The Macroeconomy: Unemployment, Inflation, and Deflation ECON 151 – PRINCIPLES OF MACROECONOMICS Chapter 7: The Macroeconomy: Unemployment, Inflation, and Deflation Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.

Unemployment Unemployment Total number of adults (aged 16 years or older) willing and able to work and who are actively looking for work and have not found a job

Unemployment (cont'd) Civilian Labor Force Individuals aged 16 years or older who either have jobs or who are looking and available for jobs; the number of employed plus the number of unemployed

Employment & Unemployment Calculations Total Population (A) Less Institutionalized Population Non-Institutionalized Population Less Not in Work Force Total Workforce (B) Less Military Civilian Workforce (C) Less Employed Unemployed (D) Labor Force Participation Rate = (B) / (A) Unemployment Rate = (D) / (C)

Unemployment (cont'd) Costs of unemployment Lost output During 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 produced Personal psychological impact

Figure 7-1 More Than a Century of Unemployment Source: U.S. Department of Labor, Bureau of Labor Statistics

Figure 7-2 Adult Population

Unemployment (cont'd) The unemployment rate is the percentage of the measured labor force that is unemployed.

Unemployment (cont'd) Labor force = The employed + The unemployed 152.7* = 145.4 + 7.3 Unemployed Labor force Unemployment rate = x 100 = x 100 = 4.8% 7.3 152.7 *U.S., millions of people; as of 2007

Unemployment (cont'd) Stock Flow The quantity of something, measured at a given point in time—for example, an inventory of goods Flow A quantity measured over time, such as the income you make per year, or the number of individuals fired every month

Unemployment (cont'd) Categories of individuals without work Job loser Reentrant Job leaver New entrant

Unemployment (cont'd) Job Loser An individual whose employment was involuntarily terminated or who was laid off 40–60% of the unemployed

Unemployment (cont'd) Reentrant An 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 (cont'd) Job Leaver An individual who voluntarily quit 10 to 15% of the unemployed

Unemployment (cont'd) New Entrant An individual who has never worked a full- time job for two weeks or longer 10 to 15% of the unemployed

Unemployment (cont'd) 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 15 years.

Unemployment (cont'd) Discouraged Workers Question Individuals who have stopped looking for a job because they are convinced they will not find a suitable one (no longer in work force) Question How does the existence of discouraged workers bias the unemployment rate?

Unemployment (cont'd) Unemployed Labor force x 100 Question How does the existence of discouraged workers bias the unemployment rate? Unemployed Labor force Unemployment rate = x 100 = x 100 = 4.8% 7.3 152.7 Assume that there are 3 million discouraged workers. = x 100 = 6.6% 10.3 155.7

Unemployment (cont'd) Labor Force Participation Rate The proportion of non-institutionalized working-age individuals who are employed or seeking employment

The Major Types of Unemployment Frictional Structural Cyclical Seasonal

The Major Types of Unemployment (cont'd) Frictional Unemployment Results from the fact that workers must search for appropriate job offers This takes time, so they remain temporarily unemployed

The Major Types of Unemployment (cont'd) Structural Unemployment Results from a poor match of workers’ abilities and skills with current requirements of employers

The Major Types of Unemployment (cont'd) Cyclical Unemployment Results from business fluctuations that occur when aggregate (total) demand is not at a level that would result in full employment Can be positive or negative

The Major Types of Unemployment Seasonal Unemployment Results from the seasonal pattern of work in specific industries Adjustments are made to offset the effects of seasonal unemployment so that meaning comparisons can be made between different periods of the year. This adjustment is needed in order to assess the affects of the other types of unemployment.

Full Employment and the Natural Rate of Unemployment (cont'd) An arbitrary level of unemployment that corresponds to “normal” friction in the labor market

Full Employment and the Natural Rate of Unemployment (cont'd) The unemployment rate that is estimated to prevail in the long-run macroeconomic equilibrium Should not reflect cyclical unemployment When seasonally adjusted, the natural rate should include only frictional and structural unemployment.

Inflation and Deflation A sustained increase in the average of all prices of goods and services in an economy Deflation A sustained decrease in the average of all prices of goods and services in an economy

Inflation and Deflation (cont'd) Purchasing Power The value of money for buying goods and services Varies with prices and income

Inflation and Deflation (cont'd) Nominal value Price expressed in today’s dollars Real value Value expressed in purchasing power, adjusted for inflation

Measuring the rate of inflation Price 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 Market Basket Representative bundle of goods and services Base Year The point of reference for comparison of prices in other years Price index =  100 Cost today of market basket Cost of market basket in base year

Table 7-1 Calculating a Price Index for a Two-Good Market Basket

Inflation and Deflation (cont'd) Real-world price indexes Consumer Price Index (CPI) Producer Price Index (PPI) GDP deflator Personal Consumption Expenditure (PCE)

Inflation and Deflation (cont'd) 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 of goods and services of typical consumer

Inflation and Deflation (cont'd) Producer Price Index (PPI) A statistical measure of a weighted average of prices of goods and services that firms produce and sell Used as a short-run leading indicator (before CPI) PPIs for Foodstuffs Intermediate goods Finished goods

Inflation and Deflation (cont'd) GDP Deflator A price index measuring the changes in prices of all new goods and services produced in the economy Broadest measure of prices; reflects both price changes and the public’s market responses to those price changes

Inflation and Deflation (cont'd) Personal Consumption Expenditure (PCE) Index A statistical measure of average price using annually updated weights based on consumer spending Primary inflation index used by the Federal Reserve

Figure 7-4 Inflation and Deflation in U.S. History Source: U.S. Department of Labor, Bureau of Labor Statistics

Anticipated versus Unanticipated Inflation To determine who is hurt by inflation we distinguish between the two types. The effects of inflation on individuals depend upon which type of inflation exists.

Anticipated versus Unanticipated Inflation (cont'd) The inflation rate that we believe will occur Unanticipated Inflation Inflation at a rate that comes as a surprise

Anticipated versus Unanticipated Inflation (cont'd) Inflation and interest rates Nominal 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

Anticipated versus Unanticipated Inflation (cont'd) Real interest rate Nominal interest rate = 10% Expected inflation rate = 6% Real rate = 10% – 6% = 4%

Anticipated versus Unanticipated Inflation (cont'd) Inflation affects people differently Unanticipated inflation Creditors lose Debtors gain

Anticipated versus Unanticipated Inflation (cont'd) Protecting against inflation Cost-Of-Living Adjustments (COLAs) Clauses in contracts that allow for increases in specified nominal values to take account of changes in the cost of living

Anticipated versus Unanticipated Inflation (cont'd) The resource cost of inflation Repricing or Menu Cost of Inflation The cost associated with recalculating prices and printing new price lists when there is inflation

Changing Inflation and Unemployment: Business Fluctuations The ups and downs in business activity throughout the economy

Changing Inflation and Unemployment: Business Fluctuations (cont'd) Expansion A business fluctuation in which the pace of national economic activity is speeding up Contraction A business fluctuation during which the pace of national economic activity is slowing down

Changing Inflation and Unemployment: Business Fluctuations (cont'd) Recession A period of time during which the rate of growth of business activity is consistently less than its long-term trend or is negative Depression An extremely severe recession

Figure 7-5 The Idealized Course of Business Fluctuations

Figure 7-6 National Business Activity, 1880 to the Present

Changing Inflation and Unemployment: Business Fluctuations (cont'd) Leading Indicators Events that have been found to occur before changes in business activity Economic downturns often follow Reduction in the average workweek Rise in unemployment insurance claims Decrease in prices of raw materials Drop in the quantity of money circulating

End of Chapter 7 Chapter 7: ECON 151 – PRINCIPLES OF MACROECONOMICS Chapter 7: The Macroeconomy: Unemployment, Inflation, and Deflation Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.