prepared by: jamal husein c h a p t e r 11 © 2005 prentice hall business publishingsurvey of...

© 2005 Prentice Hall Business Publishing© 2005 Prentice Hall Business Publishing Survey of Economics, 2/eSurvey of Economics, 2/e O’Sullivan & SheffrinO’Sullivan & Sheffrin

Prepared by: Jamal Husein

C H A P T E R

1111

Unemployment and

Inflation

© 2005 Prentice Hall Business Publishing Survey of Economics, 2/e O’Sullivan & Sheffrin 2

What Is Unemployment?What Is Unemployment?What Is Unemployment?What Is Unemployment?

The unemployed are those individuals who do not currently have a job but who are actively looking for work.

The employed are individuals who currently have jobs.

Together, the employed and unemployed comprise the labor force.


Unemployment MeasuresUnemployment MeasuresUnemployment MeasuresUnemployment Measures

The unemployment rate is the percentage of people in the labor force who are unemployed.

Labor Force = employed + unemployedLabor Force = employed + unemployed

Number of UnemployedNumber of Unemployed

Labor ForceLabor Force

UnemploymentUnemploymentRateRate ==


Unemployment MeasuresUnemployment MeasuresUnemployment MeasuresUnemployment Measures

The working age population includes individuals 16 years of age and older who can legally work in the U.S.

The labor force participation rate is the ratio of people in the labor force to the working-age population.


Population 16 and Population 16 and overover


ParticipationParticipation Rate Rate

==


Unemployment MeasuresUnemployment MeasuresUnemployment MeasuresUnemployment Measures For example, suppose an economy consists of:

200,000 individuals 16 years and older. 122,000 employed. 8,000 unemployed.

Labor Force = (122,0000 + 8,000) = 130,000Labor Force = (122,0000 + 8,000) = 130,000

130,000130,000

200,000200,000


ParticipationParticipation Rate Rate

== = 65%= 65%

8,0008,000

130,000130,000

UnemploymentUnemploymentRateRate == == 6.15% 6.15%


Unemployment Data, January 2003Unemployment Data, January 2003Unemployment Data, January 2003Unemployment Data, January 2003

U.S. civilian population over 16 years of age219,897,000

Labor force145,838,000 Not in the labor

force74,059,000Employed

137,536,000Unemployed

8,302,000

Labor force participation rate 64.12%

Unemployment rate 5.7%


Unemployment Rates (2003)Unemployment Rates (2003)Unemployment Rates (2003)Unemployment Rates (2003)

Country Unemployment Rate (%)

United States 5.7

Belgium 10.8

Sweden 5.1

France 9.1

Italy 8.9

Spain 12.1

United Kingdom 5.1

Netherlands 4.3

Japan 5.5

Australia 6.1


Who Are the Unemployed?Who Are the Unemployed?Who Are the Unemployed?Who Are the Unemployed?

The Bureau of Labor Statistics conducts a monthly survey of households to determine who is employed, unemployed, or not in the labor force.

It is difficult to determine if someone is truly looking for work, therefore, to distinguish between those people who are unemployed and those who are not in the labor force.



People who were looking for work in the recent past but did not find work and stopped looking are considered discouraged workers.

Discouraged workers are not counted as unemployed, but considered to have dropped out of the labor force.



Workers who hold part-time jobs but would prefer to have full-time jobs, and workers holding jobs far below their capabilities are called the underemployed.

It is also difficult to distinguish between employed and underemployed workers.


Unemployment RatesUnemployment RatesUnemployment RatesUnemployment Rates

Total 5.7Males 20 years and older 5.4

Female, 20 years and older 4.7

Both sexes, 16-19 years 16.8

White 5.1

African American 10.3

White, 16-19 years 15.2

African American, 16-19 years 30.4

Married men 3.5

Married women 3.8

Women maintaining families 8.0

Selected Unemployment Rates, JanuarySelected Unemployment Rates, January2003 (in percent)2003 (in percent)


Types of UnemploymentTypes of UnemploymentTypes of UnemploymentTypes of Unemployment

Cyclical unemployment is the result of fluctuations in real GDP. Unemployment rises when real GDP falls, and falls when the economy improves.

Frictional unemployment occurs naturally in the economy. It refers to the time it takes to find an appropriate job.


Types of UnemploymentTypes of UnemploymentTypes of UnemploymentTypes of Unemployment

Structural unemployment refers to the mismatch between job openings and the skills of workers seeking jobs.

It is difficult to draw the line between frictional and structural unemployment. Are workers from the “old economy” able to find jobs in the “new economy”?


The Natural Rate of UnemploymentThe Natural Rate of UnemploymentThe Natural Rate of UnemploymentThe Natural Rate of Unemployment

When the economy is at full employment, the unemployment rate is not zero, but equal to the natural rate of unemployment.

The natural rate of unemployment consists of frictional and structural unemployment. It is the unemployment that exists when actual GDP is equal to potential GDP—there is no cyclical unemployment.



In the United States, economists estimate that the natural rate of unemployment is between 4.0% and 5.5%. In Europe it is between 7% and 10%.

The economy needs some frictional unemployment to operate efficiently.



When the growth rate of real GDP slows down relative to its long-run trend, the actual unemployment rate exceeds the natural rate of unemployment—cyclical unemployment rises.

On the other hand, if economic growth is too rapid, the economy will “overheat” and cyclical unemployment will be negative.


The Costs of UnemploymentThe Costs of UnemploymentThe Costs of UnemploymentThe Costs of Unemployment Excess unemployment cause both society and

individuals to suffer: Excess unemployment means the economy is no

longer producing at its potential, i.e., some of society’s resources are being wasted;

Lower employment translates into reduced income and immediate hardship for individuals, especially those with fixed obligations;

Unemployment cost can also linger into the future. Some skills are likely to be lost as a result of prolonged unemployment;

Unemployment can impose psychological costs, i.e., divorce, crime, suicide, … etc.


Unemployment and InflationUnemployment and InflationUnemployment and InflationUnemployment and Inflation

When the economy is “overheated,” and unemployment rates are low, firms will find it difficult to recruit workers, and competition among firms will lead to increases in wages.

As wages increase, increases in prices soon follow. The sign of overheating will be a general rise in prices for the entire economy, or inflation.


The Consumer Price IndexThe Consumer Price IndexThe Consumer Price IndexThe Consumer Price Index

The Consumer Price Index (CPI) is an index that measures changes in a fixed “basket of goods” which contains items purchased by the typical consumer.

The CPI is a measure of the value of money over time.

Reality PRINCIPLE What matters to people is the real value or purchasing power of money or income, not its face value.



The CPI index for a given year, say year K, is defined as:

Cost of Basket in Year KCost of Basket in Year K

Cost of Basket in base YearCost of Basket in base Year

CPI inCPI in

Year KYear K== × 100× 100



C PI in 1992 = $200

$200 x 100 = 100

C PI in 1997 = $250

$200 x 100 = 125

Prices increased an average of 25% over this five-year period.

Example: Cost of basket in 1992, the base year = $200 Cost of same basket in 1997 = $250


The CPI and the Standard of LivingThe CPI and the Standard of LivingThe CPI and the Standard of LivingThe CPI and the Standard of Living

Suppose you have $300 in 1992. How much would you need to be able to have the same standard of living in 1997?

Using the ratio of the CPI in 1997 to the CPI in 1992:

300 x 125

100 = 375

You need $375 in 1997 just to maintain what was your standard of living in1992.


Components of the CPI, 1992Components of the CPI, 1992Components of the CPI, 1992Components of the CPI, 1992

Food & beverage (18.00%)

Other services (7.00%)

Household services (9.00%)

Transportation (7.00%)Medical (5.00%)

Apparel (6.00%)

Non-durables (11.00%)

Durables (11.00%)

Rent (26.00%)

Components of the CPI


The CPI Versus the GDP DeflatorThe CPI Versus the GDP DeflatorThe CPI Versus the GDP DeflatorThe CPI Versus the GDP Deflator

Both the CPI and the GDP deflator (including the more recent chain price for GDP) are measures of the average prices for the economy.

The CPI includes goods produced in prior years, as well as imported goods, while the GDP deflator does not.


Problems in Measuring Changes in PricesProblems in Measuring Changes in PricesProblems in Measuring Changes in PricesProblems in Measuring Changes in Prices

The CPI tends to overstate true changes in the cost of living because it does not allow for the share of the goods whose prices have risen to decline in the typical basket of goods used by the Commerce Department.

In reality, all indexes tend to overstate actual price changes, primarily because we have a difficult time measuring quality improvements in goods and services.


The CPI Tends to Overstate Price ChangesThe CPI Tends to Overstate Price ChangesThe CPI Tends to Overstate Price ChangesThe CPI Tends to Overstate Price Changes

Economists believe that the inflation rate is overstated by between 0.5% and 1.5% each year.

This means that cost-of-living adjustments to wages and social security payments based on changes in the CPI tend to be larger than they should be.


InflationInflationInflationInflation

The percentage rate of change of a price index is the inflation rate.

Example: Price index in a country in 1998 = 200 Price index in 1999 = 210

In f lation rate = (210 - 200)

200 = .05 = 5%

Conclusion: the country experienced a 5% inflation rate.


InflationInflationInflationInflation

Inflation refers not to the level of prices, whether they are high or low, but to their percentage change from one year to another.

If prices are high but remain the same from one year to another, there would be no inflation during that time.

Historically, the price level did not have a trend prior to the 1940s. After 1940, the price level increased sharply.


U.S. Inflation Rate, 1950-2000U.S. Inflation Rate, 1950-2000U.S. Inflation Rate, 1950-2000U.S. Inflation Rate, 1950-2000


DeflationDeflationDeflationDeflation

Deflation is a period during which the average level of prices falls.

During the Great Depression, between 1929 and 1933, average prices fell 33%.

As the average level of prices falls, wages tend to fall. Therefore, deflation is a problem because people may not be able to pay their debts.


The Costs of InflationThe Costs of InflationThe Costs of InflationThe Costs of Inflation

Costs associated with anticipated inflation;

Menu costs or costs associated with physically changing prices;

Shoe-leather costs that results from holding less cash or the additional wear and tear necessary to hold less cash (more frequent trips to Banks and ATMs);

Tax system and financial system do not always fully adjust to anticipated inflation.


The Costs of InflationThe Costs of InflationThe Costs of InflationThe Costs of Inflation When there is an unanticipated

inflation, there are winners & losers ; It causes unfair redistributions or transfers

of income between parties, i.e, when inflation is higher than everyone expected, buyer with fixed dollar contracts would gain and sellers making a contract in dollar terms would lose;

It also imposes real costs on the economy. When people take actions based on beating inflation, the economy becomes less efficient .

prepared by: jamal husein c h a p t e r 11 © 2005 prentice hall business publishingsurvey of...

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