Unemployment

1
Unemployment

• Chapter 6

2
The Labor Force

• The labor force includes all persons over age
  sixteen who are either working for pay or
  actively seeking paid employment.
• People who are not employed or are not actively
  seeking work are not considered part of the labor
  force.
• The labor-force participation rate is the
  percentage of the population working or seeking
  employment.

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The Labor Force, 2003
5
A Growing Labor Force
Participation Rates (age 16 and older)
Men
Women
Year
86.4
1950
33.9
83.3
1960
37.7
79.7
1970
43.3
77.4
1980
51.5
76.4
1990
57.5
74.7
2000
60.0
73.5
2004
59.5
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Growth of Production Possibilities

• Production is limited by two factors
• The availability of factors of production.
• Technological know-how.
• A growing labor force creates long-run economic
  growth or an expansion of production
  possibilities curve.

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Labor Force Growth
C
Labor-force growth increases production
possibilities
D
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Institutional Constraints

• In addition to available resources and
  technology, production possibilities in any year
  depend on how we choose to restrict their use.
• The size of labor force is limited by
  participation rates and social regulation.

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Unemployment

• To make full use of available production
  capacity, the labor force must be fully employed.
• Unemployment is the inability of labor-force
  participants to find jobs.
• Okuns Law asserts that 1 more unemployment is
  estimated to equal 2 percent less output.

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The Unemployment Rate

• A person is considered unemployed if he or she is
  not employed and is actively seeking a job.
• The unemployment rate is the proportion of the
  labor force that is unemployed.

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Unemployment Is not Experienced Equally by
Education
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Duration of Unemployment

• When the economy is growing, both unemployment
  rates and the average duration of unemployment
  decline.

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Reasons for Unemployment

• How long a person remains unemployed is affected
  by the nature of the joblessness.
• Job leavers
• Job losers
• Re-entrants
• New entrants

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Reasons for Unemployment
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Discouraged Workers

• A discouraged worker is an individual who is not
  actively seeking employment but would look for or
  accept a job if one were available.
• Discourage workers are not counted as part of the
  unemployment problem after they give up looking
  for a job.

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Underemployment

• Underemployed workers represent labor resources
  that are not being fully utilized.
• Underemployment exists when people seeking
  full-time paid employment work only part time or
  are employed at jobs below their capability.

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The Phantom Unemployed

• Some of the people who are counted as unemployed
  probably should not be.
• Many people report that they are actively seeking
  work when they have little interest in finding a
  job.
• Public policy encourages this behavior by
  requiring most welfare and unemployment benefit
  receivers to provide evidence that they are
  looking for work.

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Europes Unemployment Woes

• Unemployment levels in Europe are higher than
  those of the U.S.
• Analysts cite inflexible labor markets,
  regulation, and high unemployment benefits.

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Defining Full Employment

• Full employment is not the same as zero
  unemployment.

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Seasonal Unemployment

• Seasonal unemployment is the unemployment due to
  seasonal changes in employment or labor supply.
• At the end of each season, thousands of workers
  must go searching for new jobs, experiencing
  seasonal unemployment in the process.

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Frictional Unemployment

• Frictional unemployment is the brief periods of
  unemployment experienced by people moving between
  jobs or into the labor market.
• Frictional unemployment differs from other
  unemployment in three ways
• There is an adequate demand for the labor of the
  frictionally unemployed.
• The frictionally unemployed have the skills
  required for existing jobs.
• The job-search period will be relatively short.

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Structural Unemployment

• Structural unemployment is the unemployment
  caused by a mismatch between the skills (or
  location) of job seekers and the requirements (or
  location) of available jobs.

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Cyclical Unemployment

• Cyclical unemployment is the unemployment
  attributable to the lack of job vacancies i.e.,
  to an inadequate level of aggregate demand.
• The economy must grow at least as fast as the
  labor force to avoid cyclical unemployment.

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The Unemployment Record
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Inflationary Pressures

• In the early 1960s, the Council of Economic
  Advisors concluded that rising prices are a
  signal that employment is nearing capacity.
• The Council placed full employment at 4 below
  that, prices begin rising.

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The Natural Rate of Unemployment

• The natural rate of unemployment is the long-term
  rate of unemployment determined by structural
  forces in labor and product markets.
• The natural rate of unemployment consists of
  frictional and structural components only.
• Non-Accelerating Inflation Rate of Unemployment
  (NAIRU)

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Redefining Full Employment

• Critics suggested that structural barriers to
  full employment had gotten worse.
• More youth and women.
• Liberal transfer payments.
• Structural changes in demand.
• During 1970s and early 1980s the 4 unemployment
  goal was considered too low.
• The inflation-threshold unemployment rate was
  raised to between 6 to 7.

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Inflation

• Chapter 7

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What Is Inflation?

• Inflation is an increase in the average level of
  prices, not a change in any specific price.
• The average price is determined by finding the
  average price of all output.
• A rise in the average price is called inflation.
• A fall in the average price is called deflation.

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Relative Prices vs. the Price Level

• Relative price is the price of one good in
  comparison with the price of other goods.
• A general inflation may prevent relative price
  changes from reallocating resources in the
  economy.

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Price Effects

• Price changes are the most familiar effect of
  inflation.
• The effect on economic welfare is shown in the
  difference between nominal and real income.

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Price Effects

• Nominal income is the amount of money income
  received in a given time period, measured in
  current dollars/crowns.
• Real income is income in constant dollars/crowns
  nominal income adjusted for inflation.
• The use of nominal dollars/crowns rather than
  real dollars/crowns to measure changes in ones
  income or wealth is called the money illusion.

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Price Effects

• Two basic lessons about inflation

• Not all prices rise at the same rate during
  inflation.
• Not everyone suffers equally from inflation.
• Although inflation makes some people worse off,
  it makes some people better off.

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Price Changes in 2003
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Income Effects

• Even if all prices rose at the same rate,
  inflation would still redistribute income.
• Redistributive effects originate both in
  expenditure and income patterns.

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Income Effects

• What looks like a price to a buyer looks like an
  income to a seller.
• If prices are rising, incomes must be rising too.

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Nominal Wages and Prices
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Wealth Effects

• Winners and losers from inflation depend on the
  form of wealth they own.
• You lose when inflation reduces the real value of
  wealth.

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The Real Story of Wealth
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Redistributions

• Inflation acts like a tax, taking income or
  wealth from one group and giving it to another.
• The redistributive mechanics of inflation include
  price effects, income effects, and wealth effects.

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Price Effects

• People who prefer goods and services that are
  increasing in price least quickly end up with a
  larger share of income.

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Income Effects

• People whose nominal income rises faster than
  inflation end up with a larger share of total
  income.

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Wealth Effects

• Owners of assets that increase in real value end
  up better off than others.

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Social Tensions

• Tensions between labor and management, between
  government and the people, and among consumers
  may overwhelm a society and its institutions.

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Macro Consequences

• Inflation can alter the rate and mix of output by
  changing consumption, work, saving, investment,
  and trade behavior.

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Uncertainty

• People tend to shorten their time horizons in the
  face of inflation uncertainties.
• Time horizons are shortened as people attempt to
  spend money before it loses further value.

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Speculation

• Few people will engage in production if it is
  easy to make speculative profits.
• Such speculation may fuel hyperinflation.
• Hyperinflation is an inflation rate in excess of
  200 percent, lasting at least one year.

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Deflation Dangers

• Deflation a falling price level might not
  make people happy either.
• Deflation reverses the redistributions caused by
  inflation.
• Lenders win and creditors lose.

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Deflation Dangers

• Falling price levels have similar macro
  consequences.
• Time horizons get shorter.
• Businesses are more reluctant to borrow money or
  to invest.

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Consumer Price Index (CPI)

• The consumer price index (CPI) is a measure
  (index) of changes in the average price of
  consumer goods and services.
• By observing the extent of price increases, we
  can calculate the inflation rate.
• The inflation rate is the annual percentage rate
  of increase in the average price level.

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Constructing the CPI

• The Bureau of Labor Statistics constructs a
  market basket of goods and services that
  consumers usually buy.
• The CPI is usually expressed in terms of what the
  market basket costs in a specific base period.

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Constructing the CPI

• The relative importance of a product in the CPI
  is reflected in its item weight.
• Item weight is the percentage of total
  expenditure spent on a specific product used to
  compute inflation indexes.

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Constructing the CPI

• The impact on the CPI of a price change for a
  specific good is calculated as follows

change in CPI item weight X percentage
change in price of item
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The Market Basket
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Quality Changes

• The CPI is not a perfect measure of inflation
  because an increase in price may be caused by
  quality improvements.
• Over time, the goods themselves change as a
  result of quality improvements.
• The CPI is biased upward when new products whose
  prices are falling are left out of the market
  basket.

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Producer Price Indexes

• There are three producer price indexes (PPI)
  which keep track of average prices received by
  producers.
• One includes crude materials, another
  intermediate goods, and the last covers finished
  goods.

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The GDP Deflator

• The GDP deflator is a price index that refers to
  all goods and services included in GDP.
• It is the broadest price index is the GDP
  deflator.
• It covers all output including consumer goods,
  investment goods, and government services.

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The GDP Deflator

• The GDP deflator usually registers a lower
  inflation rate than the CPI.
• Unlike the CPI and PPI, the GDP deflator is not
  limited to a fixed basket.
• Its value reflects both price changes and market
  responses to those changes.

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Real vs. Nominal GDP

• The GDP deflator is used to adjust nominal output
  values for changing price levels.
• Nominal GDP is the value of final output produced
  in a given period, measured in the prices of that
  period (current prices).
• Real GDP is the value of final output produced in
  a given period, adjusted for changing prices.

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Real vs. Nominal GDP

• Nominal and Real GDP are connected by the GDP
  deflator

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Unemployment Concerns

• Most governments decree price stability to be a
  foremost policy goal.
• The government might have to restrain spending in
  the economy to keep prices from rising.
• This could lead to cutbacks in production and an
  increase in joblessness.

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The Historical Record

• In the long view of history, the U.S. has done a
  good job in maintaining price stability.
• Upon closer inspection, however, our inflation
  performance is very uneven.

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Annual Inflation Rates
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Causes of Inflation

• The cause of inflation is rooted in supply and
  demand.

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Demand-Pull Inflation

• Demand-pull inflation results from excessive
  pressure on the demand side of the economy.
• Too much money chases too few goods enabling
  producers to raise prices.

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Cost-Push Inflation

• The pressure on price could also originate on the
  supply side.
• Higher production costs put upward pressure on
  product prices.

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Protective Mechanisms

• Low rates of inflation do not have the shocking
  effect of hyperinflation, but they still
  redistribute real wealth and income.

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COLAs

• Market participants can protect themselves by
  indexing their nominal incomes.
• Cost-of-living adjustments (COLAs) are automatic
  adjustments of nominal income to the rate of
  inflation.

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ARMs

• An adjustable-rate mortgage (ARM) is a mortgage
  (home loan) that adjusts the nominal interest
  rate to changing rates of inflation.

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ARMs

• The real interest rate is the nominal interest
  rate minus the anticipated inflation rate.

Real interest rate nominal interest rate
anticipated interest rate
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The Cost of Mismeasurement

• Proliferation of COLAs and ARMs makes the CPI a
  critical statistic in todays economy.
• If CPI goes up, so do government transfer
  payments, union wages, and nominal interest rates.