Economic Instability Unemployment v. Inflation

Questions to Ponder: Are you (or a friend) looking for a job this summer? Are you (or a friend) looking for a job this summer? How easy is it to find a job? What kind of jobs are available? How are the wages? How easy is it to find a job? What kind of jobs are available? How are the wages? What causes unemployment in the US? What causes unemployment in the US? How does the causes of unemployment compare to your own lack of jobs? How does the causes of unemployment compare to your own lack of jobs?

What do you think the unemployment rate is for the US? DOWN in April: 5.2% looking for work. DOWN in April: 5.2% looking for work.  7,000 new jobs in April.  Unemployment rate in 2004 ran at 5.5%  8,149,000 looking for work in 2004.

The reasons for unemployment Frictional Unemployment Frictional Unemployment Structural Unemployment Structural Unemployment Seasonal Unemployment Seasonal Unemployment Cyclical Unemployment Cyclical Unemployment

Frictional Unemployment People in between jobs. People in between jobs. Short period of time while changing jobs. Short period of time while changing jobs. 3% - 4% frictional employment is considered normal. 3% - 4% frictional employment is considered normal.

Structural Unemployment When changes in market supply or demand conditions affect major industries or regions.

Causes of Structural Unemployment Decline in demand for a product Increased foreign competition Automation of production Increased raw material costs Lack of labor mobility between occupations or regions.

Seasonal Unemployment Most seasonal unemployment is tends to occur in certain industries. Most seasonal unemployment is tends to occur in certain industries.  Hotel and catering  Tourism  Fruit picking  Christmas

Cyclical Unemployment When aggregate demand in the economy is not sufficient to provide jobs for all those who seek work.  Recession  Depression

Cyclical Unemployment When the economy is operating at production capacity there is full employment aggregate demand. When the economy is operating at production capacity there is full employment aggregate demand.

Natural Rate of Unemployment The lowest level of unemployment that can be maintained without setting off increases in inflation. The lowest level of unemployment that can be maintained without setting off increases in inflation.  2005: 3.1%  Same number of new workers coming into the job market yearly.

One other kind of Unemployment HIDDEN UNEMPLOYMENT HIDDEN UNEMPLOYMENT  Reported number is only people  Actively seeking work.

Unemployment Rate does not include Discouraged workers who have stopped looking. Discouraged workers who have stopped looking. Those who work part-time when they want full-time work Those who work part-time when they want full-time work Those working that are overqualified for the job. Those working that are overqualified for the job.  underemployed

What is so wrong if everyone who wants a job has a job???

THE ANSWER???? INFLATION INFLATION  The trade-off with more employment.

Inflation Continual rise in the general level of prices in an economy.  Concern is when the prices go up faster than wages!

How do we measure inflation? CPI CPI  Consumer Price Index  Comparing prices of items at different points in time.  CPI is the most commonly used index to measure inflation.

What goods are in the MARKET BASKET for the CPI? What would you put in the market basket? What would you put in the market basket?  HINT: 200 items!

What is in the 2005 market basket? FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, service meals and snacks) FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, service meals and snacks) HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture) HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture) APPAREL (men's shirts and sweaters, women's dresses, jewelry) APPAREL (men's shirts and sweaters, women's dresses, jewelry)

What is in the market basket? TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance) TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance) MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services) MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services) RECREATION (televisions, pets and pet products, sports equipment, admissions); RECREATION (televisions, pets and pet products, sports equipment, admissions);

What is in the market basket? EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories); EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories); OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses). OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).

What is the CPI pattern in 2005? CPI measures the dollar’s worth. CPI measures the dollar’s worth.  Check out the website org/Research/data/u s/calc/index.cfm

CPI: Prices are 3.1% higher than last year. In 2004, you bought goods and services for $1 that in 2005 are costing $1.03 for the same goods and services. In 2004, you bought goods and services for $1 that in 2005 are costing $1.03 for the same goods and services.

Types of Inflation Demand-Pull Inflation Demand-Pull Inflation Cost-Push Inflation Cost-Push Inflation Monetary Inflation Monetary Inflation Stagflation Stagflation Hyperinflation Hyperinflation

Demand-Pull Inflation When the demand for goods and services exceeds the production capacity. When the demand for goods and services exceeds the production capacity.  Prices rising because of shortages.

Cost-Push Inflation Inflation can arise from changes in the costs of production of goods and services.  Increase in the price of raw materials  Increase in the price of labor  Increase in the cost of capital.

Cost-Push v. Demand Pull They push and pull prices up.  Labor contracts containing COLA clauses.  C ost- O f- L iving A djustments.

Monetary Inflation Inflation caused by excessive growth in the money supply. Inflation caused by excessive growth in the money supply.  Value of money decreases if it isn’t that “rare.”

Rule for Monetary Inflation: VELOCITY Quantity Equation Quantity Equation  M x V = T x P  Money supply times the velocity at which it changes hands equals the number of transactions times the average level of prices.

M x V = T x P Direct relationship between the money supply and the price level. Direct relationship between the money supply and the price level.

What happens when the quantity equation is “off”? Hyperinflation Money supply increases much, much faster than an economy’s output of goods and services.  THINK RUSSIA in 1990s.

Phillips Curve: The relationship between unemployment and inflation. INVERSE relationship. Unemployment goes UP, then inflation goes DOWN.

Stagflation: When things REALLY go wrong on the Phillips Curve Inflation and unemployment were at higher levels. Inflation and unemployment were at higher levels.  Combination of stagnation and inflation.  Both were increasing.

1970s: What caused Stagflation? Spending on the Vietnam War PLUS spending on domestic social programs. Spending on the Vietnam War PLUS spending on domestic social programs. Inflationary expectations Inflationary expectations Rise in energy costs caused by OPEC Rise in energy costs caused by OPEC Monopolistic pricing Monopolistic pricing

What is wrong with Inflation? Inflation reduces REAL INCOME of those whose incomes do not rise as fast as the price level. Inflation reduces REAL INCOME of those whose incomes do not rise as fast as the price level. Hurts: Hurts:  People holding assets in MONEY  Lenders

Special Note: Phillips Curve International Pg “El Dempleo” Pg “El Dempleo”  Europe 1970s had higher inflation and unemployment.  Worse because:  Labor union practices  Tax structures  Government economic policies

Consequences of Unemployment Income Effects Income Effects  Loss of income and benefits (Health insurance)  Loss of income to others because of reduced purchasing power  Reduced tax income and increased outlays of government.

Consequences of Unemployment Real Output Effects  Each 1% of unemployment results in a reduction of $100- billion in output.  Lower real investment means less growth and reduced future output.

Consequences of Unemployment Social Effects  Health Problems  Increased suicides  Break up of families  Increased child abuse  Increased crime

Consequences of INFLATION Income Effects: Income Effects:  Reduced purchasing power of the dollar  Reduced real income for fixed income receivers  Reduced real wealth of savings

Income Effects of Inflation (cont.) Benefits those whose incomes rise faster than the inflation rate. Benefits those whose incomes rise faster than the inflation rate. Benefits owners of real assets (real estate, precious metals (kinda!)) Benefits owners of real assets (real estate, precious metals (kinda!)) Benefits debtors Benefits debtors

How Inflation effects Real Output Inflation initially stimulates output Near full employment, there arise bottlenecks in supplies Costs begin rising faster than prices Interest rates accelerate, discouraging new investment.