown was less than for the real wage rate measured by wages and salaries only. d) If the real wage rate is calculated using total compensation divided by the CPI adjusted to remove the bias identified by the government commission, then the productivity growth slowdown was less severe. 4. Figure 20.6 (page 460/114) shows the three measures of real wage rates listed above, 1961–2001. III. Unemployment and Full Employment A. The Anatomy of Unemployment 1. Three types of people are unemployed: a) Job losers are workers who have been laid off or fired and are searching for new jobs. Job losers account for the largest fraction of the unemployed and the fraction rises during recessions. b) Job leavers are workers who have voluntarily quit their jobs to look for new ones. Job leavers are the smallest fraction of the unemployed. c) Entrants and reentrants are people entering the labor force for the first time or returning to the labor force and searching for work. The primary source of reentrants is (formerly) discouraged workers. 2. People end a spell of unemployment for two reasons: a) Hired or recalled workers gain jobs. b) Discouraged unemployed workers withdraw from the labor force. 3. Figure 20.7 (page 461/115) illustrates the labor market flows between the different states. 4. Figure 20.8 (page 462/116) shows unemployment by reason, 1961–2001. 5. The duration of unemployment increases during recessions and Figure 20.9 (page 462/116) shows unemployment by duration close to a business cycle peak in 2000 and close to a trough in 1992. 6. The unemployment rates for young workers and black workers are higher than the unemployment rates for older workers and white workers and Figure 20.10 (page 463/117) shows the unemployment rates of teenagers and adults, whites and blacks close to a business cycle peak in 2000 and close to a trough in 1992 B. Types of Unemployment Unemployment can be classified into three types: 1. Frictional unemployment is unemployment that arises from normal labor market turnover. a) The creation and destruction of jobs requires that unemployed workers search for new jobs. b) Increases in the number of young people entering the labor force and increases in unemployment benefit payments raise frictional unemployment. 2. Structural unemployment is unemployment created by changes in technology, the amount of foreign competition, and other changes in the structure of the economy and labor force, that change the goodness of fit between the skills necessary to perform jobs and the locations of jobs, and the skills and location of the labor force. 3. Cyclical unemployment is the fluctuation in unemployment caused by the business cycle. C. Full Employment 1. Full employment occurs when there is no cyclical unemployment or, equivalently, when all unemployment is frictional or structural. 2. The unemployment rate at full employment is called the natural rate of unemployment. The natural rate of unemployment is estimated to be somewhat less than 6 percent today in the United States. D. Real GDP and Unemployment Over the Cycle 1. Potential GDP is the quantity of real GDP produced at full employment. 2. It corresponds to the capacity of the economy to produce output on a sustained basis; actual GDP fluctuates around potential GDP with the business cycle. 3. Figure 20.11 (page 465/119) shows potential GDP and real GDP, and the unemployment rate and the natural unemployment rate, for 1981–2001. IV. The Consumer Price Index A. The price level is the “average” level of prices and is measured by using a price index. 1. The consumer price index, or CPI, measures the average level of the prices of goods and services consumed by an urban family. B. Reading the CPI Numbers 1. The CPI is defined to equal 100 for the reference base period. 2. The value of the CPI for any other period is calculated by taking the ratio of the current cost of a market basket of goods to the cost of the same market basket of goods in the reference base period and multiplying by 100. B. Constructing the CPI 1. Constructing the CPI involves three stages: a) Selecting the CPI basket, the set of goods and services represented in the index and the weight on each. There are two baskets, one for all urban workers and one for wage-earners and clerical workers. They are based on a Consumer Expenditure Survey; the current CPI is based on a 1993-95 survey, although the reference base period is still 1982-84. Figure 20.12 (page 120) illustrates the CPI basket. b) Conducting a monthly price survey, in which BLS employees check the prices of 80,000 goods and services in 30 metropolitan areas. c) Using the prices and the contents of the basket to calculate the CPI. The formula is: CPI = (Cost of CPI basket at current period prices/Cost of CPI basket at base period prices) 100. 2. Table 20.2 (page 467/121) works a simplified CPI calculation. C. Measuring Inflation 1. The main purpose of the CPI is to measure inflation. The inflation rate is the percentage change in the price level from one year to the next. 2. The inflation formula is: Inflation rate = [(CPI this year – CPI last year)/CPI last year] 100. 2. Figure 20.13 (page 468/122) shows the CPI and the inflation rate, 1971–2001. D. The Biased CPI 1. The CPI may overstate the true inflation for four reasons: new goods bias, quality change bias, commodity substitution bias, and outlet substitution bias. a) New goods bias: New goods that were not available in the base year appear and, if they are more expensive than the goods they replace, the price level may be biased higher. Similarly, if they are cheaper than the goods they replace, but not yet in the CPI basket, they bias the CPI upward. b) Quality change bias: Quality improvements generally are neglected, so quality improvements that lead to price hikes are considered purely inflationary. c) Commodity substitution bias: The market basket of goods used in calculating the CPI is fixed and does not take into account consumers’ substitutions away from goods whose relative prices increase. d) Outlet substitution bias: As the structure of retailing changes, people switch to buying from cheaper sources, but the CPI, as measured, does not take account of this outlet substitution. 2. A Congressional Advisory Commission estimated that the CPI overstates inflation by 1.1 percentage points a year. 3. The bias in the CPI distorts private contracts, increases government outlays (close to a third of government outlays are linked to the CPI), and biases estimates of real earnings. 4. To reduce the bias in the CPI, the BLS will undertake consumer expenditure surveys more frequently and revise the CPI basket every two years.