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Basics of Unemployment and Inflation in Macroeconomics

Understand the concepts of unemployment and inflation in macroeconomics, including the natural rate of unemployment and the basics of measuring price changes with the consumer price index (CPI).

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Basics of Unemployment and Inflation in Macroeconomics

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  1. Welcome to Day 8 Principles of Macroeconomics

  2. Goals for Today1) The basics of unemployment.2) The short-run and long-run in macroeconomics (sticky wages).3) The natural rate of unemployment.4) The basics of inflation.

  3. Perhaps the most basic thing we want from the economy is a job.

  4. The most basic statistic the government uses to estimate how hard it is to find a job is the unemployment rate. The government surveys people every month and puts them in 1 of 3 categories ...

  5. 1) Has a job.2) Doesn’t have a job and wants one.3) Doesn’t have a job and doesn’t want one – students, stay at home parents, retired, filthy rich, etc. We want to find the percentage of people who want a job who can’t get a job.

  6. The Labor Force is all the people who want a job, either with a job or without one. So unemployment rate is this:number unemployed X 100% number in labor force

  7. The unemployment rate is the percentage of adults who are in the labor force who do not have jobs.

  8. For example suppose we have the following.450 people with jobs.50 people without jobs who want one.300 people without jobs who don’t want one. What is the unemployment rate?50/(450+50) = 50/500 = 10%

  9. Whether someone wants a job or not can be a tricky question. The government only counts you as wanting a job if you are actively looking for one. In a bad recession, sometimes this statistic can make things look better than they are because of “discouraged workers.”

  10. Discouraged workers are workers who have stopped looking for employment and so are no longer counted in the unemployment rate.

  11. Historical unemployment for the past 60 years.

  12. Why are people unemployed?One reason is cyclical unemployment – the variation in unemployment caused by the economy moving from recession to expansion and back again.

  13. But when demand drops for labor because of a recession, why should there be so much action on the quantity side and so little on the price side?Wages seem “stickier” than other prices. The price of corn can go up and down every week. It would seem strange to us if wages did.

  14. Some workers have multi-year contracts. United Auto Workers, pilots, … me.

  15. But even where there is no contract, employers often seem to prefer to lay off workers rather than cut wages.

  16. This is what the textbook calls an implicit contract. The business will tryto keep wages fromfalling when times bad and the employee will not expect large wage increases when times are good.

  17. Another reason could be the adverse selection of wage cuts. Workers are not identical. If you cut their wages, the best ones probably leave. If you choose, you can fire the worst ones.

  18. Sticky wages causing unemployment in a recession in the short-run.

  19. Wages do not stay sticky forever. Eventually they start to move in response to the labor market situation. The period of time in macroeconomics during which wages are fixed is called the short-run.

  20. The long-run in macroeconomics is when enough time has gone by for wages to move (variable wages). Even in the long-run, when wages have adjusted and the economy is back to a natural healthy state, there will still be unemployment.

  21. Why is there unemployment even when we are not in a recession?1) Frictional – people with marketable job skills that are “between jobs”.2) Structural – people without marketable job skills.

  22. It is a concern that if you are in cyclical unemployment too long, you can move into structural. This is called “hysteresis”. Don’t worry, you don’t have to know that word for the test.

  23. Frictional unemployment plus structural unemployment is called the “Natural Rate of Unemployment”. It is the rate of unemployment rate during normal good times, when the cyclical rate is zero.

  24. Imagine an economy with 10 workers. They make a certain amount of stuff when all 10 are working. The make less when 9 are working and unemployment is 10%. They make less than that when 8 are working and unemployment is 20%.

  25. We see that there is a certain amount of production associated with each specific unemployment rate. So much is produced at U=10%, and then at U=9%, and at U=UN. The amount of output produced when U is at the natural rate of unemployment is called natural Real GDP = QN

  26. What I am calling “Natural Real GDP” and is what your textbook calls “Potential Real GDP.”

  27. Natural RGDP is not set in stone, but moves along with a country’s social expectations and regulations.What happened to America’s Natural RGDP when it became expected that women would work rather than stay home? Would the natural rate of unemployment change?

  28. What happened to Europe’s Natural RGDP when they created generous unemployment benefits?Would their natural rate of unemployment change?

  29. When I was in your shoes in the early 1980s, I was taught that the natural rate of unemployment was 6%. Your textbook mentions a rate of 5%.

  30. Now on to measuring price changes. The consumer price index (CPI) is a measure of the average price of consumer goods.

  31. Inflation is when the average price of goods is rising.Deflation is when the average price of goods is going down.Hyperinflation is very high inflation, usually over 50% a month.

  32. How do you find the rate of inflation as measured by the CPI?Here is Fred. Fred buys only 3 things: pizza, beer, and gas. If you haven’t guessed, Fred is a college student.

  33. The basket of goods is what the typical consumer buys in a year.

  34. The rate of inflation is the percentage increase in cost to buy the same basket of goods over time. So let’s say that in 2015, Fred bought the following. Pizza Beer Gas Total Q P Q P Q P Cost2015 50 $10 200 $1 100 $3 $1,000

  35. In 2016, pizza prices fall to $9, beer rises to $2, and gas falls to $2. Have prices risen or fallen overall?

  36. Pizza Beer Gas Total Q P Q P Q P Cost2012 50 $10 200 $1 100 $3 $1,0002013 50 $9 200 $2 100 $2 $1,050Prices have risen. How much have they risen? From $1,000 to $1,050 is a 5% increase. So Fred’s inflation rate is 5%.

  37. Math ReminderThe percentage increase is the amount of the change divided by the starting number, then multiplied by 100. (50/1000) X 100 = 5%

  38. What if we want to include things that the average family doesn’t buy but are part of GDP in our measure of price changes, such as aircraft carriers and steel girders?Then we use a price index called GDP deflator that includes all things counted in GDP.

  39. What we did this class:1) Calculate unemployment.2) Types of unemployment.3) The short-run and sticky wages.4) The long-run and variable wages.5) Natural rate of unemployment and natural RGDP.6) Calculating the inflation rate, CPI, and GDP deflator.

  40. Welcome to Day 9 Principles of Macroeconomics

  41. What we did last class:1) Calculate unemployment.2) Types of unemployment.3) The short-run and sticky wages.4) The long-run and variable wages.5) Natural rate of unemployment and natural RGDP.6) Calculating the inflation rate, CPI, and GDP deflator.

  42. Goals for Today1) Creating index numbers to reflect inflation.2) Problems with measuring inflation – new goods, substitutes.3) How bad is inflation?4) Indexing.

  43. Things like price changes are often presented as “index numbers.” Index numbers are unit free numbers created to make computing inflation rates easier. You chose a base year to have an index number equal to 100.

  44. For example, if it cost $47,000 to buy “the basket” of goods in 2016 and that is our base year, then divide by $47,000 and multiple by 100 to get 100.Now do the same calculation for every other year.

  45. 2016 = 100.0 2017 = 103.7 Hey, the inflation rate was 3.7%.

  46. What do you do with products that have improved in quality or are even brand new?Quality/New goods bias is overstating inflation because of not taking into account quality improvements or new goods.

  47. The government tries to guess at quality improvements. A computer 10% faster is 10% better, so is equivalent to a 10% cut in price of “computing speed.”

  48. You can sometimes estimate (guess) the price of new products if they had existed earlier. DVD players versus VCRs. But still it is best to update with a new base year every 5 years or so.

  49. Substitution Bias The over measurement of the rise in prices of a fixed basket caused by not allowing for substituting goods.

  50. Let’s say you think iphones and androids are equally good and the iphone is 10% more expensive.Which do you buy?

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