Explorations in Economics Alan B. Krueger & David A. Anderson

Chapter 14: Unemployment and Inflation -Module 41: Unemployment -Module 42: Inflation -Module 43: Unemployment, Inflation, and the Business Cycle

MODULE 41: UNEMPLOYMENT KEY IDEA: High unemployment is costly to the economy. OBJECTIVES To explain how unemployment is measured. To explore the types of unemployment and what causes each type. To identify the economic costs of unemployment.

EMPLOYMENT AND UNEMPLOYMENT Total employment in an economy is the total number of employed workers, whether they work part time or full time. The labor force is the combination of the employed workers and the unemployed workers, excluding those in the military or in prison. Total unemployment in an economy is the number of workers who are actively seeking jobs but not actually working.

EMPLOYMENT AND UNEMPLOYMENT The unemployment rate is the percentage of the labor force without a paid job. Issues in Measuring Unemployment Discouraged workers would like to work but have given up on their job search. Underemployed workers would like to work more hours or prefer a job that better matches their skills. Some unemployed hide their status since they are trying to avoid paying income tax.

TYPES OF UNEMPLOYMENT AND THEIR CAUSES Frictional unemployment is short-term unemployment that occurs while workers search for the jobs best suited for their skills and interests. The frictionally unemployed include people who have left one job in search for another, perhaps to earn a higher wage or to find a better place to live. Also included are new labor-force entrants, such as students graduating from high school or college, and reentrants, such as a parent who left the labor force to raise a child. Frictional Unemployment is sometimes referred to as the normal process of turnover in the labor market as new workers enter the market and search for jobs. Existing workers quit one job to look for another.

Types of Unemployment and their Causes Seasonal unemployment occurs when workers lose their jobs due to a change of seasons. During the winter season, job loss is common in the construction industry landscaping, crop agriculture, and beach resorts. Once the winter is over, many workers are rehired to fill these jobs again. Not considered a serious problem. Seasonal Adjustment The Bureau of Labor Statistics remove the typical and predictable changes in unemployment from each month’s unemployment numbers. 6/8/2016Chapter 14-Modules 41-43

TYPES OF UNEMPLOYMENT AND THEIR CAUSES Structural unemployment arises from a mismatch between job seekers and the types of jobs available. One cause is a mismatch of skills. Structural unemployment is a result of the imperfect labor market adjustment. Overtime, changes in demand and in technology skills will displace workers, while some workers be unwilling or unable to move freely around to keep or find a job. (geographical mismatch)

Types of Unemployment and Their Causes Cyclical unemployment is joblessness caused by an economic contraction. Usually during Contraction phase of the business cycle (GDP declines and unemployment increase) A well-functioning economy will always have some unemployment. Some will be frictionally (searching for jobs), seasonally (unemployed due to off season) or structural (for those whose skills are no longer in demand.) The natural rate of unemployment is the unemployment rate in the absence of cyclical unemployment, around which the actual unemployment rate fluctuates. 6/8/2016Chapter 14-Modules 41-43

TYPES OF UNEMPLOYMENT AND THEIR CAUSES Full employment is the level of employment when there is no cyclical unemployment. Due to the existence of other types of unemployment, the achievement of full employment does not mean that every worker is employed. The unemployment in the economy is at its natural rate. In the US it is about 5 to 6 percent unemployment.

THE COSTS OF UNEMPLOYMENT Unemployment will affect families in financial and personal ways. Some purchases are delayed, savings are depleted or homelessness may happen. Family issues arise that include difficulty in school, family separation, abuse or crime. Unemployment is costly to the national economy Total output will be reduced. Government must pay more for unemployment insurance, and nutrition assistance. Lower income tax revenues collected.

How The Costs Of Unemployment Are Distributed Not an equal distribution among groups or locations within the nation Work Experience Lack of Opportunity Discrimination Location by state

MODULE 41 REVIEW What is… A. Total employment B. Total unemployment C. Labor force D. Unemployment rate E. Frictional unemployment F. Seasonal unemployment G. Structural unemployment H. Cyclical unemployment I. Natural rate of unemployment J. Full employment K. Discouraged workers L. Underemployed M. Jobless recovery

MODULE 42: INFLATION KEY IDEA: Inflation reduces the purchasing power of money. OBJECTIVES: To explain how inflation is measured. To explain what causes inflation and why high inflation is a problem. To identify the dangers of deflation.

DEFINING INFLATION Inflation is a rise in the price level. The inflation rate is the annual percentage increase in the price level. Deflation is a decline in the price level.

MEASURING INFLATION The Consumer Price Index (CPI) is a measure of the overall price level faced by a typical urban consumer.

MEASURING INFLATION Calculating the CPI: To construct the CPI, the government first determines a market basket. A market basket is a bundle of goods and services that an average consumer might buy.

A further look at CPI A rise in the CPI is an indicator of inflation When prices are falling, the cost of the market basket decreases, so the CPI falls. A fall in the CPI is an indicator of deflation. 6/8/2016Chapter 14-Modules 41-43

MEASURING INFLATION Other Price Indexes The government uses many indexed measures to track changes in price levels. These measures are important as they are used to make cost of living adjustments in Social Security payments and many union contracts. Producer Price Index (PPI) Market basket of producer goods like raw materials and intermediate goods Used as predictor for changes in CPI Changes in the PPI normally shows up before consumers feel changes in retail price. GDP Deflator or GDP Price Index Market basket of final goods Used to calculate the difference between nominal and real GDP Tracks every good and service contained in GDP: Government purchases as well as investment purchases by firms.

THE COSTS OF INFLATION The Inflation Myth Price Stability exists when inflation is low—2 or 3% per year. Inflation reduces the number of goods and services we can buy with each dollar that we earn, and that makes us poorer. The overall effect of inflation on your purchasing power depends on how the increase in your earnings compares with the increase in the price level.

THE COSTS OF INFLATION The True Costs of High Inflation Shoe leather costs are the costs of time and effort involved in frequent trips to the bank or ATM to avoid holding too much cash during periods of high inflation. In the past, standing in line at the bank trying to withdraw your money was called a “run on the bank”. Today, does the large of number of ATM’s changed the “bank run” idea?

Shoe leather Costs 6/8/2016Chapter 14-Modules 41-43

THE COSTS OF INFLATION The True Costs of High Inflation Hyperinflation is very rapid inflation. Hyperinflation usually leaves a country’s currency worthless.

THE COSTS OF INFLATION The True Costs of High Inflation Menu Costs are the costs of updating prices due to inflation. In Germany 1920s restaurants sometimes changed the prices on their menus several times each day. Menu costs were coined to reflect the costly inputs such as labor, paper, and printing services used by restaurants whose menus had to be constantly updated. Price changes not just in restaurants but in grocery stores, billboards and sales contracts—across the economy changes. Using resources that could otherwise be put to better use.

THE COSTS OF INFLATION The True Costs of High Inflation The Costs of Unexpected Inflation In general, people who borrow money benefit when inflation turns out to be higher than expected. But people who lend money lose from higher- than expected inflation. Unexpected inflation makes borrowing and lending more risky. Lenders may be hesitant to lend and borrowers may not wish to borrow.

The Costs of Inflation The result of unexpected inflation is that it takes away the stability in the economy. When saving, borrowing and lending shuts down, spending declines and GDP falls. Unemployment increases and a contraction of the economy can easily become a severe recession. 6/8/2016Chapter 14-Modules 41-43

Deflation is a decrease in the price level. Causes consumers to reduce spending Postpone major purchases because they expect prices to further decrease and hold off large purchases. Leading to more deflation. Decrease in Aggregate Demand, contraction in economic activity Dollar incomes also fall More difficult to pay debts that do not change Banks’ losses mount as more bankruptcies occur Economic activity becomes risky and spending decreases DEFLATION AND ITS EFFECTS

Deflation in History The United States suffered a serious bout of deflation during the recession of the early 1920s, but the worst deflation occurred during the early years of the Great Depression, when average prices dropped 9 percent in 1931, 9.9 percent in 1932, and 5.1 percent in Deflation during this period led to waves of bankruptcies throughout the economy, a reduction of lending and borrowing, and a decrease in spending. In short, deflation worsened the depression and made it last longer. 6/8/2016Chapter 14-Modules 41-43

Deflation 6/8/2016Chapter 14-Modules 41-43

Economic Cartoon 6/8/2016Chapter 14-Modules 41-43

MODULE 42 REVIEW What is… A. Inflation? B. Inflation rate? C. Deflation? D. Consumer price index? E. Market basket? F. Base period? G. Producer price index? H. Hyperinflation? I. Shoe leather costs? J. Menu costs?

MODULE 43: UNEMPLOYMENT, INFLATION AND THE BUSINESS CYCLE KEY IDEA: Changes in unemployment and inflation are caused by changes in aggregate demand and aggregate supply. OBJECTIVES: To explain how changes in aggregate demand and aggregate supply affect both unemployment and inflation. To discuss the short- run tradeoff between unemployment and inflation. To describe stagflation.

ONGOING INFLATION AND UNEMPLOYMENT Some levels of frictional and structural unemployment are part of a dynamic labor market. As wages increase and prices increase to cover higher costs, the expected inflation becomes a reality. The “norm” in the economy may be some level of unemployment and some degree of inflation.

HOW AGGREGATE DEMAND AFFECTS UNEMPLOYMENT AND INFLATION The economy’s potential output is the level of real GDP that is produced when there is full employment.

HOW AGGREGATE DEMAND AFFECTS UNEMPLOYMENT AND INFLATION The economy’s potential output is the level of real GDP that is produced when there is full employment.

AGGREGATE SUPPLY AND STAGFLATION Stagflation is a combination of sluggish economic growth, high inflation, and high unemployment. A negative supply shock causes aggregate supply to decrease. costs rise and output falls unemployment increases but price levels increase A positive supply shock causes aggregate supply to increase. costs fall and output increases unemployment decreases and price levels decrease

MODULE 43 REVIEW What is… A. Potential output B. Stagflation C. Negative supply shock D. Positive supply shock