1. Economic Fluctuations
and the Labor Market

2. Labor Market Classifications
Employed – a person (16 years old or over) who is
working for pay at least one hour per week,
self employed, or,
working 15 hours or more each week without pay in a family-operated enterprise.
Unemployed – a person not currently employed who is either
actively seeking a job, or,
waiting to begin or return to a job.
Civilian Labor force – civilians (16 years and older) who are either employed or unemployed.
Not in the labor force – persons (16 years and older) who are neither employed nor unemployed (like retirees, students, homemakers, or disabled persons).

3. Labor Force Participation Rate
Economic Fluctuations
and the Labor Market
The non-institutional civilian adult population is grouped into two broad categories:
Persons not in the labor force, and,
persons in the labor force.
Labor Force Participation Rate =
# in the Labor Force
Civilian population (16+)
Employed + Unemployed
Recall the Labor Force =
To be classified as unemployed, one must either be on layoff or actively seeking work.
Rate of Unemployment =
# Unemployed
# in the Labor Force
Employed + Unemployed
Recall the Labor Force =

4. Employment / Population Ratio
Unemployment and
Measurement Problems
The definition of unemployed involves some subjectivity.
Some argue the employment/population ratio is a better indicator of job availability than the unemployment rate.
Employment / Population Ratio =
# employed
Civilian population (16+)

5. Labor Force Participation Rate Employment / Population Ratio
U.S. Population, Employment,
and Unemployment: 2001
211.9 million
Civilian population
16 and over
141.8 million
70.1 million
Not in the
labor force
Household workers
Students
Retirees
Disabled
Civilian
labor force
6.7 million
Employed
Employees
Self-employed
workers
Unemployed
New entrants
Reentrants
Lost last job
Quit last job
Laid off
135.1 million
Labor Force Participation Rate =
Civilian labor force
Civilian population (16+) =
66.9%
Employment / Population Ratio =
Number employed
Civilian population (16+) =
63.8%
Rate of Unemployment =
Number unemployed
Civilian labor force =
4.8%

6. Real and Nominal GDP

7. Real and Nominal GDP The term "real" means adjusted for inflation.
Price indexes are use to adjust income and output data for the effects of inflation.
A price index measures the cost of purchasing a market basket (or “bundle”) of goods at a point in time relative to the cost of purchasing the identical market basket during an earlier reference (or base) period.

8. Two Key Price Indexes: - Consumer Price Index - GDP Deflator

9. Two Key Price Indexes:
Consumer Price Index (CPI): measures the impact of price changes on the cost of a typical bundle of goods and services purchased by households.
GDP Deflator: designed to measure the change in the average price of the market basket of goods included in GDP (a broader price index than the CPI).

10. CPI and GDP Deflator:
CPI
Inflation rate
GDP deflator
Inflation rate
Year
( = 100)
(percent)
(1996 = 100)
(percent)
1991
136.2
4.2
89.7
3.6
1992
140.3
3.0
91.8
2.4
1993
144.5
3.0
94.1
2.4
1994
148.2
2.6
96.0
2.1
1995
152.4
2.8
98.1
2.2
1996
156.9
3.0
100.0
1.9
1997
160.5
2.3
102.0
2.0
1998
163.0
1.5
103.2
1.2
1999
166.6
2.2
104.7
1.5
2000
172.2
3.4
107.0
2.2
2001
177.1
2.8
109.4
2.2
Source: Economic Report of the President, 2001.
Even though the CPI and the GDP deflator are based on different market baskets and procedures, they yield similar estimates of the rate of inflation.

11. Using the GDP Deflator
to Derive Real GDP

12. Using the GDP Deflator to Derive Real GDP
The formula for converting the nominal GDP into real GDP is:
Real GDP2 =
GDP Deflator1
GDP Deflator2
Nominal GDP2 *
Data on both money GDP and price changes are essential for meaningful comparisons of output between two time periods.

13. Using the GDP Deflator to Derive Real GDP
Between 1996 and 2001, nominal GDP increased by 30.7%.
But, when the 2001 GDP is deflated to account for price increases, we see that real GDP increased by only 19.4%.
Source: U.S. Department of Commerce.
Nominal GDP
(billions of U.S. $)
Price index
(GDP deflator, 1996 = 100)
100.0
109.4
9.4%
Real GDP
(billions of 1996 $)
1996
$7,813
$7,813
2001
$10,208
$9,331
% increase
30.7%
19.4%

14. Converting Earlier Figures to Current Dollars
In order to make comparisons across time periods, we must use current dollars.
This can be done by “inflating” the earlier data for the increase in the price level.
The formula for converting the figures for the earlier year into current dollars is:
Figurecurrent $ =
price indexcurrent year
price indexearlier year
Figureearlier $ *
If prices have risen, this will “inflate” the data for earlier years and bring it into line with the current purchasing power of the dollar.

15. Effects of Inflation:
An Overview

16. What is Inflation? - The Rate of Inflation is calculated as: =
Inflation rate =
Last year’s price index
This year’s price index
Last year’s price index -
* 100
Inflation is an increase in the general level of prices.
High rates of inflation are almost always associated with substantial year-to-year swings in the inflation rate, making them difficult to forecast accurately.

17. The Inflation Rate,
average inflation rate = 9.2 %
Inflation rate 15
average inflation rate = 3.2 % 10
average inflation rate = 1.3 % 5
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
Sources: Derived from computerized data supplied by FAME ECONOMICS. Also see Economic Report of the President (annual).
Here are the annual inflation rates for the last 48 years.
Between 1953 and 1965, the general price level increased at an average annual rate of only 1.3%.
In contrast, the inflation rate averaged 9.2% from 1973 to 1981, reaching double-digits during several years.
Since 1982, the average rate of inflation has been lower (about 3.2% from ) and more stable.

18. Kinds of Inflation There are two different kinds of inflation:
Unanticipated inflation: An increase in the price level that comes as a surprise, at least for most individuals.
Anticipated inflation: A widely expected change in the price level.

19. Effects of Inflation
High and variable rates of inflation are harmful for a number of reasons:
Because unanticipated inflation alters the outcomes of long-term projects like the purchase of a machine or operation of a business, it will both increase the risks and retard the level of such productive activities.
Inflation distorts the information delivered by prices.
People will respond to high and variable rates of inflation by spending less time producing and more time trying to protect their wealth and income from the uncertainty created by inflation.

20. What Causes Inflation?
Nearly all economists believe that rapid expansion in the money supply is the primary cause of inflation.

21. “Money is whatever is generally accepted in exchange for goods and services — accepted not as an object to be consumed but as an object that represents a temporary abode of purchasing power to be used for buying still other goods and services.”
— Milton Friedman

22. What Is Money?

23. What is Money?
A medium of exchange: An asset used to buy and sell goods and services.
A store of value: An asset that allows people to transfer purchasing power from one period to another.
A unit of account: Units of measurement used by people to post prices and keep track of revenues and costs.

24. Why Is Money Valuable?

25. Why is Money Valuable?
The main thing that makes money valuable is the same thing that generates value for other commodities:
The demand (for money) relative to its supply.
People demand money because it reduces the cost of exchange.
When the supply of money is limited relative to the demand, money will be valuable.

26. The Supply of Money

27. The Supply of Money
Two basic measurements of the money supply are M1 and M2:
The components of M1 are:
Currency
Checking Deposits (including demand deposits and interest-earning checking deposits)
Traveler's checks
M2 (a broader measure of money) includes:
M1,
Savings,
Time deposits, and,
Money mutual funds.

28. Credit Cards Versus Money
Money is an asset.
The use of a credit card is merely a convenient way to arrange for a loan.
Credit card balances are a liability.
Thus, credit card purchases are not money.

29. Ambiguities in the Nature
and Measurement of Money

30. The Changing Nature of Money
In the past, economists have often used the growth rate of the money supply to gauge the direction of monetary policy.
rapid growth was indicative of expansionary monetary policy, while,
slow growth (or a contraction in the money supply) was indicative of restrictive policy.
Recent financial innovations and structural changes have changed the nature of money and reduced the reliability of money growth figures as an indicator of monetary policy.

31. The Changing Nature of Money
The introduction of interest earning checking accounts in the early 1980s reduced the opportunity cost of holding checking deposits and thereby changed the nature of the M1 money supply.
In the 1990s, many depositors shifted funds from interest earning checking accounts to money market mutual funds. Because money market mutual funds are not included in M1 this also reduced the comparability of the M1 figures across time periods.

32. Three Factors Changing the Nature of Money
In addition, three other factors are altering the nature of money and reducing the value of the money growth figures as an indicator of monetary policy:
Widespread use of the dollar abroad: At least one-half and perhaps as much as two-thirds of U.S. dollar currency is held abroad, and these holdings appear to be increasing. These dollars are included in the M1 money supply even though they are not circulating in the U.S..

33. Three Factors Changing the Nature of Money
(cont.)
Increasing availability of low-fee stock and bond mutual funds: Because stock and bond mutual funds are not included in any of the money aggregates, movement of funds from various M1 and M2 components into these mutual funds will distort both the M1 and M2 figures.
Debit cards and electronic money: Increased use of debit cards and various forms of electronic money will reduce the demand for currency. Like other changes in the nature of money, these innovations will reduce the reliability of the money supply figures as an indicator of monetary policy.

34. Money in the Future
Electronic money may dramatically alter the nature of money in the future.
The introduction of the euro is changing the nature of money in Europe.
Several countries (Panama and Ecuador for example) either directly use the dollar or tie their domestic currency to the dollar.
As international trade expands and people around the world search for access to sound money, the number of currencies is likely to decline in the future.

35. The Changing Nature of M1
Billions of $
2001
Total $1,203
1,200
Interest-earning checkable deposits
$262
1,050
900
Demand deposits M1
$347
750
600
Currency
$594
450
300
150
1970
1975
1980
1985
1990
1995
2000
In the 1980s, the introduction of interest-earning checking accounts caused M1 to grow rapidly.
In the 1990s, movement of funds from interest-earning checking deposits to money market mutual funds caused M1 to contract. Thus, the M1 figures are not exactly comparable across time periods.

36. Growth Rate of M1 and M2
Annual % change M1 15 M2 10 5
- 5
1970
1975
1980
1985
1990
1995
2000
Here are the annual growth rates for both the M1 and M2 money supply figures.
Since the mid-1980’s, the variability of the M1 supply has been much greater than that for M2 due largely to the regulatory changes and innovations in financial markets that have changed the nature of M1.