MONITORING JOBS AND INFLATION* *

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1 C h a p t e r 22 MONITORING JOBS AND INFLATION* * Answers to the Review Quizzes Page 112 (page 518 in Economics) 1. What determines if a person is in the labor force? Workers who have a job and workers who are unemployed are in the labor force. To be officially counted as unemployed, and thus in the labor force, means that the person does not have a job but is available and willing to work and has made some effort to find work within the past four weeks, or waiting to be called back to a job from which he or she has been laid off, or waiting to start a new job within 30 days. 2. What distinguishes an unemployed person from one who is not in the labor force? A general definition of unemployment is a person who wants to work but does not have a job. A person who is not in the labor force does not have a job and does not want one. More specifically to be considered as unemployed, and thus in the labor force, the person must not have a job but must be available and willing to work. The person must also have made some effort to find work within the past four weeks, or be waiting to be called back to a job from which he or she has been laid off, or be waiting to start a new job within 30 days. 3. Describe the trends and fluctuations in the U.S. unemployment rate from 1980 to The unemployment rate has had several significant fluctuations around its average of 6.2 percent. It started by soaring to a high that exceeded 10 percent during the 1982 recession. Then there was a gradual downward trend particularly insofar as the peaks during the recessions in and 2001 were much lower than in But that situation reversed itself with the severe and prolonged recession of when the unemployment once more jumped (slightly) above 10 percent. 4. Describe the trends and fluctuations in the U.S. employment-to-population ratio and labor force participation rate from 1980 to The labor force participation rate and the employment-to-population ratio had an upward trend from 1980 until about 2000 after which they turned downward. Both show fluctuations around these trends, especially the employment-to-population ratio which rises during expansions and falls during recessions but its fall between 2008 and * * This is Chapter 5 in Macroeconomics.

2 80 CHAPTER was particularly severe. The labor force participation rate also fell between 2008 and 2010 but the fall was not as dramatic. Recently the labor force participation rate has been near 64 percent and the employment-to-population ratio has been near 59 percent. 5. Describe the alternative measures of unemployment. The Bureau of Labor Statistics keeps track of 6 alternative measures of unemployment: U-1 measures long-term unemployment. It counts as unemployed only workers who have been unemployed for 15 or more weeks. U-2 measures job losers; that is, only workers who lost their jobs (as opposed to quitting or reentering the labor market) are counted as unemployed. U-3 is the conventional measure of unemployment. U-4 adds discouraged workers to the conventional measure of unemployment. U-5 adds all marginally attached workers to the U-4 measure of unemployment. U-6 adds part-time workers who would like a full-time job (economic part-time workers) to the U-5 measure of unemployment. Page 115 (page 521 in Economics) 1. Why does unemployment arise and what makes some unemployment unavoidable? In a dynamic economy some unemployment is unavoidable. For instance, growth means that some workers will always be entering the labor force without a job and therefore be unemployed. Consumers changing their demand for one good over another means workers in the newly less-favored industry will lose their jobs and also be unemployed. Moreover some workers will always be leaving their current job to search for a better job and these workers, too, will be unemployed. So some unemployment is unavoidable as the economy churns and reacts to changes. 2. Define frictional unemployment, structural unemployment, and cyclical unemployment. Give examples of each type of unemployment. Frictional unemployment is the unemployment that arises from the normal labor turnover from people entering and leaving the labor force and from the ongoing creation and destruction of jobs. For instance, newly graduated students entering the labor market looking for work are frictionally unemployed. Structural unemployment represents the unemployment created by changes in technology or international competition that change the skills needed to perform jobs or change the locations of jobs in the economy. For instance, workers are structurally unemployed if they lose their jobs because of changes in the amount of foreign competition and if they have different skills from those required by new jobs or if they live in a different region of the country from where new jobs are being created. Finally, cyclical unemployment is the unemployment created by business cycle fluctuations in economic activity. Specifically

3 MONITORING JOBS AND INFLATION 81 the higher than normal unemployment at a business cycle trough and the lower than normal unemployment at a business cycle peak is called cyclical unemployment. For instance, a worker laid off in 2009 because of the recession is cyclically employed. 3. What is the natural unemployment rate? The natural unemployment rate is the unemployment rate when no cyclical unemployment exists. That is, when all unemployment is frictional or structural then the unemployment rate equals the natural unemployment rate. Full employment occurs when there is no cyclical unemployment and the unemployment rate equals the natural unemployment rate. 4. How does the natural unemployment rate change and what factors might make it change? Changes in the natural unemployment rate arise because of changes in frictional and structural unemployment. Any factor that changes frictional unemployment or structural unemployment changes the natural unemployment rate. For instance, a change in the age distribution of the population, a change in the scale of structural changes that are occurring, a change in the minimum wage rate or efficiency wages, or a change in unemployment benefits all change the natural unemployment rate. 5. Why is the unemployment rate never zero, even at full employment? The unemployment rate is never zero because there is always churning going on the economy. There are always new workers entering the labor market and searching for work, there are always workers leaving one job to search for another, better job, and there are always firms laying off workers. All these cases lead to unemployment as the workers search for a job. 6. What is the output gap? How does it change when the economy goes into recession? The output gap equals the difference between real GDP and potential GDP. When the economy goes into a recession, the output gap becomes negative. 7. How does the unemployment rate fluctuate over the business cycle? During a recession the unemployment rate is generally rising. During an expansion the unemployment rate is generally falling. Page 121 (page 527 in Economics) 1. What is the price level? The price level is the average level of prices. 2. What is the CPI and how is it calculated? The CPI is the Consumer Price Index. The CPI equals (Cost of CPI basket at current prices Cost of CPI basket at base-period prices) How do we calculate the inflation rate and what is its relationship with the CPI? The inflation rate is the percentage change in a price index from one year to the next. The rate of change of the CPI is often used as a measure of inflation as faced by consumers.

4 82 CHAPTER 5 4. What are the four main ways in which the CPI is an upward-biased measure of the price level? The CPI is biased upward because of the new goods bias; the quality change bias; commodity substitution bias; and outlet substitution bias. The new goods bias reflects the point that new goods, such as DVDs are generally more expensive than the old goods they replace, VHS tapes. The quality change bias points out that part of the reason goods and services rise in price is because their quality is improved. Commodity substitution bias occurs because consumers substitute away from goods and services that have risen in the price more than other goods and services. Outlet substitution bias occurs because consumers will use discount stores more frequently when goods and services rise in price. 5. What problems arise from the CPI bias? The upward bias in the CPI distorts private contracts and government outlays that include formulas based on CPI change as a measure of inflation. If the intent is to maintain the real value of a payment, indexing payments to the CPI will in fact increase the real value of payments over time if the CPI has an upward bias. In one year, the effect of the bias may not be much, but it will accumulate over time. Close to one third of federal government outlays are indexed to the CPI. 6. What are the alternative measures of the price level and how do they address the problem of bias in the CPI? The first of three alternative price level is the chained CPI. The chained CPI is calculated in a similar manner as chained-dollar real GDP. The chained CPI overcomes the commodity substitution and new goods bias because it uses current as well as previous period quantities. The second alternative price level is the personal consumption expenditure deflator or PCE deflator. The PCE deflator is calculated from real and nominal consumption expenditure. The PCE deflator uses a broader basket of goods and services than the CPI and, similar to the chained CPI, is also calculated using a chained method. The third alternative is the GDP deflator. The GDP deflator is similar to the PCE deflator except the GDP deflator uses the prices from all the goods and services included in GDP.

5 MONITORING JOBS AND INFLATION 83 Answers to the Study Plan Problems and Applications 1. The Bureau of Labor Statistics reported the following data for 2010: Labor force: million Employment: million Working-age population: million Calculate the a. Unemployment rate. The unemployment rate is 9.5 percent. The unemployment rate is the percentage of the labor force that is unemployed. The labor force is the sum of the people unemployed and the people employed. So the number of people who are unemployed is million minus million, which is 14.6 million. The unemployment rate equals (the number of people unemployed divided by the labor force) multiplied by 100. That is, (14.6 million/153.7 million) 100, which is 9.5 percent. b. Labor force participation rate. The labor force participation rate is 64.6 percent. The labor force participation rate is the percentage of the working-age population that is in the labor force. The working-age population is million and the labor force is million, so the labor force participation rate is (153.7 million/237.9 million) 100, which equals 64.6 percent. c. Employment-to-population ratio. The employment-to-population ratio is 58.4 percent. The employmentto-population ratio is the percentage of the people of working age who have jobs. The employment-to-population ratio is equal to the number of people employed divided by the working-age population then multiplied by 100. The employment-to-population ratio is (139.1 million/237.9 million) 100, which is 58.4 percent. 2. In July 2009, in the economy of Sandy Island, 10,000 people were employed, 1,000 were unemployed, and 5,000 were not in the labor force. During August 2009, 80 people lost their jobs and didn t look for new ones, 20 people quit their jobs and retired, 150 unemployed people were hired, 50 people quit the labor force, and 40 people entered the labor force to look for work. Calculate for July 2009 a. The unemployment rate. The unemployment rate in July is 9.1 percent. The unemployment rate is the number unemployed as a percentage of the labor force. The number of unemployed workers is 1,000. The labor force is the number employed plus the number unemployed so in July it is 11,000. The unemployment rate equals (1,000/11,000) 100, which is 9.1 percent. b. The employment-to-population ratio. The employment-to-population ratio is 62.5 percent. The employmentto-population ratio is the number employed as a percentage of the working-age population. The number of employed people is 10,000. The working-age population is the sum of the labor force and the number of people who are not in the labor force, which is 16,000. The employment-to-population ratio is (10,000/16,000) 100, which is 62.5 percent.

6 84 CHAPTER 5 And calculate for the end of August 2009 c. The number of people unemployed. The number of people who are unemployed at the end of August is 840. The number of people who are unemployed at the end of August equals the number unemployed in July plus the number of people who lost their job and who stayed in the labor market plus the number of people entering the labor market minus the number of people who were hired minus the number of people who left the labor market. So the number of people unemployed equals 1, , which is 840. d. The number of people employed. The number of people who are employed at the end of August is 10,050. The number of people who are employed at the end of August equals the number employed in July minus job losers and job leavers plus hires and recalls. e. The unemployment rate. The unemployment rate at the end of August is 7.7 percent. The unemployment rate equals the number unemployed expressed as a percentage of the labor force. The number of people who are unemployed is 840. The labor force equals the number employed plus the number unemployed and at the end of August it is 10,890. The unemployment rate at the end of August equals (840/10,890) 100, which is 7.7 percent. Use the following information to work Problems 3 and 4. In October 2009, the U.S. unemployment rate was 10.0 percent. In October 2011, the unemployment rate was 8.9 percent. Predict what happened to: 3. Unemployment between October 2009 and October 2011, assuming that the labor force was constant. If the labor force is constant, the only way the unemployment rate can decrease is if the number of unemployed workers decreases. 4. The labor force between October 2009 and October 2011, assuming that unemployment was constant. If unemployment is constant, the only way the unemployment rate can decrease is if the labor force increases. 5. Shrinking U.S. Labor Force Keeps Unemployment Rate From Rising An exodus of discouraged workers from the job market kept the unemployment rate from climbing above 10 percent. Had the labor force not decreased by 661,000, the unemployment rate would have been 10.4 percent. The number of discouraged workers rose to 929,000 last month. Source: Bloomberg, January 9, 2010 What is a discouraged worker? Explain how an increase in discouraged workers influences the official unemployment rate and U 4. A discouraged worker is a person, who currently is not working, would like a job, has looked for one in the recent past, but has stopped looking for work because of repeated failures in finding a job. If a worker who had been looking for work quits looking, the official unemployment rate, U-3, falls. U-4 includes discouraged

7 MONITORING JOBS AND INFLATION 85 workers among the ranks of the unemployed so when the worker stops looking for work and becomes a discouraged worker, the U-4 unemployment rate does not change. Use the following news clip to work Problems 6 to 8. Nation s Economic Pain Deepens A spike in the unemployment rate the biggest in more than two decades raised new concerns that the economy is heading into a recession. The U.S. unemployment rate soared to 5.5% in May from 5% in April much higher than forecasted. The surge marked the biggest one-month jump in unemployment since February 1986, and the 5.5% rate is the highest seen since October Source: CNN, June 6, How does the unemployment rate in May compare to the unemployment rate during the earlier recessions? The unemployment rate in May 2008 was below the typical unemployment rate during the past recessions. 7. Why might the unemployment rate tend to actually underestimate the unemployment problem, especially during a recession? The unemployment rate probably underestimates the extent of the unemployment problem during a recession because the number of marginally attached workers, including discouraged workers, increases during a recession as does the number of part-time workers looking for full-time jobs. Both marginally attached workers and part-time workers who want full-time jobs represent an unemployment problem. In a recession neither group is providing the amount of labor they would if times were better. 8. How does the unemployment rate in May compare to the estimated natural unemployment rate? What does this imply about the relationship between real GDP and potential GDP at this time? In May the unemployment rate was above the estimated natural unemployment rate. This relationship suggests that real GDP was less than potential GDP. Use the following information to work Problems 9 and 10. Some Firms Struggle to Hire Despite High Unemployment Matching people with available jobs is always difficult after a recession as the economy remakes itself. But Labor Department data suggest the disconnect is particularly acute this time. Since the recovery began in mid-2009, the number of job openings has risen more than twice as fast as actual hires. If the job market were working normally, openings would be getting filled as they appear. Some five million more would be employed and the unemployment rate would be 6.8%, instead of 9.5%. Source: The Wall Street Journal, August 9, If the labor market is working properly, why would there be any unemployment at all? Unemployment will always exist in the labor market because of normal labor market frictions. People newly entering the labor market, workers quitting a job to look for a better job, firms laying-off workers because consumers no longer want to buy the goods produced by the firms will always be part of the labor market. All of these

8 86 CHAPTER 5 events create unemployment, so even when the labor market is operating at peak efficiency, unemployment will always be present. 10. Are the 5 million workers who cannot find jobs because of mismatching in the labor market counted as part of the economy s structural unemployment or part of its cyclical unemployment? Even though these workers are unemployed during a recessionary period, their unemployment is the result of a mismatch between their skills and the skills required for the available jobs. So while they might be counted as part of cyclical unemployment because they lost their jobs because of the recession, the mismatch means that these workers might also be counted as part of the economy s structural unemployment. 11. Which of the following people are unemployed because of labor market mismatching? Michael has unemployment benefits of $450 a week, and he turned down a full-time job paying $7.75 an hour. The reason Michael turned down the job has nothing to do with his skills or the required skills for the job. He turned the job and remained unemployed simply because his unemployment insurance benefit exceeded the wage he would earn on the job. Michael s unemployment is not the result of mismatching. Tory used to earn $60,000 a year, and he turned down a low-paid job to search for one that pays at least $50,000 a year. Tory is searching for a job that pays more, presumably because it fully utilizes his skills. Tory s unemployment is the result of the mismatch between the available job and his skill set. David turned down a temporary full-time job paying $15 an hour because it was an hour s drive away and the gas cost would be high. David turned down the job because of the mismatch between the job s location and where he lived. David s unemployment is the result of a mismatch. Use the following information to work Problems 12 and 13. The people on Coral Island buy only juice and cloth. The CPI basket contains the quantities bought in The average household spent $60 on juice and $30 on cloth in 2012 when the price of juice was $2 a bottle and the price of cloth was $5 a yard. In the current year, 2013, juice is $4 a bottle and cloth is $6 a yard. 12. Calculate the CPI basket and the percentage of the household s budget spent on juice in The CPI basket is 30 bottles of juice and 6 yards of cloth. The total amount spent on the CPI basket in 2012 was $90 and of that $60 was spent on juice. The percentage of the household s budget spent on juice was ($60/$90) 100, which is 66.7 percent. 13. Calculate the CPI and the inflation rate in The CPI in 2013 is To calculate the CPI, divide the value of the CPI basket in 2013 prices by the base-year value of the CPI basket and then multiply the resulting number by100. The value of

9 MONITORING JOBS AND INFLATION 87 the CPI basket in 2013 prices is: ($4 30) + ($6 6) = $156. The value in base-year prices is $60 + $30 (provided in the question), which equals $90. So the CPI is ($156/$90) 100 = The inflation rate in the 2013 is 73.3 percent. The inflation rate equals the CPI in 2013 year minus the CPI in the base year expressed as a percentage of the base-year CPI. Because the base-year CPI is 100, the inflation rate is [( )/ 100] 100 = 73.3 percent. Use the following data to work Problems 14 to 16. The BLS reported the following CPI data: June June June Calculate the inflation rates for the years ended June 2009 and June How did the inflation rate change in 2010? The inflation rate for the year ended June 2009 is 1.2 percent; the inflation rate for the year ended June 2010 is 1.1 percent. The inflation rate is the percentage change in the price level. It is equal to [(P this year P last year )/ P last year ] 100. For the year ended in June 2009 the inflation rate is [( )/217.3] 100, which is 1.3 percent. For the year ended in June 2010 the inflation rate is [( )/214.6] 100, which is 1.1 percent. The inflation rate increased in Why might these CPI numbers be biased? The CPI numbers might be biased because of the new goods bias, the quality change bias, the commodity substitution bias, and the outlet substitution bias. The new goods bias is that new goods are often more expensive than the older goods that they replace. The quality change bias is that increases in the quality of a good are often accompanied by increases in the good s price. The commodity substitution bias reflects the point that consumers will buy less of a good whose price increased and more of a good whose price has not changed. Finally the outlet substitution bias points out that when prices rise, consumers shop more frequently at stores with cheaper prices. 16. How do alternative price indexes help to avoid the bias in the CPI numbers? Each of the alternative price indexes attempts to overcome some of the bias in the CPI numbers. The chained CPI uses prices and quantities from the previous period and the current period. The chaining process overcomes the commodity substitution process. And because it contains current period quantities, it also does not suffer from the new goods bias. The personal consumption expenditure deflator contains goods and services omitted from the CPI. It is calculated from the nominal and real consumption expenditure data and so it, too, is computed using a chaining procedure. Because the personal consumption expenditure deflator is calculated using a chaining procedure, it does not suffer from the commodity substitution bias or the new goods bias. The GDP deflator is

10 88 CHAPTER 5 calculated from nominal and real GDP data. It is broader than the personal consumption expenditure deflator because it contains goods and services in consumption expenditure, investment, government expenditure, and net exports. The GDP deflator is calculated using a chaining procedure and so it also avoids the commodity substitution bias and new goods bias. 17. Inflation Can Act as a Safety Valve Workers will more readily accept a real wage cut that arises from an increase in the consumer prices than a cut in their nominal wage rate. Source: FT.com, May 28, 2009 Explain why inflation influences a worker s real wage rate. Why might this observation be true? The real wage rate equals the nominal wage rate divided by the price level. Inflation affects the price level, which, for an unchanged nominal wage rate, affects the real wage rate. For instance, if the nominal wage rate is kept constant, inflation raises the price level, which lowers the real wage rate. The idea that workers will accept a real wage rate cut if it comes in the form of higher prices than if it comes in the form of lower nominal wage rates could be the result of uncertainty. No worker wants to receive a lower real wage rate. Workers will instantly realize that their real wage rate has been lowered if their nominal wage rate is decreased (assuming there is not a corresponding fall in the price level). But workers might not realize that their real wage rate has been lowered if their nominal wage rate is kept steady while the price level rises. 18. The IMF World Economic Outlook reported the following price level data (2000 = 100): a. In which region was the inflation rate highest in 2010 and in 2011? Region United States Euro area Japan In 2010, the inflation rate in the United States was 1.7 percent; in the Euro area the inflation rate was 1.6 percent; and, in Japan the inflation rate was 0.4 percent. The inflation rate was the highest in the United States. In 2011, the inflation rate in the United States was 3.0 percent; in the Euro area the inflation rate was 2.8 percent; and, in Japan the inflation rate was 0.2 percent. The inflation rate was the highest in the United States. b. Describe the path of the price level in Japan. In Japan, between 2009 and 2010 the price level fell by 0.4 percent, so prices in Japan generally fell that year. Between 2010 and 2011 the price level fell by less, 0.2 percent, so the prices in Japan generally fell slightly that year. 19. Inflation Getting Uglier and Uglier The Labor Department reported that the CPI rose 4.2% through the 12 months ending in May and 0.6% in May. Energy costs rose 4.4% in May, and surged 17.4% over the 12 months ending in May; transportation costs increased 2% in May, and jumped 8.1% over the 12

11 MONITORING JOBS AND INFLATION 89 months ending in May. The price of food increased 0.3% in May, and jumped 5.1% during the 12 months ending in May. The price of milk increased 10.2% over the 12 months. The price of clothing fell 0.2% in May, and decreased 0.4% over the 12 months. The core CPI rose 0.2% in May and 2.3% during the 12 months ending in May. Source: CNN, June 13, 2008 a. Which components of the CPI basket experienced price increases (i) faster than the average and (ii) slower than the average? Energy is the component of the CPI basket that has risen most rapidly in price. Energy costs rose more than 17 percent over the past year. Related to this increase, the cost of transportation also increased significantly, 8.1 percent over the past year. Milk also contributed a large price increase, rising 10.2 percent over the past year while food in general rose 5.1 percent over the year. Clothing was the component with a well below-average price hike. Clothing actually decreased in price over the past year, falling 0.4 percent. Looking at the monthly data, food and clothing rose less than the average while the other goods and services rose more than the average. b. Distinguish between the CPI and the core CPI. Why might the core CPI be a useful measurement and why might it be misleading? The core CPI eliminates the most volatile prices in the CPI, which are, in practice, food and energy prices. The core CPI might be a useful measurement because the (actual) CPI can jump higher or lower for a month because of changes in these volatile prices. The core CPI might give a better measurement of the underlying inflation in the economy because it filters out short-term jumps. However the core CPI can also be misleading when the relative price of the omitted goods is changing. For instance over the past several years the relative price of food and energy has been rising. Omitting these prices has lead to the core inflation rate being consistently and systematically less than the CPI inflation rate. 20. Dress for Less Since 1998, the price of the Louis Vuitton Speedy handbag has more than doubled, to $685, while the price of Joe Boxer s licky face underwear has dropped by nearly half, to $8.99. As luxury fashion has become more expensive, mainstream apparel has become markedly less so. Clothing is one of the few categories in the CPI in which overall prices have declined about 10 percent since Source: The New York Times, May 29, 2008 a. What percentage of the CPI basket does apparel comprise? Apparel accounts for 4 percent of the CPI basket. b. If luxury clothing prices have increased dramatically since the late 1990s, why has the clothing category of the CPI actually declined by about 10 percent? Luxury clothing is a very small part of the clothing category of the CPI. As a result the large rise in the price of luxury has been swamped by the fall in more modestly priced clothing so that, on net, the cost of the clothing category of the CPI has declined.

12 90 CHAPTER 5 Answers to Additional Problems and Applications 21. What is the unemployment rate supposed to measure and why is it an imperfect measure? Ideally the unemployment rate would measure the underutilization of labor resources. But it is an imperfect measure for two reasons. First the unemployment rate does not include some underutilized labor. In particular the unemployment rate completely omits marginally attached workers, such as discouraged workers. These workers are not included in the unemployment rate. Second the unemployment rate counts as fully employed workers who are working part time but who want full-time jobs. These workers are underutilized because they would like to work for more hours than is presently the case. 22. The Bureau of Labor Statistics reported the following data for July 2012: Labor force participation rate: 63.7 percent Working-age population: million Employment-to-population ratio: 58.4 Calculate the a. Labor force. The labor force participation rate equals the labor force divided by the working-age population then multiplied by 100. Rearranging this formula shows that the labor force equals the working-age population multiplied by the labor force participation rate then divided by 100. Using this last formula and the data given in the problem shows that the labor force equals million 63.7/100, which is million. b. Employment. The employment-to-population ratio equals employment divided by the working-age population then multiplied by 100. Rearranging this formula shows that employment equals the working-age population multiplied by the employment-to-population ratio then divided by 100. Using this last formula and the data given in the problem shows that employment equals million 58.4/100, or million. c. Unemployment rate. The unemployment rate equals the number of people unemployed divided by the labor force. The labor force, from part (a), is million. The labor force equals the number of people employed plus the number of people unemployed. Employment, from part (b), is million so the number of people unemployed is 12.9 million. The unemployment rate equals the number of people unemployed divided by the labor force, then multiplied by 100. Using this last formula shows that the unemployment rate equals (12.9 million/155.0 million) 100, which is 8.3 percent.

13 MONITORING JOBS AND INFLATION Jobs Report: Hiring Up, Unemployment Down The Labor Department reported that hiring accelerated in November, and the unemployment rate fell to 8.6 percent from 9 percent in October. Two reasons for the fall are that more Americans got jobs, but even more people gave up on their job searches altogether. Source: CNNMoney, December 2, 2011 a. If the only change was that all the newly hired people had been unemployed in October, explain how the labor force and unemployment would have changed. The labor force would not have changed. The number of people unemployed would have decreased so the unemployment rate would have fallen. b. If the only change was that people gave up on their job searches, explain how the labor force and unemployment would have changed. The number of people unemployed would have fallen, so the labor force and the unemployment rate would have decreased. 24. The BLS reported that in July 2012, employment decreased by 195,000 to 142,220,000 and the unemployment rate increased from 8.2 percent to 8.3 percent. About 3.4 million people were marginally attached workers and 0.9 million of them were discouraged. a. Calculate the change in unemployment in July At the start of July employment was 142,220, ,000 = 142,415,000. The unemployment rate, which was 8.2 percent, equals (Unemployment/[Unemployment + Employment]) 100. Using the data for the start of July gives the result that = (Unemployment/[Unemployment + 142,415,000]). Solving for the amount of unemployment shows that unemployment at the start of July was 12,721,166 workers. Similar calculations show that at the end of July the amount of unemployment was 12,872,694 workers. Unemployment increased in July by 151,528 workers in July. b. With 3.4 million marginally attached workers and 0.9 million of them discouraged workers, what are the characteristics of the other 2.5 million marginally attached workers? The other 2.5 million marginally attached workers would like a job but have stopped looking for work. Because they are not discouraged workers, these 2.5 million workers have stopped looking for reasons other than their inability to find a job. For example, a stay-athome spouse might prefer working in the job market but have quit looking to undertake some home repairs. 25. A high unemployment rate tells us that a large percentage of the labor force is unemployed but not why the unemployment rate is high. What unemployment measure tells us if (i) people are searching longer than usual to find a job, (ii) more people are economic part-time workers, or (iii) more unemployed people are job losers? U-1 measures long-term unemployment of 15 weeks or more. If U-1 exceeds its normal value, then people are taking longer than usual to find a job. U-6 equals U-5 plus part-time workers who want fulltime jobs as unemployed, so the difference between U-6 and U-5 is the result of part-time workers who want a full-time job. If this difference is unusually large, then more workers than normal are working at part-time jobs. U-2 measures unemployment resulting from

14 92 CHAPTER 5 people losing their jobs. If U-2 is larger than normal, then more unemployment than normal results from people losing their jobs. 26. Some Firms Struggle to Hire Despite High Unemployment With about 15 million Americans looking for work, some employers are swamped with job applicants, but many employers can t hire enough workers. The U.S. jobs market has changed. During the recession, millions of middle-skill, middle-wage jobs disappeared. Now with the recovery, these people can t find the skilled jobs that they seek and have a hard time adjusting to lower-skilled work with less pay. Source: The Wall Street Journal, August 9, 2010 If the government extends the period over which it pays unemployment benefits to 99 weeks, how will the cost of unemployment change? Extending unemployment benefits to 99 weeks decreases the cost of being unemployed and thereby increases the unemployment rate as some people search for a new job for a longer period of time. 27. Why might the unemployment rate underestimate the underutilization of labor resources? The official unemployment rate underestimates the underutilization of labor resources for two reasons. First the official unemployment rate completely omits some underutilized labor. In particular the official unemployment rate omits marginally attached workers, such as discouraged workers. These workers are not included in the unemployment rate because they are not searching for a job, though if the labor market was better and jobs more plentiful they would reenter the labor market. Marginally attached workers are not a major source of mismeasurement because they are a small subset of people. Second the unemployment rate counts as fully employed workers who are working part time but who want full time jobs. These workers are underutilized because they would like to work for more hours than is presently the case. These workers are a significantly more substantial source of error because they account for a much larger part of the labor force. Use the following data to work Problems 28 to 30. The IMF World Economic Outlook reports the unemployment rates in the table. Region United What do these numbers tell you about the States phase of the business cycle in the three Euro area regions in 2011? Japan The unemployment rates fell in the United States and Japan, so it might well be the case that the United States and Japan were entering an expansionary period. The unemployment rate in the Euro area rose, so it might be the case that the Euro area was in a recession. 29. What do these numbers tell us about the relative size of their natural unemployment rates? These numbers cover only two years, so making inferences about the relative size of the natural unemployment rates is potentially dangerous. To the extent that these data are representative, the

15 MONITORING JOBS AND INFLATION 93 natural unemployment rate is likely the highest in the Euro area and the lowest in Japan. 30. Do these numbers tell us anything about the relative size of the labor force participation rates and employment-to-population ratios? The numbers tell us nothing about the relative sizes of the labor force participation rates or the employment-to-population ratios in these three regions. 31. A Half-Year of Job Losses For the first six months of 2008, the U.S. economy lost 438,000 jobs. The job losses in June were concentrated in manufacturing and construction, two sectors that have been badly battered in the recession. Source: CNN, July 3, 2008 a. Based on the news clip, what might be the main source of increased unemployment? The main source of increased unemployment likely is in the form of job losses in manufacturing and construction as opposed to people entering or reentering the labor market or people leaving their jobs. The news clip makes clear that the first six months of the year had been dismal for the economy, so these job losses are likely cyclical unemployment in nature though with a mixture of structural unemployment included because the job losses were concentrated in specific areas.. b. Based on the news clip, what might be the main type of increased unemployment? While the job losses were concentrated in manufacturing and construction, the news clip mentioned as the reason for the unemployment the point that the two sectors were badly battered in the recession. These job losses represented cyclical unemployment because there were the result of the battering that took place during the recession. 32. Governor Plans to Boost Economy with Ecofriendly Jobs Oregon s 5.6 percent unemployment rate hovers close to the national average of 5.5 percent. A few years ago, Oregon had one of the highest unemployment rates in the nation. To avoid rising unemployment, Oregon Governor Kulongoski introduced a plan that provides public schools and universities with enough state funds to meet growing demand for skilled workers. Also Kulongoski wants to use state and federal money for bridges, roads, and buildings to stimulate more construction jobs. Source: The Oregonian, July 8, 2008 a. What is the main type of unemployment that Governor Kulongoski is using policies to avoid? Explain. Governor Kulongoski is attempting to decrease both frictional and some structural unemployment. The educational policies of attempting to train students for jobs with growing demand is an attempt to decrease the frictional unemployment of newly graduated students looking for a job. If the students graduate with the skills that firms want to hire, the students quickly will find suitable jobs, thereby decreasing the state s frictional unemployment. The proposed policy of building more bridges, roads, and buildings to provide

16 94 CHAPTER 5 more construction jobs is attempting to overcome some structural unemployment in the construction industry. Apparently the number of unemployed workers in the construction sector is large enough and persistent enough that the governor wants to implement policies to decrease it. Because this unemployment is persistent in nature, it is structural unemployment. b. How might these policies impact Oregon s natural unemployment rate? Explain. If these policies succeed, they will decrease the natural unemployment rate in Oregon. Natural unemployment is comprised of frictional and structural unemployment. By decreasing these types of unemployment, Governor Kulongoski s policies are decreasing the natural unemployment rate. 33. A typical family on Sandy Island consumes only juice and cloth. Last year, which was the base year, the family spent $40 on juice and $25 on cloth. In the base year, juice was $4 a bottle and cloth was $5 a length. This year, juice is $4 a bottle and cloth is $6 a length. Calculate a. The CPI basket. The CPI basket is 10 bottles of juice and 5 lengths of cloth. b. The CPI in the current year. The CPI in the current year is To calculate the CPI, divide the value of the CPI basket in current year prices by the base-year value of the CPI basket and then multiply the resulting number by100. The value of the CPI basket in current year prices is: ($4 10) + ($6 5) = $70. The value in base-year prices is $40 + $25 (provided in the question), which equals $65. So the CPI is ($70/$65) 100 = c. The inflation rate in the current year. The inflation rate in the current year is 7.7 percent. The inflation rate equals the CPI in the current year minus the CPI in the base year expressed as a percentage of the base-year CPI. Because the base-year CPI is 100, the inflation rate is [( )/ 100] 100 = 7.7 percent. 34. Amazon.com agreed to pay its workers $20 an hour in 1999 and $22 an hour in The price level for these years was 166 in 1999 and 180 in Calculate the real wage rate in each year. Did these workers really get a pay raise between 1999 and 2001? The real wage rate equals the nominal wage rate divided by the price level. In 1999 the real wage rate was $20/ , for a real wage rate of $ In 2001 the real wage rate was $22/ , for a real wage rate of $ The workers really got a pay raise between 1999 and 2001 but it was less than the raise in their nominal wage rate. 35. News release In May 2012, real personal consumption expenditure (PCE) was $9,588 billion and the PCE deflator was In June 2012, real personal consumption expenditure was $9,576 billion and personal consumption expenditure was $11,062 billion. Source: Bureau of Economic Analysis, July 30, 2012 Calculate personal consumption expenditure in May 2012 and the PCE deflator in June 2012.

17 MONITORING JOBS AND INFLATION 95 Was the percentage increase in real personal consumption expenditure greater or smaller than that in personal consumption expenditure? Personal consumption expenditure = (real personal consumption expenditure) (PCE deflator) 100, so in May 2012 personal consumption expenditure equaled $9,588 billion = $11,064 billion. PCE deflator = ([personal consumption expenditure] [real personal consumption expenditure) 100, so in June 2012 the PCE deflator = ($11,062 billion $9,576 billion) 100 = The percentage increase in real personal consumption expenditure was smaller than the percentage increase in personal consumption expenditure. Personal consumption expenditure grows because real personal consumption expenditure grows and/or because the PCE deflator grows. During this period, both real personal consumption expenditure grew and because the PCE deflator grew so the percentage increase in (nominal) personal consumption exceeded the percentage increase in real personal consumption expenditure. 36. Hardworking Americans Should Not Be Living in Poverty The federal minimum wage has remained frozen for the past three years at $7.25 an hour, while the prices of gas and milk have risen steadily. Over this three-year period, the real value of the minimum wage has fallen to $6.77 per hour. Source: CNN, July 25, 2012 By what percentage did the CPI increase over these three years? The real minimum wage is equal to (minimum wage)/(price level). In real terms, the minimum wage has fallen by a percentage equal to [($7.25 $6.77)/(7$7.25)] 100, which is a decrease of 6.6 percent. The nominal minimum wage rate has not changed, so the only factor that has caused the change in the real minimum wage is a change in the price level. Because the real minimum wage has fallen by 6.6 percent, the price level, that is, the CPI, must have risen by 6.6 percent. 37. After you have studied Reading Between the Lines on pp ( in Economics), answer the following questions. a. What are the two measures of employment? The Current Employment Survey (CES), which is based on a survey of payroll jobs at business establishments, is one measure of employment. The Current Population Survey (CPS) which is based on a survey of households, is another measure of employment. b. What are the sources of difference between the two measures of employment? The surveys differ because the payroll job survey omits three factors that affect the measure of employment. The household survey includes: 1) farm workers; 2) self-employed; and, 3) workers on unpaid leave. c. What do the two measures of employment tell us about the U.S. economy since 2000? Since 2000, the two surveys convey generally the same picture of the U.S. economy. Both surveys show employment falling in 2001 after which they turn up, though the turn up takes about 2 years longer

18 96 CHAPTER 5 for the payroll survey. Both surveys then rose until about 2008, after which both fell until 2010, after which both again turned up. d. Thinking about the information in the news article and its implications for unemployment, would you say that the change in unemployment is a change in cyclical unemployment or a change in natural unemployment? The change in unemployment during the recession of was cyclical. If Mr. Brown is correct insofar as the growth in employment is fast enough to absorb the increase in population but not fast enough to lower the unemployment rate, the higher unemployment rate is a change in natural unemployment. e. What do the data on employment, unemployment, and underemployment imply has happened to the number (and percentage) of people who are not in the labor force? Since about 2009 the labor force has fallen increasingly below the population. This fact means that the number (and percentage) of people who are not in the labor force has increased.

19 MONITORING JOBS AND INFLATION Out of a Job and Out of Luck at 54 Too young to retire, too old to get a new job. That s how many older workers feel after getting the pink slip and spending time on the unemployment line. Many lack the skills to craft resumes and search online, experts say. Older workers took an average of 21.1 weeks to land a new job in 2007, about 5 weeks longer than younger people. Older workers will be more adversely affected because of the time it takes to transition into another job, said Deborah Russell, AARP s director of workforce issues. Source: CNN, May 21, 2008 a. What type of unemployment might older workers be more prone to experience? Older workers are more likely to experience structural unemployment. b. Explain how the unemployment rate of older workers is influenced by the business cycle. Older workers might be more likely to be fired when the economy enters a recession because the business would rather train its younger workers to prepare for the future. If this takes place, then the unemployment rate of older workers will rise more than that of other groups when the economy enters a recession. c. Why might older unemployed workers become marginally attached or discouraged workers during a recession? The news clip explains that older unemployed workers have a significantly more difficult time finding a new job than do younger unemployed workers. Older workers must search an average of 5 weeks longer to find a new job than younger workers. It would be easy for some older workers to become discouraged about their job prospects and either quit looking entirely, thereby becoming marginally attached or discouraged workers.

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