Economic Instability Unemployment v. Inflation. Questions to Ponder: Are you (or a friend) looking for a job this summer? Are you (or a friend) looking.

Economic InstabilityUnemployment v. InflationUnemployment v. Inflation

Questions to Ponder:

Are you (or a friend) looking for a job this Are you (or a friend) looking for a job this summer? summer?

How easy is it to find a job? What kind of How easy is it to find a job? What kind of jobs are available? How are the wages?jobs are available? How are the wages?

What causes unemployment in the US? What causes unemployment in the US? How does the causes of unemployment How does the causes of unemployment

compare to your own lack of jobs?compare to your own lack of jobs?

What do you think the unemployment rate is for the US? DOWN in April: 5.2% DOWN in April: 5.2%

looking for work.looking for work. 7,000 new jobs in 7,000 new jobs in

April.April. Unemployment rate in Unemployment rate in

2004 ran at 5.5%2004 ran at 5.5% 8,149,000 looking 8,149,000 looking

for work in 2004.for work in 2004.

The reasons for unemployment

Frictional Frictional UnemploymentUnemployment

Structural Structural UnemploymentUnemployment

Seasonal Seasonal UnemploymentUnemployment

Cyclical Cyclical UnemploymentUnemployment

Frictional Unemployment

People in between People in between jobs.jobs.

Short period of time Short period of time while changing jobs.while changing jobs.

3% - 4% frictional 3% - 4% frictional employment is employment is considered normal.considered normal.

Structural Unemployment

When changes in When changes in market supply or market supply or demand conditions demand conditions affect major industries affect major industries or regions.or regions.

Causes of Structural Unemployment

Decline in demand for a Decline in demand for a productproduct

Increased foreign Increased foreign competitioncompetition

Automation of productionAutomation of production Increased raw material Increased raw material

costscosts Lack of labor mobility Lack of labor mobility

between occupations or between occupations or regions.regions.

Seasonal Unemployment

Most seasonal Most seasonal unemployment is unemployment is tends to occur in tends to occur in certain industries. certain industries. Hotel and Hotel and

catering catering Tourism Tourism Fruit picking Fruit picking ChristmasChristmas

Cyclical Unemployment

When aggregate When aggregate demand in the demand in the economy is not economy is not sufficient to provide sufficient to provide jobs for all those who jobs for all those who seek work.seek work. RecessionRecession DepressionDepression

Cyclical Unemployment

When the economy is When the economy is operating at operating at production capacity production capacity there is full there is full employment aggregate employment aggregate demand.demand.

Natural Rate of Unemployment

The lowest level of The lowest level of unemployment that unemployment that can be maintained can be maintained without setting off without setting off increases in inflation.increases in inflation. 2005: 3.1%2005: 3.1% Same number of Same number of

new workers new workers coming into the job coming into the job market yearly.market yearly.

One other kind of Unemployment HIDDEN HIDDEN

UNEMPLOYMENTUNEMPLOYMENT Reported number is Reported number is

only peopleonly peopleActively seeking Actively seeking

work.work.

Unemployment Rate does not include Discouraged workers who Discouraged workers who

have stopped looking.have stopped looking. Those who work part-time Those who work part-time

when they want full-time when they want full-time workwork

Those working that are Those working that are overqualified for the job.overqualified for the job. underemployedunderemployed

What is so wrong if everyone who wants a job has a job???

THE ANSWER????

INFLATIOINFLATIONN The trade-off The trade-off

with more with more employment.employment.

Inflation

Continual rise in the Continual rise in the general level of prices general level of prices in an economy.in an economy. Concern is when Concern is when

the prices go up the prices go up faster than wages!faster than wages!

How do we measure inflation?

CPICPI CConsumer onsumer PPrice rice IIndexndex Comparing prices of Comparing prices of

items at different items at different points in time.points in time.

CPI is the most CPI is the most commonly used index commonly used index to measure inflation.to measure inflation.

What goods are in the MARKET BASKET for the CPI? What would you put in What would you put in

the market basket?the market basket? HINT: 200 items!HINT: 200 items!

What is in the 2005 market basket? FOOD AND BEVERAGES (breakfast FOOD AND BEVERAGES (breakfast

cereal, milk, coffee, chicken, wine, cereal, milk, coffee, chicken, wine, service meals and snacks) service meals and snacks)

HOUSING (rent of primary residence, HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, owners' equivalent rent, fuel oil, bedroom furniture) bedroom furniture)

APPAREL (men's shirts and sweaters, APPAREL (men's shirts and sweaters, women's dresses, jewelry) women's dresses, jewelry)

What is in the market basket?

TRANSPORTATION (new vehicles, airline TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle fares, gasoline, motor vehicle insurance) insurance)

MEDICAL CARE (prescription drugs and MEDICAL CARE (prescription drugs and medical supplies, physicians' services, medical supplies, physicians' services, eyeglasses and eye care, hospital eyeglasses and eye care, hospital services) services)

RECREATION (televisions, pets and pet RECREATION (televisions, pets and pet products, sports equipment, products, sports equipment, admissions); admissions);

What is in the market basket?

EDUCATION AND COMMUNICATION EDUCATION AND COMMUNICATION (college tuition, postage, telephone (college tuition, postage, telephone services, computer software and services, computer software and accessories); accessories);

OTHER GOODS AND SERVICES (tobacco OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and and smoking products, haircuts and other personal services, funeral other personal services, funeral expenses).expenses).

What is the CPI pattern in 2005?

CPI measures the CPI measures the dollar’s worth.dollar’s worth. Check out the Check out the

websitewebsite

http://http://minneapolisfed.org/minneapolisfed.org/Research/data/us/Research/data/us/calc/index.cfmcalc/index.cfm

CPI: Prices are 3.1% higher than last year. In 2004, you bought In 2004, you bought

goods and services for goods and services for

$1$1 that in 2005 are that in 2005 are

costing costing $1.03$1.03 for the for the same goods and same goods and services.services.

Types of Inflation

Demand-Pull InflationDemand-Pull Inflation Cost-Push InflationCost-Push Inflation Monetary InflationMonetary Inflation StagflationStagflation HyperinflationHyperinflation

Demand-Pull Inflation

When the demand for When the demand for goods and services goods and services exceeds the production exceeds the production capacity.capacity. Prices rising Prices rising

because of because of shortages.shortages.

Cost-Push Inflation

Inflation can arise from Inflation can arise from changes in the costs of changes in the costs of production of goods and production of goods and services.services. Increase in the price of Increase in the price of

raw materialsraw materials Increase in the price of Increase in the price of

laborlabor Increase in the cost of Increase in the cost of

capital.capital.

Cost-Push v. Demand Pull

They push and pull They push and pull prices up.prices up. Labor contracts Labor contracts

containing COLA containing COLA clauses.clauses.CCost-ost-OOf-f-LLiving iving

AAdjustments.djustments.

Monetary Inflation

Inflation caused by Inflation caused by excessive growth in excessive growth in the money supply.the money supply. Value of money Value of money

decreases if it isn’t decreases if it isn’t that “rare.”that “rare.”

Rule for Monetary Inflation: VELOCITY Quantity EquationQuantity Equation

M x V = T x PM x V = T x P Money supply Money supply

times the velocity at times the velocity at which it changes which it changes hands equals the hands equals the number of number of transactions times transactions times the average level of the average level of prices.prices.

M x V = T x P

Direct Direct relationship relationship between the money between the money supply and the price supply and the price level.level.

What happens when the quantity equation is “off”?

HyperinflationHyperinflation Money supply Money supply

increases much, much increases much, much faster than an faster than an economy’s output of economy’s output of goods and services.goods and services. THINK RUSSIA in THINK RUSSIA in

1990s.1990s.

Phillips Curve: The relationship between unemployment and inflation.

INVERSE relationship.INVERSE relationship.

Unemployment goes Unemployment goes UP, then inflation goes UP, then inflation goes DOWN.DOWN.

Stagflation: When things REALLY go wrong on the Phillips Curve Inflation and Inflation and

unemployment were at unemployment were at higher levels.higher levels. Combination of Combination of

stagnation and stagnation and inflation.inflation.

Both were Both were increasing.increasing.

1970s: What caused Stagflation?

Spending on the Spending on the Vietnam War PLUS Vietnam War PLUS spending on domestic spending on domestic social programs.social programs.

Inflationary Inflationary expectationsexpectations

Rise in energy costs Rise in energy costs caused by OPECcaused by OPEC

Monopolistic pricingMonopolistic pricing

What is wrong with Inflation?

Inflation reduces Inflation reduces REAL INCOME of REAL INCOME of those whose incomes those whose incomes do not rise as fast as do not rise as fast as the price level.the price level.

Hurts:Hurts: People holding People holding

assets in MONEYassets in MONEY LendersLenders

Special Note: Phillips Curve International Pg. 293-294 “El Pg. 293-294 “El

Dempleo”Dempleo” Europe 1970s had Europe 1970s had

higher inflation and higher inflation and unemployment.unemployment.

Worse because:Worse because: Labor union Labor union

practicespractices Tax structuresTax structures Government Government

economic policieseconomic policies

Consequences of Unemployment

Income EffectsIncome Effects Loss of income and Loss of income and

benefits (Health benefits (Health insurance)insurance)

Loss of income to Loss of income to others because of others because of reduced purchasing reduced purchasing powerpower

Reduced tax income Reduced tax income and increased outlays and increased outlays of government.of government.

Consequences of Unemployment

Real Output EffectsReal Output Effects Each 1% of Each 1% of

unemployment results unemployment results in a reduction of $100-in a reduction of $100-billion in output.billion in output.

Lower real investment Lower real investment means less growth and means less growth and reduced future output.reduced future output.

Consequences of Unemployment

Social EffectsSocial Effects Health ProblemsHealth Problems Increased suicidesIncreased suicides Break up of Break up of

familiesfamilies Increased child Increased child

abuseabuse Increased crimeIncreased crime

Consequences of INFLATION

Income Effects:Income Effects: Reduced Reduced

purchasing power purchasing power of the dollarof the dollar

Reduced real Reduced real income for fixed income for fixed income receiversincome receivers

Reduced real Reduced real wealth of savingswealth of savings

Income Effects of Inflation (cont.) Benefits those whose Benefits those whose

incomes rise faster incomes rise faster than the inflation rate.than the inflation rate.

Benefits owners of Benefits owners of real assets (real estate, real assets (real estate, precious metals precious metals (kinda!))(kinda!))

Benefits debtorsBenefits debtors

How Inflation effects Real Output

Inflation initially Inflation initially stimulates outputstimulates output

Near full employment, Near full employment, there arise bottlenecks in there arise bottlenecks in suppliessupplies

Costs begin rising faster Costs begin rising faster than pricesthan prices

Interest rates accelerate, Interest rates accelerate, discouraging new discouraging new investment.investment.