1 Chapter 7: Unemployment, Inflation, and Deflation ECON 151 – PRINCIPLES OF MACROECONOMICS Materials include content from Pearson Addison-Wesley which.

1

Chapter 7:

Unemployment, Inflation, and Deflation

ECON 151 – PRINCIPLES OF MACROECONOMICS

Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.

2

Explain how the U.S. government calculates the official unemployment rate

Discuss the types of unemployment Describe how price indexes are calculated

and review the key types of price indexes

Learning Objectives

3

Distinguish between nominal and real interest rates

Evaluate who loses and who gains from inflation

Understand key features of business fluctuations

Learning Objectives

4

QuestionWho are the unemployed?

UnemploymentThe total number of adults (aged 16 years or

older) who are willing and able to work and who are actively looking for work but have not found a job

Unemployment

5

Lost output Early 2000s unemployment rate rose by 2

percentage points Factory output was 80% of potential Lost output was $200 billion of goods and services

that could have been producedPersonal psychological impact

Costs of Unemployment

6Source: U.S. Department of Labor, Bureau of Labor Statistics

Figure 7-1

More than a Century of Unemployment

7

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

Unemployment

8

Labor Force Individuals aged 16 years or older who either

have jobs or are looking and available for jobs

Unemployment

Labor force = the employed + the unemployed

9

147.7* = 139.5 + 8.2

Unemployment

*U.S., millions of people; as of 2005

Labor force = the employed + the unemployed

Unemployment rate = x 100%unemployed

labor force

= x 100 % = 5.6%8.2

147.7

10

StocksThe quantity of something (unemployed)

measured at a point in time Flow

A quantity measured over time (job leavers, job finders)

Unemployment

11

Visualizing Stocks and Flows

Figure 7-4

12

Unemployment categoriesJob loserReentrantJob leaverNew entrant

Unemployment

13

Job LoserAn individual whose employment was

involuntarily terminated or who was laid off 40–60% of the unemployed

Unemployment

14

ReentrantAn 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

Unemployment

15

Job LeaverAn individual who voluntarily ended

employment Less than 10% to around 15% of the unemployed

Unemployment

16

New EntrantAn individual who has never worked a full-

time job for two weeks or longer 10–13% of the unemployed

Unemployment

17

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 decade

Unemployment

18

Discouraged Workers Individuals who have stopped looking for a job

because they are convinced they will not find a suitable one

QuestionHow does the existence of discouraged

workers bias the unemployment rate?

Unemployment

19

Labor Force Participation RateThe proportion of working-age individuals

who are employed or seeking employment

Unemployment

20

The major types of unemploymentFrictionalStructural CyclicalSeasonal

Unemployment

21

Frictional UnemploymentResults from the fact that workers must

search for appropriate job offers

Unemployment

22

Structural UnemploymentResults from a poor match of workers’

abilities and skills with current requirements of employers

Unemployment

23

Cyclical UnemploymentResults from business recessions that occur

when aggregate (total) demand is insufficient to create full employment

Unemployment

24

Seasonal UnemploymentResults from the seasonal pattern of work in

specific industries

Unemployment

25

Full EmploymentAn arbitrary level of unemployment that

corresponds to “normal” friction in the labor market

Unemployment

26

Natural Rate of UnemploymentThe unemployment rate that is estimated to

prevail in the long run when all workers and employers have fully adjusted to any changes in the economy

When seasonally adjusted the natural rate of unemployment should only take into account frictional and structural unemployment

Unemployment

27

InflationAn upward movement in the average level of

prices Deflation

A downward movement in the average level of prices

Inflation and Deflation

28

Purchasing PowerThe value of money for buying goods and

servicesVaries with prices and income


29

Nominal valuePrice expressed in today’s dollars

Real valueValue expressed in purchasing power


30

Measuring inflationPrice 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


Price index = 100cost today of market basket

cost of market basket in base year

31

Market BasketRepresentative bundle of goods and services

Base YearThe point of reference for comparison of

prices in other years.


32

1997 Cost of 2007 Cost ofMarket Price Market Price MarketBasket per Basket per Basket at

Commodity Quantity Unit in 1997 Unit 2007 Prices

Corn 100 bushels $4 $400 $8 $800

Microcomputers 2 $500 $1,000 $425 $850

Calculating a Price Indexfor a Two-Good Market Basket

Totals $1,400 $1,650

Price index = 100 = 117.86 $1,650

$1,400(1997 = base year)

33


Real-world price indexesConsumer Price Index (CPI)Producer Price Index (PPI)GDP Deflator

34


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 is based on a consumer expenditure survey

Methodology problems Substitution effect and the fixed quantity index Quality changes New products

35

Producer Price Index (PPI) A statistical measure of a weighted average of prices

of commodities that firms purchase from other firms Generally for non-retail markets Used as a leading indicator CPI PPIs for:

Food materials Intermediate goods

Finished goods


36

GDP DeflatorA price index measuring the changes in prices

of all final goods and services produced in the economy

Broadest measure of pricesNot based on a fixed market basket


37


Personal Consumption Expenditure IndexPrimary inflation index used by the Federal

ReserveBased on surveys of consumer purchases

38

Inflation and Deflation in U.S. History

Figure 7-6 Source: U.S. Department of Labor, Bureau of Labor Statistics

39

Anticipated versus Unanticipated InflationThe effects of inflation on individuals

depend upon which type of inflation exists.


40

Anticipated InflationThe rate of inflation that the majority of

individuals believe will occur Unanticipated Inflation

Inflation that comes as a surprise to individuals in the economy


41

Inflation and interest ratesNominal 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


42

Real interest rateNominal interest rate = 10%Expected inflation rate = 6%Real rate = 10% - 6% = 4%


43

Does inflation necessarily hurt everyone? Inflation affects people differently

Unanticipated positive inflationCreditor losesDebtors gains


44

Protecting against inflationCost-of-living adjustments (COLAs)

Clauses in contracts that allow for increases in specified nominal values to account of changes in the cost of living


45

The resource cost of inflationRepricing, or menu, cost of inflation

The cost associated with recalculating prices and printing new price lists when there is inflation


46

Business FluctuationsThe ups and downs in overall business

economic activity National income Employment Price level

Changing Inflation and Unemployment: Business Fluctuations

47

ExpansionA business fluctuation in which overall

business activity is rising at a more rapid rate than previously or at a more rapid rate than the overall historical trend for the nation


48

ContractionA business fluctuation during which the pace

of national economic activity is slowing down


49

RecessionA period of time during which the rate of

growth of business activity is consistently less than its long-term trend or is negative

DepressionAn extremely severe recession


50

The Idealized Course of Business Fluctuations

Figure 7-7Time

Lev

el o

f N

atio

nal

Bu

sin

ess

Act

ivit

y

Peak

Peak

Growth trend

Exp

ansi

on

Trough

Contraction

(recession)

51

National Business Activity,1880–Present

Figure 7-8Source: American Business Activity from 1790 to Today, 67th Edition,

AmeriTrust Co., January 1996, plus author’s projections.

52

Leading Indicators Events that typically occur before, or “lead” changes

in business activity Leading indicators can be used to identify external

shocks. Examples of recession indicators

Reduction in the average workweek Decrease in prices of raw materials Drop in the quantity of money circulating


53

The National Bureau of Economic Research publishes data on the length of all business contractions and expansions.

The cycle of business fluctuations has become longer over time, because the expansionary phase is now more prolonged.

Over the past half-century, the average expansion has lasted 57 months.

Issues and Applications: The Length of the Business Cycle

54

How the U.S. government calculates the official unemployment rate Unemployment is the percentage of the labor force

that is looking for work and currently not working

Types of Unemployment Frictional Structural Cyclical Seasonal

Summary Discussion of Learning Objectives

55

How price indexes are calculated and the key price indexes A price index is the cost of today’s market of goods

expressed as a percentage of the cost of the same markets basket during a base year

Key price indexes CPI PPI GDP Deflator


56


The nominal versus the real interest rate Real interest rate = nominal interest rate - anticipated

rate of inflation

Those who lose from inflation and those who gain Losers are creditors Gainers are debtors

Key features of business fluctuations Contractions Expansions

Chapter 7:

Unemployment, Inflation, and Deflation

ECON 151 – PRINCIPLES OF MACROECONOMICS

Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.

1 Chapter 7: Unemployment, Inflation, and Deflation ECON 151 – PRINCIPLES OF MACROECONOMICS Materials include content from Pearson Addison-Wesley which.

Documents

1 Chapter 7: Unemployment, Inflation, and Deflation ECON 151 – PRINCIPLES OF MACROECONOMICS Materials include content from Pearson Addison-Wesley which.