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Unemployment and Inflation. EVERYONE’S NIGHTMARE Chapter 6. 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.

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unemployment and inflation

Unemployment and Inflation


Chapter 6

unemployment and inflation2
Unemployment and Inflation
  • The two key concepts of Macroeconomics
    • Either can destabilize the economy.
    • When BOTH happen together – REALLY, REALLY BAD.
  • People who are looking for work but have no jobs.
    • ACTIVELY LOOKING is critical to the definition.
definitions for unemployment
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
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

Not included in your book – but in most other Econ texts

  • Most seasonal unemployment is tends to occur in certain industries.
    • Hotel and catering
    • Tourism
    • Fruit picking
    • Christmas
suspicious unemployment statistics
Suspicious 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.”
  • Why do we need unemployment to make the economy healthy?
the natural rate of unemployment
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
Historic Unemployment Rates
  • 1933 during the Great Depression – 25%
  • 1998 – Unemployment fell to 3.9%
3 9 unemployment
3.9% Unemployment
  • Why wouldn’t this be good for the economy???
wage inflation
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
Why would that be bad?
  • Costs go up (labor), so prices have to be upped to cover labor.
  • Higher prices make workers demand more money.
  • Cost – Push Inflation
btw current data on unemployment for the us
BTW: Current Data on Unemployment for the US
  • According to the Bureau of Labor Statistics (www.bls.gov)
    • Unemployment Rate in February: 4.8%

Average Hourly Earnings are up $ .05 in February.

unemployment data
Unemployment Data
  • Previously: 303,000 new jobless claims were filed.
  • On March 16, new numbers will be posted.
    • See www.usatoday.com / money and click on economic calendar for the latest posting.
  • 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 _______ and ____ unemployment.
what do you think
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 PRICIPLE, who had a better life?
reality principle
Reality Principle
  • What matters to people is the real value of money – its PURCHASING POWER – not the nominal or face value of money.
  • 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
What is in the “market basket”?
  • Food and Beverages
  • Housing
  • Apparel
  • Transportation
  • Medical Care
  • Recreation
  • Education
  • Other goods and services
food and beverages
Food and Beverages
  • Breakfast Cereal
  • Milk
  • Chicken
  • Wine
  • Coffee
  • Service meals
  • Snacks
  • Rent for primary residences
  • Owners equivalent rent
  • Fuel Oil (home heating)
  • Bedroom furniture
  • Men’s shirts and sweaters
  • Women’s dresses
  • Jewelry
  • New cars
  • Airline fares
  • Gasoline
  • Car insurance
medical care
Medical Care
  • Prescription drugs
  • Medical supplies
  • Doctor services
  • Eyeglasses
  • Eyeglass services
  • Hospital care
  • Television
  • Pets
  • Pet products
  • Sports equipment
  • Admissions
education and communication
Education and Communication
  • College Tuition
  • Postage
  • Telephone Services
  • Computer Software
  • Computer accessories
other goods and services
Other Goods and Services
  • Tobacco and smoking products
  • Haircuts
  • Other personal services
  • Funeral Expenses
  • CPI for 2006:
  • UP .7% so far for the year.
  • How does that compare with our wages?
  • Statistics from bls.gov
  • Used by both government and the private sector to measure changes in prices facing consumers.
  • SEE PAGE 122 to calculate CPI
cpi versus chained gdp
CPI versus Chained 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 v chained gdp
CPI v. Chained 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
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
What Economists THINK
  • CPI may be overestimated by .5% to 1.5% each year.
  • BIG argument among the econ community.
cost of living adjustments
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 Rate:
    • The percentage rate of change of the price level of the economy.
calculating inflation rates
Calculating Inflation Rates
  • Inflation Rate = percentage rate of change of a price index.
  • See page 124 for more on how to calculate!
looking ahead
Looking Ahead
  • Two “Schools” of Macroeconomics
    • Classical Economics
    • Keynsian Economics
classical economics
Classical Economics
  • A school of economic thought that provides insights into the economy when it operates at or near full employment.
    • Popular thought so far in 2006.
    • Picture of David Ricardo (Travis’ favorite economist)
      • Darwin meets Economics
keynsian economics
Keynsian Economics
  • A school of economic thought that provides insights into the economy when it operates away from full employment.
    • Economic fluctuations, business cycles, sharp changes in the economy.
this concludes what the book has on unemployment and inflation

THIS Concludes what the book has on unemployment and inflation

I THINK you need and deserve more info on inflation!



    • The trade-off with more employment.

What is the CPI pattern in 2005?

  • CPI measures the dollar’s worth.
    • Check out the website
    • http://minneapolisfed.org/Research/data/us/calc/index.cfm
    • TRY THE professor’s salary from the beginning with this site!

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.
    • Labor 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
    • M x V = T x P
    • Money supply times the velocity at which it changes hands equals the number of transactions times the average level of prices.

M x V = T x P

  • 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.

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:
    • Labor 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.

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.