21 Monitoring Cycles, Jobs, and the Price Level

21 Monitoring Cycles, Jobs, and the Price Level
CHAPTER Notes and teaching tips: 4, 15, 16, 26, 35, 44, 51, 54, and 65. To view a full-screen figure during a class, click the red “expand” button. To return to the previous slide, click the red “shrink” button. To advance to the next slide, click anywhere on the full screen figure.

Objectives After studying this chapter, you will able to
Explain how we date business cycles Define the unemployment rate, the labour force participation rate, the employment-to-population ratio, and aggregate hours Describe the sources and types of unemployment and define full employment and the natural rate of unemployment Explain how we measure the price level and the inflation rate using the CPI

Vital Signs Our economy ebbs and flows like a tide between strong expansion, slow down, and recession. What is a recession, who makes the decision that we are in one, and how? How do we measure unemployment and what other data do we use to monitor the labour market? Being employed alone does not determine standard of living; the cost of living also matters, so we also need to know what the Consumer Price Index is, and how it is measured and used.

The Business Cycle The business cycle is the periodic but irregular up-and-down movement in production and jobs. There is no official, government-sponsored agency that dates the business cycle. That job is done by two private agencies, the Economic Cycle Research Institute (ECRI) and National Bureau of Economic Research (NBER).

The Business Cycle The ECRI defines the business cycle as follows:
… pronounced, pervasive, and persistent advances and declines in aggregate economic activity, which cannot be defined by any single variable, but by the consensus of key measures of output, income, employment and sales.

The Business Cycle The NBER, whose methods the ECRI uses, defines the phases and turning points of the business cycle as follows: A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion.

The Business Cycle Business Cycle Dates
Figure 21.1(a) shows the output gap—percentage deviation of real GDP from potential—from 1926 to 2005.

The Business Cycle Growth Rate Cycles
Because recessions are rare, the ECRI also defines a growth rate cycle downturn: … pronounced, pervasive, and persistent decline in the growth rate of aggregate economic activity. The procedures used to identify peaks and troughs in the growth rate cycle are analogous to those used to identify business cycle turning points, except that they are applied to the growth rates of the same time series, rather than their levels.

The Business Cycle Figure 21.1(b) shows the growth rate cycles since 1961, the first year in which Canada has quarterly real GDP data.

The Business Cycle The two deepest recessions occurred in 1982 and 1991. The other growth rate recessions are identified by the green bars

Jobs and Wages Population Survey
Statistics Canada conducts a monthly population survey to determine the status of the labour force in Canada. The population is divided into two groups: The working-age population—the number of people aged 15 years and older who are not in jail, hospital, or other institution People too young to work (less than 15 years of age) or in institutional care

Jobs and Wages The working-age population is divided into two groups:
People in the labour force People not in the labour force The labour force is the sum of employed and unemployed workers.

Jobs and Wages To be considered unemployed, a person must be in one of the following three categories: Without work but has made specific efforts to find a job within the previous four weeks Waiting to be called back to a job from which he or she has been laid off Waiting to start a new job within four weeks Positive versus normative. Unemployment is an emotionally charged subject and is a good one for reinforcing the important point that economics is positive in contrast to normative. The economist’s job is to try to explain why unemployment exists, what determines its rate, and assess the efficient amount of unemployment. The benefits of unemployment. It comes as a shock to most students that unemployment has benefits as well as costs and that there is an efficient amount of unemployment that is greater than zero. (Note that this statement is positive!) You might like to spend a bit of class time on this topic. If you do, here are some ideas about what to do: A good way to introduce the idea that unemployment brings benefits is to think about the unemployment of things rather than people. Look around the campus and notice all the unemployed automobiles in the parking lots/stations. Notice the unemployed class rooms early in the morning and late at night. Notice the unemployed coffee shop seats at peak lecture times. Look around the city and notice all the unemployed automobiles in the car sales lots. Try to make a reservation at any of the hotels in the city and notice that you can almost always get a room—hence, lots of unemployed hotel rooms. [Continued on the note for the next slide.]

Jobs and Wages Figure 21.2 shows the population labour force categories for 2004. Now ask: does all this unemployment bring benefits? The students quickly see that it would be very costly to organize rental markets in which cars don’t sit idle all day, and so on. Now ask: do the same ideas apply to unemployed people? (Be sure to be compassionate about the misery that unemployment can bring. You are not claiming that it is not costly. You’re trying to identify the benefits, if any.) You’ll quickly get your students to see that imagining an economy without any unemployment is nearly impossible. If consumers are free to change their decisions about what they want to buy, some goods and services must fall out of favor when others come into favor. The firms making the unfavoured products fall on hard times and often their workers are fired or laid off. Sure, these laid off workers could start work right away, cleaning shoes or selling flowers at intersections. But they are better off (in their own opinion) being frictionally unemployed and searching for new jobs. To eliminate this source of unemployment we would need to forbid consumers from changing their buying plans or insist that no one remain idle and get on with doing any job even if it doesn’t earn a wage. Note that if this is how we ran our economy, we’d still be using coal-fired stoves and the pony express, and we’d be wearing coonskin caps. There would be no McDonald’s, Federal Express, or Nike shoes.

Jobs and Wages Four Labour Market Indicators The unemployment rate
The involuntary part-time rate The labour force participation rate The employment-to-population ratio

Jobs and Wages The Unemployment Rate
The unemployment rate is the percentage of the labour force that is unemployed. The unemployment rate is (Number of people unemployed/labour force)  100. The unemployment rate reaches its peaks during recessions.

Jobs and Wages The Involuntary Part-Time Rate
The involuntary part-time rate is the percentage of the people in the labour force who have part-time jobs and want full-time jobs. The involuntary part-time rate is (Number of involuntary part-time workers/Labour force)  100. In 2004, there were 922,000 involuntary part-time workers, the labour force was million, so the involuntary part-time rate was 5.4 percent.

Jobs and Wages The Labour Force Participation Rate
The labour force participation rate is the percentage of the working-age population that is in the labour force. The labour force participation rate is (Labour force/Working-age population)  100. The labour force participation rate has increased from 54.1 percent in the early 1960s to 67.6 percent in the 2004. The labour force participation rate for men has declined, but for has increased for women.

Jobs and Wages The labour force participation rate falls during recessions as discouraged workers—people available and willing to work but who have not made an effort to find work within the last four weeks—leave the labour force.

Jobs and Wages The Employment –to-Population Ratio
The employment-to-population ratio is the percentage of working-age people who have jobs. The employment-to-population ratio is (Number of people employed/Working-age population)  100. The employment-to-population ratio has increased from 50 percent in the early 1960s to 62.7 percent in 2004. The employment-to-population ratio has declined for men and increased for women.

Jobs and Wages Figure 21.3 shows the four labour market indicators for 1960–2004.

Jobs and Wages Figure 21.4 shows the changing face of the labour market. The employment-to-population ratio and labour force participation rate of females is rising. Male-female differences in the labour market. Students are interested in the different behaviour of the male labour force participation rate and the female labour force participation rate. Students will probably believe that the reason for the increasing female participation rate is social, not economic. They will identify changing social attitudes toward women as the major source and probably see the women’s liberation movement as the driving force for this change. While not to deny the importance of attitudes, this area is a good one in which to get students to explore the economic forces that lie behind social attitudes and change. Get them to think about the technological advances that have contributed to more women being in the labour force. Many goods that were previously produced in the household are now mass-produced and available for purchase—most items of prepared food, for example. New appliances have increased productivity in the home enabling household production in less time—laundry, kitchen, and cleaning equipment for example. The market provides new goods and services that households want but can’t readily make at home—entertainment equipment (TV, CD, DVD, etc) for example. These changes lead to many families deciding to have two income-earners rather than the older tradition of one. It is interesting to let students discuss what they think will happen to the labour force participation rates in the future and whether or not they think they will ever be equal—or unequal in the opposite direction! Jobs and home production. It is interesting to ask students to think about appropriate measures of labour force participation over long periods of time or in very different economic arrangements. The technical definition involves spending time working for gain, or seeking work for gain. In Canada, this usually equates to work outside the home. Ask students whether women who are unpaid family workers on farms are in or out of the labour force; and then ask whether they are if they don’t work outside the home, but cook, make and wash clothing, and otherwise maintain the household for a large family. The employment-to-population ratio and labour force participation rate of males is falling.

Jobs and Wages Aggregate Hours
Aggregate hours are the total number of hours worked by all workers during a year. Aggregate hours have increased since 1960 but less rapidly than the total number of workers because the average workweek has shortened.

Jobs and Wages Aggregate Hours Figure 21.5(a) shows aggregate hours.
Over the 44 years from 1960 to 2004, aggregate hours increased by a bit more than 118 percent.

Jobs and Wages Aggregate Hours
Figure 21.5(b) shows average weekly hours. Average weekly hours decreased from a bit more than 40 hours a week in the early 1960s to about 33 hours a week in the 2000s.

Jobs and Wages Real Wage Rate
The real wage rate is the quantity of goods and services that an hour’s work will buy. Figure 21.6 shows the real wage rate from 1960 to 2004 calculated as total labour compensation in 1997 dollars per hour of work.

Unemployment and Full Employment
The Anatomy of Unemployment People become unemployed if: 1. Lose their jobs and search for another. 2. Leave their jobs and search for another job. 3. Enter or re-enter the labour force to search for a job. People end a spell of unemployment if they 1. Are hired or recalled. 2. Withdraw from the labour force. Labour turnover and unemployment. Ask in class how many students have jobs and how many of them have changed their job within the last 12 months. You can now discuss the constant movement in and out of the labour market and the consequence that frictional unemployment will always exist.

Figure 21.7 illustrates the labour market flows between the different states.

Sources of Unemployment Figure 21.8 shows unemployment by reason, 1975–2004. Job leavers are the smallest group. Job losers are the largest and the most cyclical group.

Duration of Unemployment The duration of unemployment increases during recessions Figure 21.9 shows unemployment by duration close to a business cycle peak in 1989… … and close to a trough in 1992.

Demographics of Unemployment Figure shows the unemployment rates of different age groups close to a business cycle peak in 1989… … and close to a trough in 1992. Teenagers experience the highest unemployment rates.

Types of Unemployment Unemployment can be classified into four types: Frictional Structural Seasonal Cyclical Identifying frictional, structural, and cyclical unemployment. Ask your class if anyone they know has been laid off. Then discuss whether losing a job creates frictional, structural, or cyclical unemployment. Look at your local examples. If you live in a steel-producing area, for example, you can talk about local structural unemployment arising from the closing of a steel manufacturer due to international competition. For cyclical unemployment, ask students how they think the business cycle and cyclical unemployment is related to full-time enrollments at higher education institutions. Students often don’t think there is any relationship. But nationally during a recession, the growth rate of full-time enrollments increases. Ask students if they can explain this relationship. The answer is that during a recession and due to the increase in cyclical unemployment, the opportunity cost of school decreases. This is a great way to keep students thinking about marginal benefits and costs.

Frictional Unemployment Frictional unemployment is unemployment that arises from normal labour market turnover. The creation and destruction of jobs requires that unemployed workers search for new jobs. Increases in the number of young people entering the labour force and increases in unemployment benefit payments raise frictional unemployment.

Other Types of Unemployment Structural unemployment is unemployment created by changes in technology and foreign competition that change the match between the skills necessary to perform jobs and the locations of jobs, and the skills and location of the labour force. Seasonal unemployment is the unemployment that arises because the number of jobs available has decreased because of the season. Cyclical unemployment is the fluctuation in unemployment caused by the business cycle.

Full employment occurs when there is no cyclical unemployment or, equivalently, when all unemployment is frictional, structural, and seasonal. The unemployment rate at full employment is called the natural rate of unemployment. The natural rate of unemployment was high during the early 1980s but has gradually decreased.

Real GDP and Unemployment Over the Cycle Potential GDP is the quantity of real GDP produced at full employment. Potential GDP corresponds to the capacity of the economy to produce output on a sustained basis. Over the business cycle, actual real GDP fluctuates around potential GDP and the unemployment rate fluctuates around the natural rate of unemployment.

Figure shows real GDP, and the unemployment rate... …and estimates of potential GDP and the natural unemployment rate, for 1980–2004.

The Consumer Price Index
The price level is the “average” level of prices and is measured by using a price index. The consumer price index, or CPI, measures the average level of the prices of goods and services consumed by an urban family. The CPI—an average. It is important for students to understand that the CPI is based on the average expenditure basket, not the expenditure pattern of any given household. Displaying the detailed press releases on the Statistics Canada Web site helps make this point very forcibly: students often do not realize until they see the numbers that the CPI must include both costs of owning a house and costs of renting one; costs of buying a car and costs of public transportation; and so on.

Reading the CPI Numbers The CPI is defined to equal 100 for the base period. Currently, the base period for the CPI is 1992. The value of the CPI for any other period is calculated by taking the ratio of the current cost of a market basket of goods to the cost of the same market basket of goods in the reference base period and multiplying by 100.

Constructing the CPI Constructing the CPI involves three stages: Selecting the CPI basket Conducting a monthly price survey Using the prices and the basket to calculate the CPI

Figure illustrates the CPI basket. Shelter is the largest component. Transportation and food are the next largest components. The remaining components account for 36.5 percent of the basket. Making the CPI personal. If you have time (or want to make time) you can get your students to construct their own CPI basket. Each student makes a statement of her/his expenditure in the same categories as the CPI basket in the figure on this slide. Students then compare their expenditure patterns to the average of the CPI basket.

The CPI basket is based on a Consumer Expenditure Survey. The CPI basket today is based on data collected in the 1996 Consumer Expenditure Survey. Every month, Statistics Canada employees check the prices of the goods and services in the CPI basket in 64 urban areas. The CPI is calculated using the prices and the contents of the basket.

For a simple economy that consumes only oranges and haircuts, we can calculate the CPI. The CPI basket is 10 oranges and 5 haircuts. Item Quantity Price Cost of CPI basket Oranges 10 $1.00 $10 Haircuts 5 $8.00 $40 Cost of CPI basket at base period prices $50

This table shows the prices in the base period. The cost of the CPI basket in the base period was $50. Item Quantity Price Cost of CPI basket Oranges 10 $1.00 $10 Haircuts 5 $8.00 $40 Cost of CPI basket at base period prices $50

This table shows the prices in the current period. The cost of the CPI basket in the current period is $70. Item Quantity Price Cost of CPI basket Oranges 10 $2.00 $20 Haircuts 5 $10.00 $50 Cost of CPI basket at base period prices $70

The CPI is calculated using the formula: CPI = (Cost of basket in current period/Cost of basket in base period)  100. Using the numbers for the simple example, CPI = ($70/$50)  100 = 140. The CPI is 40 percent higher in the current period than it was in the base period.

Measuring Inflation The main purpose of the CPI is to measure inflation. The inflation rate is the percentage change in the price level from one year to the next. The inflation formula is: Inflation rate = [(CPI this year – CPI last year)/CPI last year]  100.

Figure 21.13(a) shows the CPI from1970 to 2004.

Figure 21.13(b) shows that the inflation rate is high when the price level is rising rapidly and low when the price level is rising slowly.

The Biased CPI The CPI may overstate the true inflation for four reasons New goods bias Quality change bias Commodity substitution bias Outlet substitution bias CPI biases—concrete illustrations. New goods bias can be illustrated with MP3 music rather than CDs; quality change with computers and cars; commodity substitution with movies versus videos; and outlet substitution by the growth of Wal-mart, Target, and shopping on the internet.

New Goods Bias New goods that were not available in the base year appear and, if they are more expensive than the goods they replace, the price level may be biased higher. Similarly, if they are cheaper than the goods they replace, but not yet in the CPI basket, they bias the CPI upward. Quality Change Bias Quality improvements generally are neglected, so quality improvements that lead to price hikes are considered purely inflationary.

Commodity Substitution Bias The market basket of goods used in calculating the CPI is fixed and does not take into account consumers’ substitutions away from goods whose relative prices increase. Outlet Substitution Bias As the structure of retailing changes, people switch to buying from cheaper sources, but the CPI, as measured, does not take account of this outlet substitution.

Some Consequences of the Bias The bias in the CPI Distorts private contracts, Increases government outlays (close to a third of government outlays are linked to the CPI) Biases estimates of real earnings. To reduce the bias in the CPI, Statistics Canada undertakes consumer expenditure surveys more frequently and revises the CPI basket frequently and makes other adjustments to minimize the bias.

21 Monitoring Cycles, Jobs, and the Price Level

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