Introduction
Roger LeRoy Miller
Economics Today Twelfth Edition
Some measures of economic activity tend to decline ahead of overall declines in the macroeconomy. Such measures are called leading indicators.
Chapter 7 The Macroeconomy: Unemployment, Inflation, and Deflation Copyright © 2004 Pearson Addison Wesley. All rights reserved.
Slide 7-2
Learning Objectives
Learning Objectives
Explain how the U.S. government calculates the official unemployment rate
Distinguish between nominal and real interest rates
Discuss the types of unemployment
Evaluate who loses and who gains from inflation
Describe how price indexes are calculated and review the key types of price indexes
Understand key features of business fluctuations
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1
Chapter Outline
Did You Know That...
Unemployment Inflation and Deflation Changing Inflation and Unemployment: Business Fluctuations
At the onset of a business downturn, there is a sudden jump in the frequency with which the word “recession” appears in the press?
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Unemployment
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Unemployment
Question
Question
– Who are the unemployed?
– What are the costs of unemployment?
Unemployment – The total number of adults (aged 16 years or older) who are willing and able to work and who are actively looking for work but have not found a job Slide 7-7
Slide 7-8
2
Unemployment
Unemployment
Answer
Question
– Lost output
– How would you show the cost of unemployment on a production possibilities curve?
• Early 2000s unemployment rate rose by 2 percentage points • Factory output was 80% of potential • Lost output was $200 billion of goods and services that could have been produced
– Personal psychological impact
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More than a Century of Unemployment
Capital Goods
Production Possibilities
K1
C1
Source: U.S. Department of Labor, Bureau of Labor Statistics
Consumer Goods Slide 7-11
Figure 7-1
Slide 7-12
3
Unemployment
Unemployment
The unemployment rate is the percentage of the measured labor force that is unemployed.
Labor Force – Individuals aged 16 years or older who either have jobs or are looking and available for jobs Labor force = the employed + the unemployed
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Unemployment
Unemployment
Labor force = the employed + the unemployed 135.4*
=
141.2
+
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5.8
The arithmetic determination of unemployment – Job Leavers = Job Finders
unemployed Unemployment rate = labor force
• Unemployment rate is unchanged
x 100%
– Job Leavers > Job Finders • Unemployment rate increases
= *U.S., millions of people; as of April 2000
5.8 x 100 % = 4.1% 141.2 Slide 7-15
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4
Adult Population
Unemployment Stocks – The quantity of something (unemployed) measured at a point in time
Flow – A quantity measured over time (job leavers, job finders) Source: U.S. Department of Labor, Bureau of Labor Statistics
Figure 7-2
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Visualizing Stocks and Flows
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Unemployment Unemployment categories – Job loser – Reentrant – Job leaver – New entrant
Figure 7-4
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5
Unemployment
Unemployment
Job Loser
Reentrant
– An individual whose employment was involuntarily terminated or who was laid off • 40–60% of the unemployed
– An individual who has worked a full-time job before but left the labor force and has now reentered it looking for a job • 20–30% of the unemployed
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Unemployment
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Unemployment
Job Leaver
New Entrant
– An individual who voluntarily ended employment
– An individual who has never worked a fulltime job for two weeks or longer
• Less than 10% to around 15% of the unemployed
• 10–13% of the unemployed
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6
Unemployment
Unemployment Question
Duration of unemployment – More than a third of job seekers find work within one month – Approximately another third find employment within a second month
– What is likely to happen to the duration of unemployment during a downturn in the economy?
– About a sixth are still unemployed after six months – Average duration is just over 15 weeks throughout the last decade Slide 7-25
Unemployment
Slide 7-26
Unemployment
Discouraged Workers
Labor Force Participation Rate
– Individuals who have stopped looking for a job because they are convinced they will not find a suitable one
– The proportion of working-age individuals who are employed or seeking employment
Question – How does the existence of discouraged workers bias the unemployment rate? Slide 7-27
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7
Labor Force Participation Rates by Sex
Unemployment Question – Is there an economic explanation for the increase in the female labor force participation rate?
Figure 7-5
Source: U.S. Department of Labor, Bureau of Labor Statistics
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Unemployment
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Unemployment
The major types of unemployment
Frictional Unemployment
– Frictional
– Results from the fact that workers must search for appropriate job offers
– Structural – Cyclical – Seasonal
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8
Unemployment
Unemployment
Structural Unemployment
Cyclical Unemployment
– Results from a poor match of workers’ abilities and skills with current requirements of employers
– Results from business recessions that occur when aggregate (total) demand is insufficient to create full employment
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Unemployment
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Unemployment
Seasonal Unemployment
Question
– Results from the seasonal pattern of work in specific industries
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– Does full employment mean that everybody has a job?
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Unemployment
Unemployment Natural Rate of Unemployment
Full Employment – An arbitrary level of unemployment that corresponds to “normal” friction in the labor market
– The unemployment rate that is estimated to prevail in the long run when all workers and employers have fully adjusted to any changes in the economy – When seasonally adjusted the natural rate of unemployment should only take into account frictional and structural unemployment
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Unemployment
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Inflation and Deflation
Question
Inflation
– Does an increase in the unemployment rate necessarily mean there has been a decrease in the employment rate?
– An upward movement in the average level of prices
Deflation – A downward movement in the average level of prices
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Inflation and Deflation
Inflation and Deflation
Purchasing Power
Nominal value
– The value of money for buying goods and services – Varies with prices and income
– Price expressed in today’s dollars
Real value – Value expressed in purchasing power
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Inflation and Deflation
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Inflation and Deflation
Question
Answer
– Is a 30-second ad during the Super Bowl really 40 times more expensive today (about $2.00 million) compared to 1967 ($50,000)?
– Depends on what has happened to the price level and the size of the audience during this time – Prices: fourfold increase – Audience: doubled
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Inflation and Deflation
Inflation and Deflation
Analysis
Measuring inflation
– Adjusting for viewership and inflation, the cost per viewer is about five times what it was in 1967—not 25 times.
– Price Index • The cost of today’s market basket of goods expressed as a percentage of the cost of the same market basket during a base year
Price index =
cost today of market basket × 100 cost of market basket in base year
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Calculating a Price Index for a Two-Good Market Basket
Inflation and Deflation Market Basket – Representative bundle of goods and services
Commodity Corn Microcomputers
Base Year
Market Basket Quantity
2002 Price per Unit
Cost of Market Basket at 2002 Prices
$4
$400
$8
$800
2
$500
$1,000
$425
$850
$1,400
Price index = (1992 = base year)
Slide 7-47
Cost of Market Basket in 1992
100 bushels
Totals
– The point of reference for comparison of prices in other years.
1992 Price per Unit
$1,650
$1,650 × 100 = 117.86 $1,400 Slide 7-48
12
Inflation and Deflation
Inflation and Deflation Consumer Price Index (CPI)
Real-world price indexes – Producer Price Index (PPI)
– A statistical measure of a weighted average of prices of a specified set of goods and services purchased by wage earners in urban areas
– GDP Deflator
– Market basket is based on a consumer expenditure survey
– Consumer Price Index (CPI)
– Methodology problems • Substitution effect and the fixed quantity index • Quality changes • New products Slide 7-49
Inflation and Deflation
Slide 7-50
Inflation and Deflation
Producer Price Index (PPI)
GDP Deflator
– A statistical measure of a weighted average of prices of commodities that firms purchase from other firms – Generally for non-retail markets
– A price index measuring the changes in prices of all final goods and services produced in the economy
– Used as a leading indicator CPI
– Broadest measure of prices
– PPIs for:
– Not based on a fixed market basket
• Food materials • Intermediate goods • Finished goods Slide 7-51
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Inflation and Deflation in U.S. History
Inflation and Deflation Anticipated versus Unanticipated Inflation – The effects of inflation on individuals depend upon which type of inflation exists.
Figure 7-6
Source: U.S. Department of Labor, Bureau of Labor Statistics
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Inflation and Deflation
Slide 7-54
Inflation and Deflation
Anticipated Inflation
Inflation and interest rates
– The rate of inflation that the majority of individuals believe will occur
Unanticipated Inflation
– Nominal Rate of Interest • The market rate of interest expressed in today’s dollars
– Real Rate of Interest
– Inflation that comes as a surprise to individuals in the economy
• The nominal rate of interest minus the anticipated rate of inflation
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Inflation and Deflation
Inflation and Deflation Does inflation necessarily hurt everyone?
Real interest rate – Nominal interest Rate = 10%
– Inflation affects people differently
– Expected inflation Rate = 5%
Unanticipated positive inflation
– Real Rate = 10% - 5% = 5%
– Creditor loses – Debtors gains
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Inflation and Deflation
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Inflation and Deflation
Protecting against inflation
The resource cost of inflation
– Cost-of-living adjustments (COLAs)
– Repricing, or menu, cost of inflation
• Clauses in contracts that allow for increases in specified nominal values to account of changes in the cost of living
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• The cost associated with recalculating prices and printing new price lists when there is inflation
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Changing Inflation and Unemployment: Business Fluctuations Business Fluctuations
Changing Inflation and Unemployment: Business Fluctuations Expansion
– The ups and downs in overall business economic activity • National income • Employment • Price level
– A business fluctuation in which overall business activity is rising at a more rapid rate than previously or at a more rapid rate than the overall historical trend for the nation
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Changing Inflation and Unemployment: Business Fluctuations Contraction
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Changing Inflation and Unemployment: Business Fluctuations Recession
– A business fluctuation during which the pace of national economic activity is slowing down
– A period of time during which the rate of growth of business activity is consistently less than its long-term trend or is negative
Depression – An extremely severe recession
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National Business Activity, 1880–Present
nd tre wth o r G
C (re ontr ce ac ss tio Trough ion n )
Figure 7-8
ans io
Peak
n
Peak
Exp
Level of National Business Activity
The Typical Course of Business Fluctuations
Time
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Changing Inflation and Unemployment: Business Fluctuations
Figure 7-9
Source: American Business Activity from 1790 to Today, 67th Edition, AmeriTrust Co., January 1996, plus author’s projections.
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Changing Inflation and Unemployment: Business Fluctuations Leading Indicators
Explaining business fluctuations: external shocks
– Events that typically occur before, or “lead” changes in business activity
– War
– Leading indicators can be used to identify external shocks.
– Weather patterns
– Examples of recession indicators • Reduction in the average workweek • Decrease in prices of raw materials • Drop in the quantity of money circulating
– Oil shock
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Issues and Applications: Using Leading Indicators to Predict Business Fluctuations The Leading Economic Indicators Index as compiled by the Conference Board includes items such as – Changes in hourly employment
Issues and Applications: Using Leading Indicators to Predict Business Fluctuations These LEI measures have been selected because they all preceded past recessions. The Conference Board regularly revises the index to include factors that are likely to predict future recessions.
– Changes in the number of new unemployment claims – New manufacturing orders – The number of building permits Slide 7-69
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Summary Discussion of Learning Objectives
Web Links The following Web links appear in the margin of this chapter in the textbook: – http://www.imf.org/external
How the U.S. government calculates the official unemployment rate – Unemployment is the percentage of the labor force that is looking for work and currently not working
Types of Unemployment
– http://www.nber.org
– – – –
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Frictional Structural Cyclical Seasonal
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Summary Discussion of Learning Objectives
Summary Discussion of Learning Objectives
How price indexes are calculated and the key price indexes – A price index is the cost of today’s market of goods expressed as a percentage of the cost of the same markets basket during a base year – Key price indexes
The nominal versus the real interest rate – Real interest rate = nominal interest rate - anticipated rate of inflation
Those who lose from inflation and those who gain – Losers are creditors – Gainers are debtors
• CPI • PPI • GDP Deflator
Key features of business fluctuations – Contractions – Expansions Slide 7-73
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End of Chapter
Chapter 7 The Macroeconomy: Unemployment, Inflation, and Deflation Copyright © 2004 Pearson Addison Wesley. All rights reserved.
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