Unemployment and Inflation: Impact and Measurement

1. Chapter 7 The Macroeconomy: Unemployment and Inflation

2. Learning Objectives Explain how the U.S. government calculates the official unemployment rate Discuss the types of unemployment Describe how price indexes are calculated and define the key types of price indexes

3. Learning Objectives (cont'd) Distinguish between nominal and real interest rates Evaluate who looses and who gains from inflation Understand key features of business fluctuations

4. Chapter Outline Unemployment The Major Types of Unemployment Full Employment and the Natural Rate of Unemployment Inflation and Deflation Anticipated versus Unanticipated Inflation Changing Inflation and Unemployment: Business Fluctuations

5. Did You Know That... Estimates indicate that each year, discount pricing by retailers such as Wal-Mart, K-Mart, and Target, helps to keep the overall U.S. inflation rate about 0.4% lower? Additionally, every year discount pricing by food superstores holds the annual rate of increase in average U.S, food prices 0.75% below the rate it otherwise would reach? Trying to understand and better measure inflation and the overall performance of the national economy is a central objective of macroeconomics.

6. Unemployment Unemployment Total number of adults (aged 16 years or older) willing and able to work and who are actively looking for work but have not found a job. Unemployment creates a cost to the entire economy in terms of lost output – often ranging in the billions of dollars.

7. 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 The unemployment rate is the percentage of the measured labor force that is unemployed.

8. Unemployment (cont'd) Question What are the costs of unemployment?

9. Unemployment (cont'd) Answers Lost output During early 2000s, unemployment rate rose by 2 percentage points Firm output was 80% of potential Lost output was $200 billion of goods and services that could have been produced Personal psychological impact

10. Figure 7-1 More Than a Century of Unemployment Source: U.S. Department of Labor, Bureau of Labor Statistics

11. Figure 7-2 Adult Population Source: U.S. Department of Labor, Bureau of Labor Statistics.

12. 155.7* = 145.3 + 10.4 Unemployment (cont'd) 10.4 155.7 x 100 = 6.7% = Labor force = The employed + The unemployed Unemployed Labor force x 100 Unemployment rate = *U.S., millions of people; as of 2009

13. 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

14. Unemployment (cont'd) Categories of individuals without work Job loser Reentrant Job leaver New entrant

15. Unemployment (cont'd) Job Loser An individual whose employment was involuntarily terminated or who was laid off 40–60% of the unemployed

16. 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

17. Unemployment (cont'd) Job Leaver An individual who voluntarily quit 10 to 15% of the unemployed

18. 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

19. Figure 7-3 The Logic of the Unemployment Rate

20. 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.

21. Unemployment (cont'd) Question What is likely to happen to the duration of unemployment during a downturn in the economy?

22. 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?

23. Unemployment (cont'd) Labor Force Participation Rate The proportion of non-institutionalized working-age individuals who are employed or seeking employment

24. The Major Types of Unemployment The major types of unemployment Frictional Structural Cyclical Seasonal

25. 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

26. The Major Types of Unemployment (cont'd) Structural Unemployment Results from a poor match of workers’ abilities and skills with current requirements of employers Considerable evidence shows that government labor market policies influence how many jobs businesses wish to create, thereby affecting structural unemployment.

27. 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

28. In 2007, home-building activity fell by more than 25%. Yet, cyclical unemployment increased by only 4%. What was different about this particular housing slump was that construction firms had hired large numbers of illegal-immigrant workers alongside U.S. residents. International Example: How Illegal Aliens Affect Measured Cyclical U.S. Unemployment

29. The Major Types of Unemployment (cont'd) • Seasonal Unemployment • Results from the seasonal pattern of work in specific industries

30. Full Employment and the Natural Rate of Unemployment Questions Does full employment mean that everybody has a job? Is it always possible for everyone who is looking for a job to find one?

31. 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

32. 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.

33. 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

34. Inflation and Deflation (cont'd) Purchasing Power The value of money for buying goods and services Varies with prices and income

35. Inflation and Deflation (cont'd) Nominal value Price expressed in today’s dollars Real value Value expressed in purchasing power, adjusted for inflation

36. Inflation and Deflation (cont'd) Measuring the Rate of Inflation • Market Basket • Representative bundle of goods and services • Base Year • The point of reference for comparison of prices in other years

37. Inflation and Deflation (cont'd) 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 Cost of market basket in base year  100 Price index =

38. Example: Why are Women Confronting Higher Inflation Than Men • The price index for the market basket of a typical U.S. female resident has increased at a rate at least 1% higher than her male counterpart. • Compared to years past, more women are employed. They are also marrying and having children later in life. Higher-income single women tend to spend more of their income than men.

39. Table 7-1 Calculating a Price Index for a Two-Good Market Basket

40. Inflation and Deflation (cont'd) Real-world price indexes Consumer Price Index (CPI) Producer Price Index (PPI) GDP deflator Personal Consumption Expenditure (PCE)

41. 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

42. 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

43. 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

44. 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

45. Figure 7-4 Inflation and Deflation in U.S. History Source: U.S. Department of Labor, Bureau of Labor Statistics

46. 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.

47. 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

48. 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

49. Anticipated versus Unanticipated Inflation (cont'd) Real interest rate Nominal interest rate = 10% Expected inflation rate = 6% Real rate = 10% – 6% = 4%

50. Anticipated versus Unanticipated Inflation (cont'd) Does inflation necessarily hurt everyone? Inflation affects people differently Unanticipated inflation Creditors lose Debtors gain