Realm of Macroeconomics Where the telescope ends, the microscope begins. Which of the two has the grander view? VICTOR HUGO

Employment # of unemployed Unemployment rate = Total labor force total labor force = # of employed + # of unemployed

Remarks on the definition of “unemployed”  Those who have part-time jobs are not qualified  Those who are not actively looking for jobs are not qualified  So the “discouraged workers” are not qualified.  Out-of-labor-force

Types of unemployment  1. Frictional  2. Structural  3. Cyclical

Frictional unemployment  These are the people who are changing occupation or moving for better offers or other reasons.  They are just temporary between jobs.  This type of unemployment cannot be reduced.  It is a normal state.

Structural unemployment  It refers to workers who have lost jobs because their skills no longer in demand due to the shift in economic structure.  Coexistence of shortage and surplus in the labor market

Cyclical unemployment  Caused by recession  Unemployment in all sectors, all occupations

Natural unemployment rate  Unemployment rate cannot be reduced to zero  The Full employment state  The unemployment rate in the full employment state  Natural unemployment rate

Unemployment rate in the recent U.S. history

Recent U.S. unemployment rate Unemployment rate The percent of the labor force that is unemployed, not seasonally adjusted. More info »More info » Data source: U.S. Bureau of Labor Statistics - Last updated July 26, 2010U.S. Bureau of Labor Statistics Search Google: “unemployment rate” “

Inflation  Inflation rate is the percentage increase in the general price level  General Price Level (P) is measured by price indices a. GDP Deflator (GDP Price Index) b. Consumer Price Index (CPI)

Price Level YearGDP Price Index (2000=100) Consumer Price Index ( = 100) Selected U.S. Macroeconomic Data

Index  Why use indices to measure the general price level?  because GDP is an aggregate product, which cannot be measured by a physical unit.  Index is an indicator that compares to a benchmark, which is set to 100.

Consumer Price Index (CPI)  CPI bureau of Labor Statistics surveys the average consumption basket of urban residents.  Measuring the cost of living of a typical urban household

Calculating CPI Suppose a typical urban household only consumes the following items: ItemPriceQuantityPriceQuantity Hog Dog Pants (pair) Coke (can)

Calculating CPI  Compute the CPI in 1991 (1990=100) 0.85 X X X = X X X =  Conventionally, the index is multiplied by 100, so X 100 =

CPI  The CPI is used to calculate the real income so you can draw conclusion if you have been better off during the last several years.  Nominal Wage versus Real Wage  Real wage is corrected for inflation.

Case  During 1980 to 1990, your income increased from 20,000 to 28,000 U.S. dollars. but prices also rose during the period and eroded the purchasing power of dollars. You want to know if you are better off or not during this period.

Price Level YearGDP Price Index (2000=100) Consumer Price Index ( = 100) Selected U.S. Macroeconomic Data

Derive Real Income by Deflating  To do that, we deflate the nominal income to get real income  Deflating –is a process to convert nominal terms to real terms. Nominal income Nominal income Real income = X 100 CPI CPI

Derive Real Income by Deflating  Check the table: Real income in 1980 = (20,000 / 82.4) X 100 = Real income in 1990 = (28,000 / 130.7) X 100 =

Derive Real Income by Deflating  Check the table: Real income in 1980 = 20,000 / 82.4 X 100 = 24,271 Real income in 1990 = 28,000 / X 100 =21,423  You are worse off.

GDP Deflator / GDP price index  GDP Deflator; or  GDP Price Index  Including the prices of ALL products that are included in GDP  GDP Deflator and CPI use different baskets of the goods. CPI include only those items consumed by a typical urban household.

Case: Calculate Real GDP  Calculate Real GDP in 2003 at 2000 price.  From the table in 2003 Nominal GDP = GDP Deflator (2000=100) = 106

Derive Real GDP by Deflating Nominal GDP Nominal GDP Real GDP = X 100 GDP Price Index Real GDP = X 100 =

Calculating the inflation rate  Inflation Rate (p) = percentage increase in the price index P t - P t-1 P t = X 100% =( ) X 100% P t-1 P t-1 P t-1 P t-1

Calculating the inflation rate  Calculate inflation rates between  by GDP Deflator  by CPI  ( 55.3 / ) X 100% = 8.6%  ( 72.6 / ) X 100% = 11.3%

Exercise   Table 1   Year Real GDP Price Index         1. The inflation rate between 2002 in Table 1 was approximately equal to _______ percent   2.The growth rate in 2002 in Table 1 is approximately _______ percent

The inflation rate in the United States since 1870 Figure 6 29

The U.S. CPI Inflation Rate

Inflation history in the U.S.  inflation. Reasons: tax cut, defense spending associated with the Viet Nam War  inflation. Reasons: Poor harvest, oil shock and loose monetary policy during the Johnson period. Stagflation.  Inflation in 1979, second oil shock  1980s. Price stabilization. Reagan administration. Monetary contraction and high interest rate. Economic recession in  1990s. Low inflation as productivity rose.  2009 Deflation caused by recession

Dis- or De-flation  Disinflation -- Inflation decelerates (The absolute price level increases, but at a diminishing rate)  Deflation -- Price falls

International comparison CPI Inflation rates 2004 Country Inflation Rate Zimbabwe419.9 Iraq25.4 Russia11.5 China4.1 The U.S. 2.4 U.K.1.4 Japan-0.1 Hong Kong -0.3

International comparison CPI Inflation rates 2007 Data from CIA factbook

Cost of Inflation  Purchasing power erosion  Run-away Inflation or Hyperinflation –The case in Germany in 1923 –At an annul rate of > 100,000,000 –breakdown of the market system  Inflation cause uncertainty in the interest rate, thus, impeding investment and economic growth

Redistribution between borrowers and lenders  Actual inflation rate = π ACT  Expected inflation rate = π e  Nominal interest rate = real interest rate + π e  If π ACT > π e, then lenders lose.  If π ACT < π e, then borrowers lose.  This discourage investment