Unemployment and Inflation.

Unemployment and Inflation.

Unemployment, Prices and Inflation The Learning Objectives in this presentation are covered in Chapter 16: Measuring Total Production and Income LEARNING OBJECTIVES 1. For Unemployment there are 3 Learning Objectives 2. For Prices and Inflation there are 4 Learning Objectives 2

Unemployment and Inflation Persistent Problems in the Arab World Unemployment is by no means unique to the Arab world, it s very high in Europe at the moment. However, an unemployment rate of around 14 percent, means that the Arab region has one of the world s highest rates of unemployment 3

Unemployment LEARNING OBJECTIVES 1. Define and calculate unemployment rates and labour force participation rates 2. To become familiar with the three types of unemployment 3. Explain the factors determining the unemployment rate 4

Key Labour Market Definitions LEARNING OBJECTIVE: (1) ONE Labor force The sum of employed and unemployed workers in the economy. Unemployment rate The percentage of the labor force that is unemployed. Working age population Those aged between 16 64 for example. Not in the labour force = Retirees, full time students, stay at home parents, prisoners, discouraged workers Discouraged workers = People who are available for work but have not looked for a job during the period of estimation because they believe no jobs are available for them. The Household Survey = US survey to collect employment data 5

Labor Market Statistics LEARNING OBJECTIVE: (1) ONE The unemployment rate measures the percentage of the labour force that is unemployed Number of unemployed Labor force 100 Unemployment rate The labor force participation rate measures the percentage of the working age population in the labor force. Labor force 100 Working-age population Labor force participation rate 6

LEARNING OBJECTIVE: (1) ONE Putting it into Practice hat Happens if You Include the Military? People on active military service are usually not included in the totals for employment, the labor force, or the working age population. Suppose people in the military were included in these categories. Number of unemployed Labor force 100 Labor force 100 Working-age population 7

Unemployment Rate Measurement Problems LEARNING OBJECTIVE: (1) TWO Problems with Measuring the Unemployment Rate» Although labor statistics departments usually report the unemployment rate measured to the tenth of a percentage point, it is not a perfect measure of the current state of joblessness in the economy.» The unemployment rate provides some useful information about the employment situation in the country, but it is far from an exact measure of joblessness in the economy. 8

Types of Unemployment LEARNING OBJECTIVE: (1) TWO Frictional Unemployment and Job Search Short term unemployment that arises from the process of matching workers with jobs. Structural Unemployment Unemployment arising from a persistent mismatch between the skills and characteristics of workers and the requirements of jobs. Cyclical Unemployment Cyclical unemployment is caused by a business cycle recession. 9

Natural Rate of Unemployment LEARNING OBJECTIVE: (1) TWO The Natural rate of Unemployment The normal or natural rate of unemployment, consisting of frictional unemployment plus structural unemployment. Is different to zero, most economies experience some positive natural unemployment resulting from job search and frictional unemployment. 10

Reducing Unemployment LEARNING OBJECTIVE: (1) TWO Government Policy and Unemployment» Governments can help reduce the level of frictional unemployment by pursuing policies and creating institutions that help speed up the process of matching unemployed workers with unfilled jobs.» Governments can help reduce structural unemployment through policies that aid the retraining of workers, such as: the Textiles Merchandiser Training Program in Egypt and the Sales Training Program in Morocco.» A few Arab countries apply an unemployment insurance programs such as Bahrain and Algeria.» Unemployment insurance helps the unemployed maintain their income and spending, which lessens the personal hardship of being unemployed and also helps reduce the severity of recessions. 11

Unemployment: International Comparisons LEARNING OBJECTIVE: (1) THREE Graph Average Unemployment Rates in the United States, Canada, Japan, and Europe, 1998 2007 12

Government Policies and Unemployment LEARNING OBJECTIVE: (1) THREE Minimum Wage Laws Quite good number of Arab countries apply minimum wages laws such as: Kuwait, Egypt, Saudi Arabia, Jordan, Algeria, Libya, Syria, Iraq, Lebanon and Tunisia. It is argued that if the minimum wage is set above the market wage determined by the demand and supply of labor, the quantity of labor supplied will be greater than the quantity of labor demanded which may result in some unemployment. Low skilled workers and teenagers tend to be most affected. Should the UAE adopt minimum wage law? 13

Unemployment: Minimum Wage Law LEARNING OBJECTIVE: (1) THREE If the minimum wage (W1) is Above the market clearing wage (W2) then unemployment can Result (the difference between Q1 and Q2). Without the minimum wage there would be a higher quantity of workers employed (Q2). Q2 14

Explaining Unemployment LEARNING OBJECTIVE: (1) THREE Labor Unions Labor unions are organizations of workers that bargain with employers for higher wages and better working conditions for their members. In theory, labour unions raise wages about market clearing rates. Efficiency Wages Efficiency wage is a higher than market wage that a firm pays to increase worker productivity. This then increases the costs to the worker of losing their job and should increase their motivation. 15

An inside Look Food Prices, Housing Prices, And Youth Unemployment: Major Problems Facing The Arab World Youth unemployment rate is the highest in the Middle East and North Africa 16

Prices and Inflation LEARNING OBJECTIVES 1. Define price level and inflation rate and understand how they are computed 2. Use price indexes to adjust for the effects of inflation 3. Distinguish between the nominal interest rate and the real interest rate 4. Discuss the problems that inflation causes 17

Measuring Inflation LEARNING OBJECTIVE: (2) ONE Price level = A measure of the average prices of goods and services in the economy. Inflation rate = The percentage increase in the price level from one year to the next. Inflation = An increase in the price level. Deflation = A decline in the price level. There measures of the price level: 1. Consumer Price Index (CPI) 2. Producer Price Index (PPI) 3. GDP Deflator (already covered in chapter 15 handout) 18

Measuring Inflation: Consumer Price Index The Consumer Price Index» Consumer price index (CPI) An average of the prices of a basket of goods and services purchased by the typical urban family of four.» Notice that the quantities in the basket of goods remain the same over a period of time. BASE YEAR (1999) 2008 2009 LEARNING OBJECTIVE: (2) ONE PRODUCT QUANTITY PRICE EXPENDITURES PRICE EXPENDITURES (ON BASE-YEAR QUANTITIES) PRICE EXPENDITURES (ON BASE-YEAR QUANTITIES) Diabetes 1 $50.00 $50.00 $100.00 $100.00 $85.00 $85.00 examination Rice 20 10.00 200.00 15.00 300.00 14.00 280.00 Chicken 20 25.00 500.00 25.00 500.00 27.50 550.00 Total $750.00 $900.00 $915.00 19

Calculating CPI and Inflation LEARNING OBJECTIVE: (2) ONE FORMULA APPLIED TO 2008 APPLIED TO 2009 CPI = Expenditures in the current year 100 Expenditures in the base year $900 $750 100 120 $915 $750 100 122 Inflation Rate 2009 = 122 120 100 1.7% 120 Three steps: 1. Use the data on prices to calculate the cost of the basket of goods and services at different times using the quantities in a designated base year. 2. Compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100. 3. The inflation rate is the annual percentage change in the index. 20

Measuring Inflation LEARNING OBJECTIVE: (2) ONE Is the CPI Accurate? It is important that the CPI be as accurate as possible However, there are four biases that make changes in the CPI overstate the true inflation rate by estimated 0.5 1%: Substitution bias Increase in quality bias. New product bias. Outlet bias. 21

CPI and GDP Deflator Compared LEARNING OBJECTIVE: (2) ONE Economists and policymakers monitor both the GDP deflator and the CPI to gauge how quickly prices are rising. There are two important differences between the indexes that can cause them to diverge. The GDP deflator reflects the prices of all goods and services produced domestically, whereas... the Consumer Price Index reflects only the prices of goods and services bought by the average consumer. 22

Producer Price Index (PPI) LEARNING OBJECTIVE: (2) ONE Producer price index (PPI)» An average of the prices received by producers of goods and services at all stages of the production process.» Often includes the prices of intermediate goods and services that businesses have to pay.» Is a leading indicator of the CPI because producers often pass on any increases in their costs to customers.» The US has three PPI, PPI commodities, Intermediate goods and final goods. 23

Using Price Indexes to Adjust for Inflation LEARNING OBJECTIVE: (2) TWO Price indexes are used to correct for the effects of inflation when comparing, for example, US$ figures from different times. Inflation is often a large part of any apparent growth in a data series over time when measured in $. By adjusting we find the real growth in the data series. In that case, to correct for the effects of inflation, we can divide the nominal variable by a price index and multiply by 100 to obtain a real variable. E.g. We want to convert wages from being measured in 2009 dollars to dollars in the base year, by doing this we compare the real change in wages after removing the price effect Real Value = (Nominal Value/CPI) x 100 24

Using Price Indexes to Adjust for Inflation cont. LEARNING OBJECTIVE: (2) TWO» A real variable is an economic variable that uses prices in a base year i.e. constant prices, so it adjusts for inflation» A nominal variable is an economic variable that is calculated using current year prices» To compare variables at different times in today s dollars:» Value in 2013 dollars = Value in 1980 dollars x CPI 2013 CPI 1980» Value in 1980 dollars = Value in 2013 dollars x CPI 1980 CPI 2013 25

Using Price Indexes: An Example LEARNING OBJECTIVE: (2) TWO Problem 16.5 SOLVED Calculating Real Average Hourly Earnings YEAR NOMINAL AVERAGE HOURLY EARNINGS CPI (1982-1984 = 100) 2005 $16.13 195.3 2006 16.76 201.6 2007 17.42 207.3 YEAR NOMINAL AVERAGE HOURLY EARNINGS CPI (1982-1984 = 100) REAL AVERAGE HOURLY EARNINGS (1982-1984 DOLLARS) 2005 $16.13 195.3 $8.26 2006 16.76 201.6 8.31 2007 17.42 207.3 8.40 26

Real versus Nominal Interest Rates LEARNING OBJECTIVE: (2) THREE Nominal interest rate = The stated interest rate on a loan, not corrected for inflation Real interest rate = The nominal interest rate minus the inflation rate. A better measure of the incentives to save or borrow in the economy, the higher the real interest rate the more people will be willing to save. The anticipated rate of return from holding a financial instrument after taking into account the extent to which inflation is expected to reduce the amount of goods and services that this return could be used to buy Real interest rate = Nominal interest rate Inflation rate 27

Problems of Inflation LEARNING OBJECTIVE: (2) FOUR» The extent to which inflation redistributes income depends in part on whether the inflation is anticipated in which case consumers, workers, and firms can see it coming and can prepare for it or unanticipated in which case they do not see it coming and do not prepare for it. The Problem with Anticipated Inflation» Menu costs = The costs to firms of changing prices, such as printing new price lists, sending them to customers and advertising them. 28

Problems of Unanticipated Inflation LEARNING OBJECTIVE: (2) FOUR» When the actual inflation rate turns out to be very different from the expected inflation rate, some people gain, and other people lose because it affects the distribution of income.» Inflation affects the purchasing power of our money/savings/incomes/salaries» Purchasing power of money: The value of money in terms of the amount of real goods and services it buys.» For those people whose incomes are rising more slowly than inflation they will be made worse off because they will see a fall in their purchasing power.» Borrowers will win from higher than expected inflation, whilst savers will lose.» For this reason sometimes wages and financial instrument returns are indexed to inflation rates. 29

An inside Look Inflation in the UAE: Double digit inflation for several years during the recent economic boom Consumer price inflation (average, %) Prior to the financial crisis inflation rates were above 12%, compared to an average of 2 4% for the rest of the world. What were the causes and implications? Source: EIU, 2011 30

Key Terms» Consumer Price Index (CPI)» Cyclical unemployment» Deflation» Discouraged workers» Efficiency wage» Frictional unemployment» Inflation rate» Labor force» Labor force participation rate» Menu costs» Natural rate of unemployment» Nominal interest rate» Price level» Producer Price Index (PPI)» Real interest rate» Structural unemployment» Unemployment rate 31