Ch 5: Macroeconomic Measurements, Part I Prices & Unemployment James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts University ©2005 Thomson Business & Professional Publishing, A Division of Thomson Learning

Measuring Prices Price Level: A weighted average of the prices of all goods and services. Price Index: A measure of the price level. Consumer Price Index (CPI): A widely cited index for the price level; the weighted average of prices of a specific set of goods and services purchased by a typical household.

Consumer Price Index We use a base year to calculate the CPI. The CPI is equal to the total dollar expenditure in the current year for the market basket divided by the total dollar expenditure in the base year for the market basket. This result is then multiplied by 100.

Exhibit 1: Computing the Consumer Price Index

Exhibit 2: CPI, 1959-2003

(CPI later year – CPI earlier year) X 100 Calculating the Percentage Change in Prices (as measured by the CPI) Over One Year or Several Years Percentage difference in the CPI from one year to any other year = (CPI later year – CPI earlier year) X 100 __________________________________________________________________________________ CPI earlier year Inflation: an increase in the price level.

Are You Beating (CPI) Inflation or is Inflation Beating You? Nominal Income: the current-dollar amount of a person’s income. Real Income: nominal income adjusted for price changes. Real Income (in base year prices) = [(Nominal Income)/CPI]x100

How Is The CPI Used? An economic indicator The CPI is used as: An economic indicator To find the real value of an economic variable To adjust certain income payments

Substitute Bias in Fixed Weight Measures A fixed weight price assumes the same items are bought A substitute bias is introduced when one good is substituted for another. As a result of the substitution bias, fixed weight measures can overstate the “cost of living”

Other Measures The Chain-Weighted Price Index corrects for the substitution bias found in fixed weight measures. The GDP Deflator or GDP Implicit Price Deflator is based on all goods and services within an economy.

Converting Dollars from One Year to Another Take your price, income, or salary that you want to compare. Choose the current year and the year to compare to. Complete this formula: Salary current year = (CPI current year / CPI earlier year) x Income earlier year

Self-Test Explain how the CPI is calculated. If the CPI in one year is 132.5, and is 143.6 the following year, what is the inflation rate? In year 1, your annual income is $45,000 and the CPI is 143.6; in year 2, your annual income is $51,232 and the CPI is 150.7. Has your real income risen, fallen, or remained constant? Explain your answer.

UNEMPLOYMENT Civilian Non-Institutional Population (Potentially Employed) 16 years of age or older not in the armed services not institutionalized. A person is considered Employed if did any work for pay or profit during the survey reference week worked at least 15 hours per week as an unpaid worker in a family-operated enterprise was temporarily absent from work due to illness, vacation, strike, bad weather, industrial dispute, or various personal reasons.

Exhibit 3: Breakdown of the U.S. Population and the Labor Force

Unemployment A person is Unemployed if: They do not have a job, have made specific active efforts to find a job during the prior 4 weeks, and were available for work. They were not working and were waiting to be called back to a job from which they had been temporarily laid off.

The Unemployment and Employment Rates Unemployment Rate: Number of Unemployed Persons divided by the Civilian Labor Force Employment Rate: Number of Employed Persons divided by the Civilian Non-institutionalized Population. Labor Force Participation Rate: Civilian Labor Force divided by the Civilian Non-institutionalized Population.

Classifying the Unemployed Job Loser: was employed in the civilian labor force, was either fired or laid off. Job Leaver: was employed in the civilian labor force, quit his or her job. Reentrant: was employed, hasn’t been for a period of time and is currently reentering the labor force. New Entrant: has never held a full time job for two weeks or longer, but is now looking. Unemployed Persons = Job Losers+ Job Leavers +Reentrants + New Entrants

Discouraged Workers A person who gives up looking for a job, for whatever reason, is no longer considered part of the unemployment rate. The unemployed worker gets counted and the discouraged worker does not. Does this give us a good count of the “true unemployment problem” today?

Types of Unemployment Frictional Unemployment: unemployment due to the natural “frictions” of the economy, which is caused by changing market conditions and is represented by qualified individuals with transferable skills who change jobs. Structural Unemployment: unemployment due to structural changes in the economy that eliminate some jobs and create others for which the unemployed are unqualified. Natural Unemployment Rate: The sum of the Frictional Unemployment Rate and the Structural Unemployment Rate.

Full Employment? Full Employment: when the unemployment rate is equal to the natural unemployment rate. Cyclical Unemployment Rate: the difference between the unemployment rate and the natural unemployment rate.

Self-Test What is the major difference between a person who is frictionally unemployed and one who is structurally unemployed? If the cyclical unemployment rate is positive, what does this imply?

Coming Up (Ch. 6): Macroeconomic Measurements, Part II: GDP and Real GDP