Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 1 of 36 Labor force The sum of employed and unemployed workers in the economy. Employed can be in any job -- part-time, underemployed Unemployment rate The percentage of the labor force that is unemployed: not working and looking. Measuring the Unemployment Rate and the Labor Force Participation Rate The Household Survey Discouraged workers: Available for work but haven’t looked for a job (for the past four weeks) because they believe no jobs are available for them.

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 2 of 36 The Employment Status of the Civilian Working-Age Population, April 2007

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 3 of 36 Unemployment rate: the percentage of the labor force that is unemployed … not working and looking. Labor force participation rate: the percentage of the working-age civilian population in the labor force.

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 4 of 36 Solved Problem 8-1 What Happens if You Include the Military? In the BLS household survey, people on active military service are not included in the totals for employment, the labor force, or the working-age population. Suppose people in the military were included in these categories.

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 5 of 36 FIGURE 8-2 Trends in the Labor Force Participation Rates of Adult Men and Women Since 1948 Trends in Labor Force Participation

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 6 of 36 LENGTH OF TIME UNEMPLOYEDPERCENTAGE OF TOTAL UNEMPLOYED Less than 5 weeks35.6% 5 to 14 weeks to 26 weeks weeks or more17.5 How Long Are People Usually Unemployed?

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 7 of 36 Household and Establishment Survey Data for March and April 2007 HOUSEHOLD SURVEYESTABLISHMENT SURVEY MARCHAPRILCHANGE MARCHAPRILCHANGE EMPLOYED 146,254,000145,786,000−468,000137,596,000137,684,000+88,000 UNEMPLOYED 6,724,0006,801,000+77,000 LABOR FORCE 152,979,000152,587,000−392,000 UNEMPLOYMENT RATE 4.4%4.5%+0.1% The Establishment Survey: Another Measure of Employment

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 8 of 36 Learning Objective 8.1 Establishments Creating and Eliminating Jobs, April–June 2006 NUMBER OF ESTABLISHMENTS NUMBER OF JOBS ESTABLISHMENTS CREATING JOBS Existing establishments1,558,0006,286,000 New establishments360,0001,475,000 ESTABLISHMENTS ELIMINATING JOBS Existing establishments1,543,0005,937,000 Closing establishments341,0001,358,000 Measuring the Unemployment Rate and the Labor Force Participation Rate Job Creation and Job Destruction Over Time

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 9 of 36 FIGURE 8-3 Unemployment Rates in the United States by Demographic Group, April 2007 Unemployment Rates for Demographic Groups

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 10 of 36 Frictional Unemployment and Job Search Frictional unemployment Short-term unemployment that arises from the process of matching workers with jobs. Types of Unemployment Structural unemployment Unemployment because of persistent mismatch between worker skills and characteristics and job requirements. Declining industries and regions / Expanding industries and regions Cyclical unemployment Unemployment caused by a business cycle recession. Cyclical Unemployment Structural Unemployment

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 11 of 36 Full Employment and “Natural” Rate of Unemployment Natural rate of unemployment A normal rate of unemployment, consisting of frictional plus structural unemployment.

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 12 of 36 Average Unemployment Rates in the United States, Canada, Japan, and Europe, 1997–2006 International Comparisons Government Policies and the Unemployment Rate Explaining Unemployment

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 13 of 36 Unemployment Insurance and Other Payments to the Unemployed Explaining Unemployment Minimum Wage Laws Labor Unions / Work Rules Seniority / Probation Periods Efficiency Wages : higher-than-market wage that a firm pays to increase worker productivity  wait unemployment. Reduce hiring costs, turnover, monitoring costs, shirking Increase morale

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 14 of 36 Measuring Inflation Price level (= P) A measure of the average prices of goods and services in the economy. Inflation rate (= π) The percentage increase in the price level from one year to the next. Π = 100 x (P t - P t-1 ) / P t-1 Price Indices of Note GDP Deflator Consumer Price Index Core CPI: CPI excluding energy and food Producer Price Index

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 15 of 36 Measuring Inflation The Consumer Price Index The CPI Market Basket, December 2006

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 16 of 36 Consumer price index (CPI) An average of the prices of the goods and services purchased by the typical urban family of four. The Consumer Price Index BASE YEAR (1999) PRODUCT QUANT- ITY PRICE EXPEND- ITURESPRICE EXPENDITURE S (ON BASE- YEAR QUANTITIES)PRICE EXPENDITU RES (ON BASE-YEAR QUANTITIES) Eye exams 1$50 $100 $85 Pizzas Books Total$750$900$915

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 17 of 36 The Consumer Price Index APPLIED TO 2008APPLIED TO 2009 CPI = Inflation Rate = Π = 100 x (P P 2008 ) / P 2008 Π =

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 18 of 36 Is the CPI Accurate? Substitution bias. Increase in quality bias. Outlet bias. New product bias. CPI inflation overstates the increase in the “Cost of Living”

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 19 of 36 Using Price Indexes to Adjust for the Effects of Inflation YEAR NOMINAL AVERAGE HOURLY EARNINGS CPI ( = 100) 2004$ Value in constant 1983$ = Value in 2006$ x [CPI in 1983/CPI in 2006] = Value in $2006$ x [100/CPI in 2006] Calculating Real Average Hourly Earnings (Real Wage) YEAR NOMINAL AVERAGE HOURLY EARNINGS CPI ( = 100) REAL AVERAGE HOURLY EARNINGS ( DOLLARS) 2004$ $

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 20 of 36 Real versus Nominal Interest Rates Nominal interest rate The stated interest rate on a loan. Real interest rate The nominal interest rate minus the inflation rate. Real interest rate = Nominal interest rate − Inflation rate Deflation A decline in the price level.

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 21 of 36 Real versus Nominal Interest Rates FIGURE 8-7 Nominal and Real Interest Rates, 1970–2006

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 22 of 36 Does Inflation Impose Costs on the Economy? Inflation Affects the Distribution of Income –Arbitrary redistribution Debtors gain / Creditors lose  disincentive to save Pensioners lose The Problem with Anticipated Inflation Menu costs The costs to firms of changing prices. The Problem with Unanticipated Inflation Price Uncertainty  fear  Stagnation

Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 23 of 36 Consumer price index (CPI) Cyclical unemployment Deflation Discouraged workers Efficiency wage Frictional unemployment Inflation rate Labor force Labor force participation rate Menu costs Natural rate of unemployment Nominal interest rate Price level Producer price index (PPI) Real interest rate Structural unemployment Unemployment rate K e y T e r m s