6-1 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation Copyright © 2012 Pearson Prentice Hall. All rights reserved.

Unemployment and Inflation Brock Williams P R E P A R E D B Y In February 2010, the Bureau of Labor Statistics (BLS) announced that the unemployment rate was 9.7 percent. CHAPTER 6 Copyright © 2012 Pearson Prentice Hall. All rights reserved.

6-3 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation 1 2 What do the recent data show about trends in the percentage of women who are working? After Growing Sharply, Women’s Labor Force Participation Has Leveled Off Does more liberal disability insurance decrease measured unemployment? More Disability, Less Unemployment? Are you less upset from being unemployed if unemployment is common in your peer group? Social Norms, Unemployment, and Perceived Happiness How large is the bias in the CPI due to not immediately incorporating new goods? The Introduction of Cell Phones and the Bias in the CPI 3 4 A P P L Y I N G T H E C O N C E P T S

6-4 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation ● labor force The total number of workers, both the employed and the unemployed. EXAMINING UNEMPLOYMENT 6.1 How Is Unemployment Defined and Measured? ● unemployment rate The percentage of the labor force that is unemployed.

6-5 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation ● labor force participation rate The percentage of the population over 16 years of age that is in the labor force. EXAMINING UNEMPLOYMENT (cont’d) 6.1 How Is Unemployment Defined and Measured?

6-6 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation EXAMINING UNEMPLOYMENT (cont’d) 6.1 How Is Unemployment Defined and Measured?  FIGURE 6.1 Unemployment Data, February 2010 Approximately 65 percent of the civilian population is in the labor force. The unemployment rate in February 2010 was 9.7 percent.

6-7 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation EXAMINING UNEMPLOYMENT (cont’d) 6.1 How Is Unemployment Defined and Measured?  FIGURE 6.2 Unemployment Rates in Developed Countries Among the developed countries, unemployment rates vary substantially.

6-8 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation In 1948, the labor force participation rate for women 20 years and older was 32 percent. By 1970, it had grown to 43 percent, and by 1997 it had reached 60 percent. Since 1997, the figure has remained virtually constant at 60 percent. Explanations: Women may simply have run out of available time. Even with new technology, housework and childcare do take time. Conclusion: Because women provide more household services than men, it is understandable why their labor force participation may have reached a peak. AFTER GROWING SHARPLY, WOMEN’S LABOR FORCE PARTICIPATION HAS LEVELED OFF APPLYING THE CONCEPTS #1: What do the recent data show about trends in the percentage of women who are working? A P P L I C A T I O N 1

6-9 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation EXAMINING UNEMPLOYMENT (cont’d) 6.1 Alternative Measures of Unemployment and Why They Are Important ● discouraged workers Workers who left the labor force because they could not find jobs.  FIGURE 6.3 Alternative Measures of Unemployment, February 2010 Including discouraged workers, marginally attached workers, and individuals working part time for economic reasons substantially increases measured unemployment in 2010 from million to million.

6-10 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation EXAMINING UNEMPLOYMENT (cont’d) 6.1 Who Are the Unemployed?  FIGURE 6.4 Selected U.S. Unemployment Statistics, Unemployment Rates for February 2010 The incidence of unemployment differs sharply among demographic groups.

6-11 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation The federal Disability Insurance program provides income to nonelderly workers who are deemed unable to engage in substantial employment. Economists David Autor and Mark Duggan studied the impact of this program on labor force participation. They found that the changes in the rules administering the program, the increased generosity of the benefits of the program for low-skilled workers, and the increase in the value of health care services all contributed to an increase in participation in this program. Since these workers, a portion of whom would have been unemployed, were no longer in the labor force, the economists estimated that the effect of the Disability Insurance program was to lower the measured unemployment rate by 0.5 percent, a very large effect. MORE DISABILITY, LESS UNEMPLOYMENT? APPLYING THE CONCEPTS #2: Does more liberal disability insurance decrease measured unemployment? A P P L I C A T I O N 2

6-12 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation EXAMINING UNEMPLOYMENT (cont’d) 6.1 Who Are the Unemployed? ●seasonal unemployment The component of unemployment attributed to seasonal factors.

6-13 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation CATEGORIES OF UNEMPLOYMENT 6.2 Types of Unemployment: Cyclical, Frictional, and Structural ● cyclical unemployment Unemployment that occurs during fluctuations in real GDP. ● frictional unemployment Unemployment that occurs with the normal workings of the economy, such as workers taking time to search for suitable jobs and firms taking time to search for qualified employees. ● structural unemployment Unemployment that occurs when there is a mismatch of skills and jobs.

6-14 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation CATEGORIES OF UNEMPLOYMENT (cont’d) 6.2 The Natural Rate of Unemployment ● natural rate of unemployment The level of unemployment at which there is no cyclical unemployment. It consists of only frictional and structural unemployment. ● full employment The level of unemployment that occurs when the unemployment rate is at the natural rate.

6-15 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation THE COSTS OF UNEMPLOYMENT 6.3 ●unemployment insurance Payments unemployed people receive from the government.

6-16 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation Individuals do not like to become unemployed. A seven year British study showed that: ▪ Well-being declines when we become unemployed. ▪ If employed, having peers lose their job also decreases happiness. ▪ Interestingly, losing one’s job causes less of a decrease in well-being if peers were also unemployed. ▪ In other words, misery loves company. Why is this significant? ▪ The more unhappy an unemployed person is, the more aggressive they are about finding another job. ▪ If your peer group is unemployed, you may be less aggressive about trying to find another job. SOCIAL NORMS, UNEMPLOYMENT, AND PERCEIVED HAPPINESS APPLYING THE CONCEPTS #3: Are you less upset from being unemployed if unemployment is common in your peer group? A P P L I C A T I O N 3

6-17 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation THE CONSUMER PRICE INDEX AND THE COST OF LIVING 6.4 ● Consumer Price Index A price index that measures the cost of a fixed basket of goods chosen to represent the consumption pattern of a typical consumer. The CPI index for a given year, say year K, is defined as R E A L - N O M I N A L P R I N C I P L E What matters to people is the real value of money or income—its purchasing power—not the face value of money or income.

6-18 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation THE CONSUMER PRICE INDEX AND THE COST OF LIVING (cont’d) 6.4  FIGURE 6.5 Components of the Consumer Price Index (CPI) Rent and food and beverages make up 44 percent of the CPI basket. The remainder consists of other goods and services. The CPI versus the Chain Index for GDP

6-19 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation THE CONSUMER PRICE INDEX AND THE COST OF LIVING (cont’d) 6.4 Problems in Measuring Changes in Prices ●cost-of-living adjustments (COLAs) Automatic increases in wages or other payments that are tied to the CPI.

6-20 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation Cell phones were introduced in 1983, but not included in the CPI until 1998 According to Jerry Hausman of MIT, this resulted in an upward bias of the telecommunication component of the CPI of 0.8 to 1.9 percent. The reported increase in telecommunication prices during this period might have actually been a decrease of.8 percent. Room air conditioners also took 15 years to be included. Since new products are constantly being introduced, the bias in the CPI can be large. THE INTRODUCTION OF CELL PHONES AND THE BIAS IN THE CPI APPLYING THE CONCEPTS #4: How large is the bias in the CPI due to not immediately incorporating new goods? A P P L I C A T I O N 4

6-21 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation INFLATION 6.5 ●inflation rate The percentage rate of change in the price level. inflation rate = percentage rate of change of a price index

6-22 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation INFLATION (cont’d) 6.5 Historical U.S. Inflation Rates  FIGURE 6.6 Price Index for U.S. GDP, 1875–2009 After remaining relatively flat for 60 years, the price level began to steadily increase after World War II. The price of a postage stamp in 1940 and 2009 illustrates the change in the overall price level that occurred.

6-23 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation INFLATION (cont’d) 6.5 Historical U.S. Inflation Rates

6-24 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation INFLATION (cont’d) 6.5 Historical U.S. Inflation Rates  FIGURE 6.7 U.S. Inflation Rate, 1950–2009, Based on Chain-Weighted Price Index Inflation reached its highest peaks in the postwar era during the decade of the 1970s when the economy was hit with several increases in oil prices. In recent years, the inflation rate has been relatively low.

6-25 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation INFLATION (cont’d) 6.5 The Perils of Deflation ●deflation Negative inflation or falling prices of goods and services.

6-26 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation THE COSTS OF INFLATION 6.6 ●anticipated inflation Inflation that is expected. ●unanticipated inflation Inflation that is not expected.

6-27 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation THE COSTS OF INFLATION (cont’d) 6.6 ● menu costs The costs associated with changing prices and printing new price lists when there is inflation. ● shoe-leather costs Costs of inflation that arise from trying to reduce holdings of cash. Anticipated Inflation ● hyperinflation An inflation rate exceeding 50 percent per month. Unanticipated Inflation

6-28 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 6 Unemployment and Inflation anticipated inflation Consumer Price Index (CPI) cost-of-living adjustments (COLAs) cyclical unemployment deflation discouraged workers frictional unemployment full employment hyperinflation inflation rate labor force labor force participation rate menu costs natural rate of unemployment seasonal unemployment shoe-leather costs structural unemployment unanticipated inflation unemployment insurance unemployment rate K E Y T E R M S