Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Chapter 7 The Macroeconomy: Unemployment and Inflation

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 7-2 Unemployment –Total number of adults (aged 16 years or older) willing and able to work and who are actively looking for work but have not found a job. –Unemployment creates a cost to the entire economy in terms of lost output – often ranging in the billions of dollars.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 7-3 Unemployment (cont'd) 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 The unemployment rate is the percentage of the measured labor force that is unemployed.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 7-4 What are the Costs of Unemployment? Answers –Personal psychological impact –Lost output During early 2000s, unemployment rate rose by 2 percentage points Lost output was $200 billion of goods and services that could have been produced

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 7-5 Source: U.S. Department of Labor, Bureau of Labor Statistics Figure 7-1 More Than a Century of Unemployment

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 7-6 Figure 7-2 Adult Population Source: U.S. Department of Labor, Bureau of Labor Statistics.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved * = Unemployment (cont'd) *U.S., millions of people; as of 2009 Labor force = The employed+ The unemployed Unemployment rate =  x 100 Unemployed Labor force =  x 100 = 6.7%

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 7-8 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.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 7-9 Unemployment (cont'd) Discouraged Workers –Individuals who have stopped looking for a job because they are convinced they will not find a suitable one Question –How does the existence of discouraged workers bias the unemployment rate?

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Major Types of Unemployment The major types of unemployment –Frictional –Structural –Cyclical –Seasonal (seasonal, regular pattern)

Copyright © 2010 Pearson Addison-Wesley. All rights reserved 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 Structural Unemployment –Results from a poor match of workers’ abilities and skills with current requirements of employers

Copyright © 2010 Pearson Addison-Wesley. All rights reserved The Major Types of Unemployment (cont'd) Cyclical Unemployment –Results from business recessions that occur when aggregate (total) demand is insufficient to create full employment

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Full Employment and the Natural Rate of Unemployment Questions –Does full employment mean that everybody has a job? –Is it always possible for everyone who is looking for a job to find one?

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Full Employment and the Natural Rate of Unemployment (cont'd) Full Employment –An arbitrary level of unemployment that corresponds to “normal” friction in the labor market

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Full Employment and the Natural Rate of Unemployment (cont'd) Natural Rate of Unemployment (Full Employment) –The normal unemployment rate that prevails over time –Should not reflect cyclical unemployment –When seasonally adjusted, the natural rate should include only frictional and structural unemployment.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Inflation and Deflation Inflation –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

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Inflation and Deflation (cont'd) Purchasing Power –The value of money for buying goods and services –Varies with prices and income

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Inflation and Deflation (cont'd) Nominal value –Price expressed in today’s dollars Real value –Value expressed in purchasing power, adjusted for inflation

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Price index =  100 Cost today of market basket Cost of market basket in base year Inflation and Deflation (cont'd) –Price Index (Consumer 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 Example: 2009 spending=$ spending=$220

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Figure 7-4 Inflation and Deflation in U.S. History Source: U.S. Department of Labor, Bureau of Labor Statistics

Copyright © 2010 Pearson Addison-Wesley. All rights reserved How inflation affects you? Does it make you “poor”? 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

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Anticipated versus Unanticipated Inflation (cont'd) Real interest rate –Nominal interest rate = 10% –Expected inflation rate = 6% –Real rate = 10% – 6% = 4%

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Anticipated versus Unanticipated Inflation (cont'd) Does inflation necessarily hurt everyone? –Inflation affects people differently Unanticipated inflation –Creditors (lenders, savers) lose –Debtors (borrowers) gain

Copyright © 2010 Pearson Addison-Wesley. All rights reserved 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

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Changing Inflation and Unemployment: Business Fluctuations Figure 7-5

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Figure 7-6 National Business Activity, 1880 to the Present Sources: American Business Activity from 1790 to Today, 67th ed., AmeriTrust Co., January 1996, plus author’s estimates.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Changing Inflation and Unemployment Recession –Inflation (high or low?) –Unemployment (high or low?) Expansion –Inflation (high or low?) –Unemployment (high or low?)

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Myth #7: Life is getting tougher over time The fact is life is more calm than 50 or 100 years ago … hang around