Chapter 7 Unemployment, Inflation, and Long-Run Growth. Unemployment. Unemployment. Measuring Unemployment

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1 Chapter 7, Inflation, and Long-Run Growth Measuring Components of the Rate The Costs of Inflation The Consumer Price Index The Costs of Inflation Long-Run Growth Output and Productivity Growth Measuring employed Any person 16 years old or older: (1)who works for pay, either for someone else or in his or her own business for 1 or more hours per week (2)who works without pay for 15 or more hours per week in a family enterprise, or (3)who has a job but has been temporarily absent with or without pay. unemployed A person 16 years old or older: (1) who is not working, (2) who is available for work, and (3) Who has made specific efforts to find work during the previous 4 weeks. Measuring not in the labor force A person who is not looking for work because he or she does not want a job or has given up looking. labor force The number of people employed plus the number of unemployed. labor force = employed + unemployed population = labor force + not in labor force 1

2 Measuring unemployment rate The ratio of the number of people unemployed to the total number of people in the labor force. unemployed unemployment rate = employed + unemployed labor force participation rate The ratio of the labor force to the total population 16 years old or older. labor force labor force participation rate = population Defining and Measuring Computing the unemployment rate for the month of July 2008: Labor force: million Employed: million Unemployed: 8.8 million 8.8 rate = 5.7% July Macroeconomic Concerns unemployment rate The percentage of the labor force that is unemployed. Computing the unemployment rate for the month of July 2009 and 2011: Labor force: million million Employed: million million Unemployed: 14.5 million 13.9 million rate 2009 = % rate 2011 = %

3 Measuring TABLE 7.1 Employed, Unemployed, and the Labor Force, (1) Population 16 Years Old Or Over (Millions) (2) Labor Force (Millions) Note: Figures are civilian only (military excluded). Source: Economic Report of the President, 2008, Table B-35. (3) Employed (Millions) Unemployed (Millions) Labor Force Participation Rate (Percentage Points) (4) (5) (6) Rate (Percentage Points) Components of the Rate Discouraged-Worker Effects discouraged-worker effect The decline in the measured unemployment rate that results when people who want to work but cannot find jobs grow discouraged and stop looking, thus dropping out of the ranks of the unemployed and the labor force. It lowers the unemployment rate! Components of the Rate The Duration of TABLE 7.4 Average Duration of, Weeks Weeks Weeks

4 Some Is Inevitable When we consider the various costs of unemployment, it is useful to categorize unemployment into three types: Frictional unemployment Structural unemployment Cyclical unemployment Some Is Inevitable Frictional, Structural, and Cyclical frictional unemployment The portion of unemployment that is due to the normal working of the labor market; used to denote short-run job/skill matching problems. structural unemployment The portion of unemployment that is due to changes in the structure of the economy that result in a significant loss of jobs in certain industries. The Costs of Frictional, Structural, and Cyclical natural rate of unemployment The unemployment that occurs as a normal part of the functioning of the economy. The sum of frictional unemployment and structural unemployment. cyclical unemployment The increase in unemployment that occurs during recessions and depressions. 4

5 The Costs of Social Consequences In addition to economic hardship, prolonged unemployment may also bring with it social and personal ills: anxiety, depression, deterioration of physical and psychological health, drug abuse (including alcoholism), and suicide. Inflation DEFINING INFLATION inflation An increase in the overall price level. disinflation A decrease in the rate of inflation. deflation A decrease in the overall price level. Inflation The Consumer Price Index consumer price index (CPI) A price index computed each month by the Bureau of Labor Statistics using a bundle that is meant to represent the market basket purchased monthly by the typical urban consumer. 5

6 Inflation The Consumer Price Index FIGURE 7.1 The CPI Market Basket The CPI market basket shows how a typical consumer divides his or her money among various goods and services. Most of a consumer s money goes toward housing, transportation, and food and beverages. Source: The Bureau of Labor Statistics Inflation The Consumer Price Index TABLE 7.5 The CPI, Percentage Change in CPI CPI Sources: Bureau of Labor Statistics, U.S. Department of Labor. Percentage Change in CPI CPI Percentage Change in CPI CPI Calculation of Inflation Rate (percent change calculation) CPI in CPI in Inflation rate 2007: 2.8% CPI CPI CPI Inflation Rate(%) Inflation Rate(%) = x100 x %

7 Calculation of Growth Rate is the same (percent change) GDP in year 1 - $10,245 billion GDP in year 2 - $10,995 billion Growth rate from year 1 to year 2: GDP GDP GDP 2 1 Growth Rate(%) ,995 10, Growth Rate(%) = x100 x % Inflation The Producer Price Index producer price indexes (PPIs) Measures of prices that producers receive for products at all stages in the production process. Reasons why the CPI may overstate inflation Substitution bias: The CPI uses fixed weights, so it cannot reflect consumers ability to substitute toward goods whose relative prices have fallen. Introduction of new goods: The introduction of new goods makes consumers better off and, in effect, increases the real value of the dollar. But it does not reduce the CPI, because the CPI uses fixed weights. Unmeasured changes in quality: Quality improvements increase the value of the dollar, but are often not fully measured. 7

8 The Costs of Inflation People s income increases during inflations, when most prices, including input prices, tend to rise together. Inflation changes the distribution of income. People living on fixed incomes are particularly hurt by inflation. The Costs of Inflation The benefits received by many retired workers, including social security, are fully indexed to inflation. When prices rise, benefits rise. The poor have not fared so well. Welfare benefits are not indexed and have not kept pace with inflation. The Costs of Inflation Unanticipated inflation an inflation that takes people by surprise can hurt creditors. Inflation that is higher than expected benefits debtors (borrows); inflation that is lower than expected benefits creditors (lenders). The real interest rate is the difference between the interest rate on a loan and the inflation rate. 8

9 Real and Nominal Interest Rates Nominal Interest Rates Interest Rates expressed in current dollar terms. For example 5%. Real Interest Rates Nominal Interest Rate adjusted for inflation. Real and Nominal Interest Rates Suppose you lend someone $100 at 5% for 1-year. What do you get back at the end of the year? What if inflation is 4%? What is the purchasing power of what you get back at the end of the year? Real and Nominal Interest Rates Real interest rate = nominal interest rate rate of inflation 9

10 Distinction Between Real and Nominal Interest Rates if nominal interest rate = 5% and inflation = 3% then: real interest rate = 5% 3% = 2% if nominal interest rate = 8% and inflation = 10% then real interest rate = 8% 10% = 2% INFLATION INFLATION: PUBLIC ENEMY NUMBER ONE? Some people consider inflation to be our public enemy number one. Elected leaders have vigorously pursued policies designed to stop inflation. The recessions of 1974 to 1975 and 1980 to 1982 were the price we had to pay to stop inflation. Stopping inflation is costly. Inflation The Costs of Inflation Administrative Costs and Inefficiencies There may also be costs associated even with anticipated inflation. One is the administrative cost associated with simply keeping up. 10

11 Long-Run Growth output growth The growth rate of the output of the entire economy. per-capita output growth The growth rate of output per person in the economy. productivity growth The growth rate of output per worker. Long-Run Growth Output and Productivity Growth FIGURE 7.2 Output per Worker Hour (Productivity), 1952 I 2007 IV Productivity grew much faster in the 1950s and 1960s than since. Long-Run Growth Output and Productivity Growth FIGURE 7.3 Capital per Worker, 1952 I 2007 IV Capital per worker grew until about 1980 and then leveled off som ewhat. 11

12 REVIEW TERMS AND CONCEPTS consumer price index (CPI) cyclical unemployment discouraged-worker effect employed frictional unemployment labor force labor force participation rate natural rate of unemployment not in the labor force output growth per-capita output growth producer price indexes (PPIs) productivity growth real interest rate structural unemployment unemployed unemployment rate 1. Labor force = employed + unemployed 2. Population = labor force + not in labor force unemployed 3. rate employed unemployed labor force 4. Labor forceparticipationrate population 12

Unemployment, Inflation, and Long-Run Growth

Unemployment, Inflation, and Long-Run Growth 7 C H A P T E R O U T L I N E Unemployment Measuring Unemployment Components of the Unemployment Rate The Costs of Unemployment Inflation The Consumer Price