Chapter 7: Unemployment,Inflation and Long Run Growth

Chapter 7:, and Long Run Growth Week 3 Presenter: Feb 1, 2013 Chapter 7:, and

Table of Contents 1 2 3 Chapter 7:, and

Figure 1: No one likes unemployment! Chapter 7:, and

Figure 2: A breakdown of population of 16 years or older Chapter 7:, and

Questions Which workers are consider employed? Which are unemployed?(2011mid1 M10) Additional Reading 3: Q1 What is unemployment(employment) rate? What is labor force? Given the number of unemployed and employed, can you compute unemployment(employment) rate? (PEQ3 Q1-3; 2012Mid1 M17; 2012Mid1 M21;2011Mid1 M22 ) What is participation rate? (2012Mid1 M22)(2011Mid1 M24) Additional Reading 3: Q2 What are discouraged workers? In a recession,how would their number change? How would change affect unemployment rate? (2012Mid1 M18 2011Mid1 M24 ) What are the three types of unemployment? What do they refer to?(2011mid1 E3) Chapter 7:, and

2012Mid1 M17 Page 194 17. If the number of people classified as unemployed is 10,145 and the number of people classified as employed is 620,000, what is the unemployment rate? A 0.016% B 0.15% C 1.59% D 1.61% E 1.64% Chapter 7:, and

2012Mid1 M21 Page 194 to the information provided in Table 7.1 below to answer the question that follows. Table 1: Information on employment employed 11,000 unemployed 2,500 not in the labor force 3,000 Chapter 7:, and

2012Mid1 M21 Page 194 Refer to Table 7.1. The unemployment rate is A 9.09% B 18.5%. C 15.8% D 16.9% Chapter 7:, and

2012Mid1 M21 Page 194 Refer to Table 7.1. The unemployment rate is A 9.09% B 18.5%. C 15.8% D 16.9% number of unemployed number of unemployed +number of employed = 2500 2500+11000 = 18.5% Chapter 7:, and

2011Mid1 M22 Page 205 Carla lost her job and immediately started looking for another job.as a result the A labor force increases B unemployment rate increases C unemployment rate remains constant D labor force decreases The labor force remains constant because labor force=employed(-1)+unemployed(+1). Carla moves from an employed to an unemployed but she did not leave the labor force. However the unemployment rate increases because Rate = unemployed labor force Chapter 7:, and

2012Mid1 M22 Page 195 Refer to the information provided in Table 7.2 below to answer the question that follows. Table 2: Information on employment Labor Participation Rate 65% Total population 16 years of age and older 210 million Rate 5% Chapter 7:, and

2012Mid1 M22 Page 195 Refer to Table 7.2. The total number of people employed is A 129.68 million. B 128.92 million. C 126.96 million. D 131.83 million. Chapter 7:, and

2012Mid1 M22 Page 195 Refer to Table 7.2. The total number of people employed is A 129.68 million. B 128.92 million. C 126.96 million. D 131.83 million. Labor force = Populaion Participation Rate = 210 0.65 = 136.5(m); number of employed = Labor Force (1 unemployment rate) = 136.5 (1 5%) = 129.68(m) Chapter 7:, and

2012Mid1 M18 Page 194 During recessions, the number of discouraged workers and this the unemployment rate? A falls; reduces B decreases; increases C increases; reduces D increases; increases Chapter 7:, and

2012Mid1 M18 Page 194 In recession,discouraged workers would increase since more people may feel so frustrated about not being able to find a job that they give up searching, therefore leaving labor force. This would lead to an underestimation of the unemployed. unemployment rate = unemployed(a) x labor force(b) x Why? this has to do with "salt water inequality" which says a x b x < a b where x < a < b( You can think of it as the concentration of a cup of salt water, when you add some salt, it would taste saltier and vice versa.) Chapter 7:, and

2011Mid1 M24 Page 205 Mike has just graduated from college and is now looking for a job,but has not yet found one. This causes the unemployment rate to and the labor force participation rate to. A increase; stay the same B increase;decrease C stay the same;stay the same D increase; increase Recall unemployment rate = unemployed(a)+1 labor force(b)+1. Using "salt water inequality" a+1 b+1 > a b when a < b, we know that unemployment rate would increase. For participation rate, because population of 16 years or older remains constant and labor force increases by one, so labor force +1 participation rate = pop.16 years or older Chapter 7:, and

2011Mid1 E3 (Part 1) Page 211 For each of the following examples of unemployment please indicate if it can be classified as cyclical,frictional or structural (a) An entertainer who worked at Disneyland over the summer but was recently laid off due to recessionary budget cuts. (b) A lawyer who recently quit her job in New York to move to a new job in California (c) A newspaper reporter who was laid-off as printed newspaper circulation fell due to online newspapers. Chapter 7:, and

2011Mid1 E3 (Part 1) Page 211 For each of the following examples of unemployment please indicate if it can be classified as cyclical,frictional or structural (a) An entertainer who worked at Disneyland over the summer but was recently laid off due to recessionary budget cuts. Cyclical (b) A lawyer who recently quit her job in New York to move to a new job in California (c) A newspaper reporter who was laid-off as printed newspaper circulation fell due to online newspapers. Chapter 7:, and

2011Mid1 E3 (Part 1) Page 211 For each of the following examples of unemployment please indicate if it can be classified as cyclical,frictional or structural (a) An entertainer who worked at Disneyland over the summer but was recently laid off due to recessionary budget cuts. Cyclical (b) A lawyer who recently quit her job in New York to move to a new job in California Frictional (c) A newspaper reporter who was laid-off as printed newspaper circulation fell due to online newspapers. Chapter 7:, and

2011Mid1 E3 (Part 1) Page 211 For each of the following examples of unemployment please indicate if it can be classified as cyclical,frictional or structural (a) An entertainer who worked at Disneyland over the summer but was recently laid off due to recessionary budget cuts. Cyclical (b) A lawyer who recently quit her job in New York to move to a new job in California Frictional (c) A newspaper reporter who was laid-off as printed newspaper circulation fell due to online newspapers. Structural Chapter 7:, and

Remarks frictional : involve qualified individuals and have transferrable skills but seeking for a job. e.g. short contract software engineers; new college graduates. structural: due to underlying structural change usually characterized by technological advancement that may eliminate some old jobs and create new jobs for which unemployed may be unqualified. e.g. laid-off textile workers can t find a job in IT industry. cyclical : due to the downturn(recession) in business cycle.it s caused by the drop-off of labor demand since many firms have much less sales (therefore less profits) during the recession. Chapter 7:, and

2011Mid1 E3 (Part 2 Revised) Page 211 If unemployment rate in the US is currently 7.8% and the natural rate of unemployment is normally set at 5%, what is the cyclical unemployment rate? Answer: cyclical unemployment rate=7.8%-5%=2.8% Remark: Natural rate of unemployment=frictional+structural unemployment rate. And also, The term "full employment" doesn t mean everyone in the labor force is employed, instead, it means the rate of unemployment equals the natural rate of unemployment. Chapter 7:, and

Table of Contents 1 2 3 Chapter 7:, and

Figure 3: Why is inflation bad? Chapter 7:, and

Questions What is the Definition of CPI? (HW7 Q10) What s the difference between CPI, PPI and GDP deflator?(hw7 Q9) Additional Reading 3: Q5 Do you know how to calculate inflation rate between year X and Y given CPI of these two years?2012mid1 M19 What is cost of inflation?(2012mid1 E4(b) ) Who benefits from inflation?(example 1;2012Fin M27) Who loses from inflation? (Example 2;2012Mid1 E4(a)) What about delation?2012mid1 E4(c) Do you know the relationship between real interest rate and nominal interest rate? (2012Mid1 M20;) Chapter 7:, and

Homework7 Q10 CPI is a fixed weight index. It compares the price of a fixed bundle of goods in some year with the price of a fixed bundle of goods in base year. Good Amounts in Market basket price in 2008 price in 2009 price in 2010 x 100 $2.50 $4.00 $ 4.38 y 175 $3.00 $4.50 $ 4.20 z 60 $5.00 $5.50 $ 5.00 Chapter 7:, and

Homework7 Q10 Cost of Market Basket in 2008 equals $1075 Using year 2008 price and quantities:$2.50 100 + $3.00 175 + $5.00 60 = $1075 Cost of Market Basket in 2009 equals $1517.5 Using year 2008 price and quantities:$4.00 100+$4.50 175+$5.50 60 = $1517.15 Cost of Market Basket in 2009 equals $ 1473 Using year 2008 price and quantities:$4.38 100 + $4.20 175 + $5.00 60 = $1473 Chapter 7:, and

Homework7 Q10 Formula for CPI in current year: CPI in 2008 100 100 = 100 1075 1075 CPI in 2009 141.16 100 = 141.16 1517.5 1075 CPI in 2010 137.02 100 = 137.02 1473 1075 Cost of market basket in current year Cost of market basket in base year 100 Chapter 7:, and

Homework7 Q10 is the rate of change in CPI Rate of inflation between 2008 and 2009 is 41.16% CPI 2009 CPI 2008 CPI 2008 100% = 41.16% Rate of inflation between 2008 and 2009 is -2.93% CPI 2010 CPI 2009 CPI 2009 100% = 2.93% Chapter 7:, and

CPI vs PPI vs GDP Deflator HW7 Question9 (a) A price index that is computed monthly by BLS using a bundle of goods and service that represents the "market basket " (b) A price index for products at all stages in the production process is the (c) A price index for all newly and domestically produced final goods and services in an economy is Chapter 7:, and

CPI vs PPI vs GDP Deflator HW7 Question9 (a) A price index that is computed monthly by BLS using a bundle of goods and service that represents the "market basket " Consumer Price Index(CPI) (b) A price index for products at all stages in the production process is the (c) A price index for all newly and domestically produced final goods and services in an economy is Chapter 7:, and

CPI vs PPI vs GDP Deflator HW7 Question9 (a) A price index that is computed monthly by BLS using a bundle of goods and service that represents the "market basket " Consumer Price Index(CPI) (b) A price index for products at all stages in the production process is the Produce Price Index(PPI) (c) A price index for all newly and domestically produced final goods and services in an economy is Chapter 7:, and

CPI vs PPI vs GDP Deflator HW7 Question9 (a) A price index that is computed monthly by BLS using a bundle of goods and service that represents the "market basket " Consumer Price Index(CPI) (b) A price index for products at all stages in the production process is the Produce Price Index(PPI) (c) A price index for all newly and domestically produced final goods and services in an economy is GDP deflator Chapter 7:, and

CPI PPI vs GDP Deflator HW7 Question9 Compared to GDP, CPI includes a different range of goods and services (e.g it doesn t include investment goods or exported goods BUT includes imported consumption goods). Compared to GDP, CPI is based on a fixed basket of goods and services while the "basket" for GDP deflator is allowed to change with people s consumption and investment patterns. This would lead to CPI overestimating inflation by ignoring "substitution effect".therefore, substituting for relatively low priced item would reduce the value of GDP deflator which CPI fails to capture. Compared to PPI, CPI may underestimate the inflation without accounting for the rise in the prices of intermediate goods which PPI include. Chapter 7:, and

2012Mid1 M19 Page 194 If the CPI in 2010 was 125.2 and the CPI in 2011 was 142.6, then the rate of inflation between 2010 and 2011 was A 11.1%. B 12.9% C 13.9%. D 14.3%. Chapter 7:, and

2012Mid1 M19 Page 194 If the CPI in 2010 was 125.2 and the CPI in 2011 was 142.6, then the rate of inflation between 2010 and 2011 was A 11.1%. B 12.9% C 13.9%. D 14.3%. inflation rate is the rate of change in CPI between 2010 and 2011, thus 142.6 125.2 125.2 100% = 13.9% Chapter 7:, and

2012Mid1 M20 Page 194 You want to make a 2% real return on a loan that you are planning to make, and the expected inflation rate during the period of the loan is -1%. You should charge a nominal interest rate of A 1%. B 3%. C -3%. D 2%. A: Nominal interest rate incorporates the inflation rate as a compensation to the creditor for the value loss of each unit of money in the inflation(this erodes purchasing power),i.e. nominal interest rate=real interest rate(real return) + inflation rate=2%+(-1%)=1%. In this case,deflation,so the creditor gains from the change in money value and demand less than interest rate. Chapter 7:, and

Q: Who gains from inflation? A: borrowers on fixed rate debts Ex. Suppose you rent an apartment on Green Street for $100 per month but you consider buying a house for 100,000 dollars. Busey Bank offers you a 30-years fixed-rate mortgage at 10 percent. 100, 000 (1 +.1) = 110, 000$ You monthly payment: 110, 000 110, 000 = = 305.6$ > 100$ 12 30 360 Also, the projected rent payment path indexed with inflation rate 15 percent is like this year 1 year 2 year 3 year 4 year 5 year 6 year 7 year 8 100 115 132 152 175 201 266 306 After 8 years, you ll be paying less for the house than the apartment you need to rent Chapter 7:, and

Q: Who loses from inflation? A: Mainly people living on fixed incomes. Ex. Suppose a person started in 1960 to pay a retirement plan. Every Month, until she retired in 2000, she had to pay 100 dollars. The benefits are 1200 dollars each month. In 1960, the living cost per month was 700 dollars but in 2000, it was 1500 dollars. So if retirement benefits are fixed but not indexed to inflation rate, inflation hurts people living on fixed incomes Chapter 7:, and

2012Fin M27 Page 271 What is the impact of inflation that is higher than expected? A It benefits creditors B It benefits debtors C It makes the allocation of resources more efficient D There is no effect on resource allocation A: Since Real interest rate = Nominal interest rate - inflation rate. a higher-than expected inflation would reduce the real interest rate paid from debtors to creditors that would have been higher without excessive inflation. Therefore, this implies the real return debtors pay to creditors have been lowered which of course would benefit debtors Chapter 7:, and

2012Fin M27 Page 271 Remarks If inflation is higher than expected, we know that Real interest rate = Nominal interest rate inflation rate, so it benefits debtors (borrowers) and hurts creditors (lenders) and vice versa. In this case, the income is going to be distributed from creditors to debtors and vice versa. Keep in mind that this conclusion only applies to lender and borrowers on fixed nominal interest rates.if nominal interest rate is indexed to inflation rate, an adjustment after inflation rate is realized can lead to real interest rate remaining the same. Chapter 7:, and

2012Fin M27 Page 271 Remarks Similarly, given that nominal wage is fixed, under a situation where inflation is higher than expected, the purchasing power is going to be redistributed from wager earners to producers. For more information, go to Additional Reading 3: Question 4 Chapter 7:, and

2012 Mid1 E4a a. Explain how inflation can redistribute income? Chapter 7:, and

2012 Mid1 E4a a. Explain how inflation can redistribute income? A: There is redistribution from creditors to debtors (on fixed nominal interest rate loan). Debtors pay their loans in future dollars,which are worth less. Creditors earn a real rate of return that declines if it is a fixed nominal interest rate loan Chapter 7:, and

2012 Mid1 E4b Explain the administrative costs associated with inflation. Chapter 7:, and

2012 Mid1 E4b Explain the administrative costs associated with inflation. A: When inflation rises rapidly, this reduces the value of money, increasing the opportunity cost of holding cash. To avoid this, people keep less cash in the pocket and go more often to banks to make transactions. This wastes time, which is one of our main endowments. Chapter 7:, and

2012 Mid1 E4c.If inflation is a bad thing, deflation must be beneficial from a macroeconomic perspective. Is this statement true or false? Explain. Chapter 7:, and

2012 Mid1 E4c.If inflation is a bad thing, deflation must be beneficial from a macroeconomic perspective. Is this statement true or false? Explain. A: This statement is false because of the following reasons. 1 Government cannot lower interest rate to counter recession. 2 Consumers wait to purchase so worsen recession. 3 Deflation redistributes income form debtor to creditor. Chapter 7:, and

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2011Mid1 M21 Page 205 21.Which of the following is considered capital? A A tractor produced by John Deere B The knowledge an individual acquires through education C A factory a company builds to produce other output. D all of the above Chapter 7:, and

PEQ 3 Page 165 [Calculating,, and Interest Rates] Answer questions 1 through 5 using the following information. Arboc has a population of 2, 000, 000. The labor force participation rate is 90%. Assume that the citizens of Arboc, when trying to determine the inflation rate for the next 12 months, base their calculations solely on the current inflation rate. The following table provides information on the consumer price index (CPI) and unemployment rate for Arboc over a five?year period. Chapter 7:, and

PEQ 3 Page 165 Information on CPI and Rate from Year 1999-2003 Chapter 7:, and

PEQ 3 Page 165 1 Based on the information, calculate the number of workers in the labor force.a1 2 Based on the information, calculate the number of workers unemployed in 2000.A2 3 Based on the information, calculate the number of workers employed in 2002.A3 4 Based on the information, calculate the inflation rate for 2000, 2001, 2002, and 2003.A4 5 In 2001, the market interest rate was 12%. Based on the information, calculate the real interest rate.a5 Chapter 7:, and

PEQ 3 Page 165 1. Population = 2,000,000. Labor force participation = 90%. Labor Force = Population Labor force participation = 2, 000, 000 90% = 1, 800, 000. Chapter 7:, and

PEQ 3 Page 165 2. Using formula number of unemployed = labor force unemployment rate for 2000, number of unemployed = 1, 800, 000 4.2% = 75, 600 Figure 4: The Number of Unemployed Workers 1999-2003 Chapter 7:, and

PEQ 3 Page 165 3. Using formula number of employed = number of labor force number of unemployed for 2002, number of employed = 1, 800, 000 176, 400 = 1, 623, 600 Figure 5: The Number of Unemployed Workers 1999-2003 Chapter 7:, and

PEQ 3 Page 165 Figure 6: CPI and rate 1999-2003 4. Rate in 2000 = 0%; Rate in 2001 = 10% Rate in 2002 = 5%; Rate in 2003 = 2% Chapter 7:, and

PEQ 3 Page 165 5.Taking market interest rate as nominal interest rate(market interest rate is representative of nominal interest rate) and using the formula Real Interest Rate=Nominal Interest Rate- Rate. For 2001, 12%-10%=2%. So Real Interest Rate is 2%. Chapter 7:, and