1. 1 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation CHAPTER 8 Fernando Quijano Prepared by: Unemployment and Inflation

2. 2 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Measuring the Unemployment Rate and the Labor Force Participation Rate Labor force The sum of employed and unemployed workers in the economy. Unemployment rate The percentage of the labor force that is unemployed. The Household Survey Discouraged workers People who are available for work but have not looked for a job during the previous four weeks because they believe no jobs are available for them. Define unemployment rate and labor force participation rate and understand how they are computed. 8.1 LEARNING OBJECTIVE

3. 3 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation FIGURE 8-1 The Employment Status of the Civilian Working-Age Population, July 2009 Measuring the Unemployment Rate and the Labor Force Participation Rate The Household Survey Define unemployment rate and labor force participation rate and understand how they are computed. 8.1 LEARNING OBJECTIVE

4. 4 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Measuring the Unemployment Rate and the Labor Force Participation Rate The unemployment rate measures the percentage of the labor force that is unemployed. The Household Survey The labor-force participation rate measures the percentage of the working-age population in the labor force. Define unemployment rate and labor force participation rate and understand how they are computed. 8.1 LEARNING OBJECTIVE

5. 5 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation 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. Define unemployment rate and labor force participation rate and understand how they are computed. 8.1 LEARNING OBJECTIVE

6. 6 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Measuring the Unemployment Rate and the Labor Force Participation Rate Problems with Measuring the Unemployment Rate Although the BLS reports the unemployment rate measured to the tenth of a percentage point, it is not a perfect measure of the current state of joblessness in the economy. The unemployment rate provides some useful information about the employment situation in the country, but it is far from an exact measure of joblessness in the economy. Define unemployment rate and labor force participation rate and understand how they are computed. 8.1 LEARNING OBJECTIVE

7. 7 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation FIGURE 8-2 Trends in the Labor Force Participation Rates of Adult Men and Women Since 1948 Measuring the Unemployment Rate and the Labor Force Participation Rate Trends in Labor Force Participation The labor force participation rate of adult men has declined gradually since 1948, but the labor force participation rate of adult women has increased significantly, making the overall labor force participation rate higher today than it was in 1948. Define unemployment rate and labor force participation rate and understand how they are computed. 8.1 LEARNING OBJECTIVE

8. 8 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Why Was Male Unemployment So High During the Recent Recession? Making the Connection Define unemployment rate and labor force participation rate and understand how they are computed. 8.1 LEARNING OBJECTIVE Employment in the industries that were hit particularly hard by the recession of 2007– 2009—construction, financial services, and manufacturing—is disproportionately male, while employment in industries that fared relatively well during the recession, such as medical services and education, is disproportionately female.

9. 9 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation FIGURE 8-3 Unemployment Rates in the United States by Demographic Group, July 2009 Measuring the Unemployment Rate and the Labor Force Participation Rate Unemployment Rates for Demographic Groups The unemployment rate of black adults is much higher than that of white adults, and the unemployment rate of black teenagers is much higher than that of white teenagers. The adult unemployment rates apply to persons aged 20 and over who are in the labor force. The teenage unemployment rates apply to persons aged 16 to 19 who are in the labor force. Define unemployment rate and labor force participation rate and understand how they are computed. 8.1 LEARNING OBJECTIVE

10. 10 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Table 8-1 Duration of Unemployment LENGTH OF TIME UNEMPLOYEDPERCENTAGE OF TOTAL UNEMPLOYED Less than 5 weeks35.6% 5 to 14 weeks31.3 15 to 26 weeks15.7 27 weeks or more17.5 (a) Duration of unemployment during an economic expansion. Less than 5 weeks22.0% 5 to 14 weeks24.2 15 to 26 weeks19.9 27 weeks or more33.8 (b) Duration of unemployment during an economic recession. Measuring the Unemployment Rate and the Labor Force Participation Rate How Long Are People Typically Unemployed? Define unemployment rate and labor force participation rate and understand how they are computed. 8.1 LEARNING OBJECTIVE

11. 11 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Table 8-2 Household and Establishment Survey Data for July and August 2013 Measuring the Unemployment Rate and the Labor Force Participation Rate The Establishment Survey: Another Measure of Employment Define unemployment rate and labor force participation rate and understand how they are computed. 8.1 LEARNING OBJECTIVE

12. 12 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Table 8-3 Establishments Creating and Eliminating Jobs, September-December 2012 Measuring the Unemployment Rate and the Labor Force Participation Rate Job Creation and Job Destruction over Time Define unemployment rate and labor force participation rate and understand how they are computed. 8.1 LEARNING OBJECTIVE Number of Jobs Establishments Creating Jobs Existing establishments5,752,000 New establishments1,299,000 Establishments Eliminating Jobs Existing establishments5,180,000 Closing establishments1,203,000

13. 13 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation FIGURE 8-4 The Annual Unemployment Rate in the United States, 1950–2008 8.2 LEARNING OBJECTIVE Identify the three types of unemployment.. The unemployment rate (u) rises during recessions and falls during expansion. Shaded areas indicate recessions. Types of Unemployment

14. 14 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Frictional unemployment Short-term unemployment that arises from the process of matching workers with jobs. Types of Unemployment Structural unemployment Unemployment arising from a persistent mismatch between the skills and attributes of workers and the requirements of jobs. Cyclical unemployment Unemployment caused by a business cycle recession. 8.2 LEARNING OBJECTIVE Identify the three types of unemployment..

15. 15 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Natural rate of unemployment The normal rate of unemployment, consisting of frictional unemployment plus structural unemployment. Full Employment Types of Unemployment 8.2 LEARNING OBJECTIVE Identify the three types of unemployment..

16. 16 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Unemployment Insurance Government Policies and the Unemployment Rate Explaining Unemployment In the United States and most other industrial countries, the unemployed are eligible for unemployment insurance payments from the government. In the United States, these payments are generally equal to about half the average wage. Unemployment insurance helps the unemployed maintain their income and spending, which lessens the personal hardship of being unemployed and also helps reduce the severity of recessions. Explain what factors determine the unemployment rate. 8.3 LEARNING OBJECTIVE

17. 17 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation FIGURE 8-5 Average Unemployment Rates in the United States, Canada, Japan, and Europe, 1999–2008 International Comparisons Government Policies and the Unemployment Rate Explaining Unemployment The unemployment rate in the United States is usually lower than the unemployment rates in most other high-income countries, other than Japan. This is partly because the United States has tougher requirements for the unemployed to receive government payments. These requirements raise the costs of searching for a better job and lower the unemployment rate. Explain what factors determine the unemployment rate. 8.3 LEARNING OBJECTIVE

18. 18 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Minimum Wage Laws Government Policies and the Unemployment Rate Explaining Unemployment In 1938, the federal government enacted a national minimum wage law. If the minimum wage is set above the market wage determined by the demand and supply of labor, the quantity of labor supplied will be greater than the quantity of labor demanded. Economists agree that the current minimum wage is above the market wage for some workers, but they disagree on the amount of unemployment that has resulted. Explain what factors determine the unemployment rate. 8.3 LEARNING OBJECTIVE

19. 19 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Efficiency wage A higher-than-market wage that a firm pays to increase worker productivity. Explaining Unemployment Labor unions are organizations of workers that bargain with employers for higher wages and better working conditions for their members. Explain what factors determine the unemployment rate. 8.3 LEARNING OBJECTIVE

20. 20 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Measuring Inflation Price level (P) A measure of the average prices of goods and services in the economy. Inflation rate The percentage increase in the price level from one year to the next. 8.4 LEARNING OBJECTIVE Define price level and inflation rate and understand how they are computed.

21. 21 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Measuring Inflation The Consumer Price Index FIGURE 8-6 The CPI Market Basket, December 2012 8.4 LEARNING OBJECTIVE Define price level and inflation rate and understand how they are computed.

22. 22 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Measuring Inflation BASE YEAR (1999)20142015 PRODUCTQUANTITYPRICEEXPENDITURESPRICE EXPENDITURES (ON BASE-YEAR QUANTITIES)PRICE EXPENDITURES (ON BASE-YEAR QUANTITIES) Eye examinations 1$50.00 $100.00 $85.00 Pizzas2010.00200.0015.00300.0014.00280.00 Books2025.00500.0025.00500.0027.50550.00 TOTAL$750.00$900.00$915.00 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 8.4 LEARNING OBJECTIVE Define price level and inflation rate and understand how they are computed.

23. 23 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Measuring Inflation The Consumer Price Index FORMULAAPPLIED TO 2014APPLIED TO 2015 CPI = 8.4 LEARNING OBJECTIVE Define price level and inflation rate and understand how they are computed.

24. 24 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Measuring Inflation Is the CPI Accurate? Substitution bias Quality bias Outlet bias New product bias It is important that the CPI be as accurate as possible, but there are four biases that cause changes in the CPI to overstate the true inflation rate: 8.4 LEARNING OBJECTIVE Define price level and inflation rate and understand how they are computed.

25. 25 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Measuring Inflation The Producer Price Index Producer price index (PPI) An average of the prices received by producers of goods and services at all stages of the production process. 8.4 LEARNING OBJECTIVE Define price level and inflation rate and understand how they are computed.

26. 26 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Using Price Indexes to Adjust for the Effects of Inflation For some purposes, we are interested in tracking changes in an economic variable over time rather than in seeing what its value would be in today’s dollars. In that case, to correct for the effects of inflation, we can divide the nominal variable by a price index and multiply by 100 to obtain a real variable. 8.5 LEARNING OBJECTIVE Use price indexes to adjust for the effects of inflation..

27. 27 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Solved Problem 8-5 Calculating Real Average Hourly Earnings YEAR NOMINAL AVERAGE HOURLY EARNINGS CPI (1982-1984 = 100) 2006$16.76201.6 200717.43207.3 200818.08215.3 YEAR NOMINAL AVERAGE HOURLY EARNINGS CPI (1982-1984 = 100) REAL AVERAGE HOURLY EARNINGS (1982-1984 DOLLARS) 2006$16.76201.6$8.31 200717.43207.3 8.41 200818.08215.3 8.40 8.5 LEARNING OBJECTIVE Use price indexes to adjust for the effects of inflation..

28. 28 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Real versus Nominal Interest Rates Nominal interest rate (i) The stated interest rate on a loan. Real interest rate (r) The nominal interest rate minus the inflation rate. r = i − inflation Deflation A decline in the price level. 8.6 LEARNING OBJECTIVE Distinguish between the nominal interest rate and the real interest rate.

29. 29 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Real versus Nominal Interest Rates FIGURE 8-7 Nominal and Real Interest Rates, 1970–2008 The real interest rate is equal to the nominal interest rate minus the inflation rate. The real interest rate provides a better measure of the true cost of borrowing and the true return on lending than does the nominal interest rate. The nominal interest rate in the figure is the interest rate on three-month U.S. Treasury bills. The inflation rate is measured by the percentage change in the CPI from the same quarter during the previous year. 8.6 LEARNING OBJECTIVE Distinguish between the nominal interest rate and the real interest rate.

30. 30 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation Does Inflation Impose Costs on the Economy? Inflation Affects the Distribution of Income The Problem with Anticipated Inflation Menu costs The costs to firms of changing prices. The Problem with Unanticipated Inflation The extent to which inflation redistributes income depends in part on whether the inflation is anticipated—in which case consumers, workers, and firms can see it coming and can prepare for it— or unanticipated—in which case they do not see it coming and do not prepare for it. When the actual inflation rate turns out to be very different from the expected inflation rate, some people gain, and other people lose. This outcome seems unfair to most people because they are either winning or losing only because something unanticipated has happened. This apparently unfair redistribution is a key reason why people dislike unanticipated inflation. 8.7 LEARNING OBJECTIVE Discuss the problems that inflation causes.

31. 31 of 38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 8: Unemployment and Inflation 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 (i) Price level (P) Producer price index (PPI) Real interest rate (r) Structural unemployment Unemployment rate (u) KEY TERMS