Chap8pp

© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.

Fernando & Yvonn Quijano

Prepared by:

Chapter

8

Unemployment and Inflation

© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 2 of 36

Alcatel-Lucent Contributes to Unemployment

8.1 Define unemployment rate and labor force participation rate and understand how they are computed.

8.2 Identify the three types of unemployment.

8.3 Explain what factors determine the unemployment rate.

8.4 Define price level and inflation rate and understand how they are computed.

8.5 Use price indexes to adjust for the effects of inflation.

8.6 Distinguish between the nominal interest rate and the real interest rate.

8.7 Discuss the problems that inflation causes.

Learning Objectives

When total employment in the United States declined during 2001, Lucent contributed to the decline.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Labor force The sum of employed and unemployed workers in the economy.

Unemployment rate The percentage of the labor force that is unemployed.

Measuring the Unemployment Rate and the Labor Force Participation Rate

Learning Objective 8.1

The Household Survey

Discouraged workers People who are available for work but have not looked for a job during the previous four weeks because they believe no jobs are available for them.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



FIGURE 8-1

The Employment Status of the Civilian Working-Age Population, April 2007



Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


100Number of unemployed

Unemployment rateLabor force


• The unemployment rate measures the percentage of the labor force that is unemployed.



• The labor force participation rate measures the percentage of the working-age population in the labor force.

100Labor force

Labor force participation rateWorking-age population

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Solved Problem 8-1What Happens if You Include the Military?


In the BLS household survey, people on active military service are not included in the totals for employment, the labor force, or the working-age population. Suppose people in the military were included in these categories.

100Number of unemployed

Labor force

100Labor force

Working-age population

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion




Problems with Measuring the Unemployment Rate

Although the BLS reports the unemployment rate measured to the tenth of a percentage point, it is not a perfect measure of the current state of joblessness in the economy.

The unemployment rate provides some useful information about the employment situation in the country, but it is far from an exact measure of joblessness in the economy.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



FIGURE 8-2

Trends in the Labor Force Participation Rates of Adult Men and Women Since 1948


Trends in Labor Force Participation

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



What Explains the Increase in “Kramers”?

Makingthe

Connection

Why do more men seem to be adopting Kramer’s lifestyle?

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



FIGURE 8-3

Unemployment Rates in the United States by Demographic Group, April 2007


Unemployment Rates for Demographic Groups

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



Table 8-1

Duration of Unemployment

LENGTH OF TIME UNEMPLOYED PERCENTAGE OF TOTAL UNEMPLOYED

Less than 5 weeks 35.6%

5 to 14 weeks 31.3

15 to 26 weeks 15.7

27 weeks or more 17.5


How Long Are People Usually Unemployed?

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



Table 8-2

Household and Establishment Survey Data for March and April 2007

HOUSEHOLD SURVEY ESTABLISHMENT SURVEY

MARCH APRIL CHANGE MARCH APRIL CHANGE

EMPLOYED 146,254,000 145,786,000 −468,000 137,596,000 137,684,000 +88,000

UNEMPLOYED 6,724,000 6,801,000 +77,000

LABOR FORCE 152,979,000 152,587,000 −392,000

UNEMPLOYMENT RATE 4.4% 4.5% +0.1%


The Establishment Survey: Another Measure of Employment

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



Table 8-3

Establishments Creating and Eliminating Jobs, April–June 2006

NUMBER OF ESTABLISHMENTS

NUMBER OF JOBS

ESTABLISHMENTS CREATING JOBS

Existing establishments 1,558,000 6,286,000

New establishments 360,000 1,475,000

ESTABLISHMENTS ELIMINATING JOBS

Existing establishments 1,543,000 5,937,000

Closing establishments 341,000 1,358,000


Job Creation and Job Destruction Over Time

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Types of Unemployment


FIGURE 8-4

The Annual Unemployment Rate in the United States, 1950–2006

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



Frictional Unemployment and Job Search

Frictional unemployment Short-term unemployment that arises from the process of matching workers with jobs.


Structural unemployment Unemployment arising from a persistent mismatch between the skills and characteristics of workers and the requirements of jobs.

Cyclical unemployment Unemployment caused by a business cycle recession.

Cyclical Unemployment

Structural Unemployment

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



Natural rate of unemployment The normal rate of unemployment, consisting of frictional unemployment plus structural unemployment.

Full Employment


Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



How Should We Categorize the Unemployment at Alcatel-Lucent?

Makingthe

Connection

The people who lost their jobs at Alcatel-Lucent fit into more than one category of unemployment.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



Unemployment Insurance and Other Payments to the Unemployed

Government Policies and the Unemployment Rate

Explaining Unemployment

In the United States and most other industrial countries, the unemployed are eligible for unemployment insurance payments from the government.

In the United States, these payments are equal to about half the average wage.

Unemployment insurance helps the unemployed maintain their income and spending, which lessens the personal hardship of being unemployed and also helps reduce the severity of recessions.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



FIGURE 8-5

Average Unemployment Rates in the United States, Canada, Japan, and Europe, 1997–2006

International Comparisons



Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



Minimum Wage Laws



In 1938, the federal government enacted a national minimum wage law.

If the minimum wage is set above the market wage determined by the demand and supply of labor, the quantity of labor supplied will be greater than the quantity of labor demanded.

Economists agree that the current minimum wage is above the market wage for some workers, but they disagree on the amount of unemployment that has resulted.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



Efficiency Wages

Efficiency wage A higher-than-market wage that a firm pays to increase worker productivity.

Labor Unions


Labor unions are organizations of workers that bargain with employers for higher wages and better working conditions for their members.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



Why Does Costco Pay Its Workers So Much More Than Wal-Mart Does?

Makingthe

Connection

Costco’s relatively high wages and health benefits reduce employee turnover and raise morale and productivity.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Measuring Inflation


Price level A measure of the average prices of goods and services in the economy.

Inflation rate The percentage increase in the price level from one year to the next.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Measuring Inflation


The Consumer Price Index

FIGURE 8-6

The CPI Market Basket, December 2006

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Measuring Inflation


Consumer price index (CPI) An average of the prices of the goods and services purchased by the typical urban family of four.


BASE YEAR (1999) 2008 2009

PRODUCTQUANTIT

Y PRICE EXPENDITURES PRICE

EXPENDITURES(ON BASE-YEAR

QUANTITIES) PRICE

EXPENDITURES (ON BASE-

YEAR QUANTITIES)

Eye examinations 1 $50.00 $50.00 $100.00 $100.00 $85.00 $85.00

Pizzas 20 10.00 200.00 15.00 300.00 14.00 280.00

Books 20 25.00 500.00 25.00 500.00 27.50 550.00

Total $750.00 $900.00 $915.00

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Measuring Inflation



FORMULA APPLIED TO 2008 APPLIED TO 2009

120100750$

900$

122100750$

915$

CPI = 100year base in the esExpenditur

yearcurrent in the esExpenditur

122 120100 1.7%

120

Don’t Let This Happen to YOU!Don’t Miscalculate the Inflation Rate

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Measuring Inflation


Is the CPI Accurate?

• Substitution bias.

• Increase in quality bias.

• Outlet bias.

• New product bias.

It is important that the CPI be as accurate as possible, but there are four biases that make changes in the CPI overstate the true inflation rate:

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Measuring Inflation


The Producer Price Index

Producer price index (PPI) An average of the prices received by producers of goods and services at all stages of the production process.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Using Price Indexes to Adjust for the Effects of Inflation

1980in CPI

2006in CPIdollars 1980in Valuedollars 2006in Value


Falling Real Wages at Alcatel-Lucent

For some purposes, we are interested in tracking changes in an economic variable over time rather than in seeing what its value would be in today’s dollars.

In that case, to correct for the effects of inflation, we can divide the nominal variable by a price index and multiply by 100 to obtain a real variable.

Nominal average hourly earnings are often referred to as the nominal wage, and real average hourly earnings are often referred to as the real wage.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Solved Problem 8-5Calculating Real Average Hourly Earnings


YEARNOMINAL AVERAGE HOURLY EARNINGS

CPI(1982-1984 = 100)

2004 $15.69 188.9

2005 16.13 195.3

2006 16.76 201.6

YEARNOMINAL AVERAGE HOURLY EARNINGS

CPI(1982-1984 = 100)

REAL AVERAGEHOURLY EARNINGS

(1982-1984 DOLLARS)

2004 $15.69 188.9 $8.31

2005 16.13 195.3 8.26

2006 16.76 201.6 8.31

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Real versus Nominal Interest Rates


Nominal interest rate The stated interest rate on a loan.

Real interest rate The nominal interest rate minus the inflation rate.

Real interest rate = Nominal interest rate − Inflation rate

Deflation A decline in the price level.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Real versus Nominal Interest Rates


FIGURE 8-7

Nominal and Real InterestRates, 1970–2006

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Does Inflation Impose Costs on the Economy?


Inflation Affects the Distribution of Income

The Problem with Anticipated Inflation

Menu costs The costs to firms of changing prices.

The Problem with Unanticipated Inflation

The extent to which inflation redistributes income depends in part on whether the inflation is anticipated—in which case consumers, workers, and firms can see it coming and can prepare for it— or unanticipated—in which case they do not see it coming and do not prepare for it.

Like many of life’s other problems, inflation is easier to manage if you see it coming.

Even when inflation is perfectly anticipated, however, some individuals will experience a cost.

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion



Why a Lower Inflation Rate Is Like a Tax Cut for Alcatel-Lucent’s Bondholders

Makingthe

Connection

PRINCIPALREAL

INTEREST RATEINFLATION

RATENOMINAL

INTEREST RATE

$1,000 4% 6% 10%

$1,000 4% 2% 6%

INFLATION RATE

NOMINAL INTEREST PAYMENT

TAX PAYMENT

AFTER-TAX INTEREST PAYMENT

ADJUSTMENT FOR

INFLATION

REAL AFTER-TAX INTEREST PAYMENT

6% $100 – $25 = $75 – $60 = $15

2% $60 – $15 = $45 – $20 = $25

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


An Inside LOOK Making Sense of Employment Data

Jobs Data Signal Growth Is Easing but Still Solid

Ch

apte

r 8:

U

ne

mp

loym

ent

and

In

flat

ion


Consumer price index (CPI)

Cyclical unemployment

Deflation

Discouraged workers

Efficiency wage

Frictional unemployment

Inflation rate

Labor force

Labor force participation rate

Menu costs

Natural rate of unemployment

Nominal interest rate

Price level

Producer price index (PPI)

Real interest rate

Structural unemployment

Unemployment rate

K e y T e r m s

Chap8pp

Documents

annual unemployment

duration of unemployment

rateand thereal

labor forcethe sum

bls household survey

unemployed workers

closing establishments

new establishments