Unemployment and InflationUnemployment and Inflation

EVERYONE’S NIGHTMARE

Chapter 6

Unemployment and InflationUnemployment and Inflation

The two key concepts of Macroeconomics– Either can destabilize

the economy.– When BOTH happen

together – REALLY, REALLY BAD.

STAGFLATION

UnemploymentUnemployment

People who are looking for work but have no jobs.– ACTIVELY

LOOKING is critical to the definition.

Definitions for UnemploymentDefinitions for Unemployment

Labor Force = Employed + unemployed

Unemployment Rate = number of unemployed / total labor force

Labor Force Participation Rate = labor force / population 16 and over

Definitions of UnemploymentDefinitions of Unemployment

Discouraged Workers – People who left the

labor force because they could not find jobs.

Underemployed– Workers holding part-

time work, but prefer full-time work OR hold jobs that are far below their capabilities.

The reasons for The reasons for unemploymentunemployment

Frictional Unemployment

Structural Unemployment

Seasonal Unemployment

Cyclical Unemployment

Cyclical UnemploymentCyclical Unemployment

When GDP fluctuates demand in the economy is not sufficient to provide jobs for all those who seek work.– Recession– Depression

Frictional UnemploymentFrictional Unemployment

People in between jobs.

Short period of time while changing jobs.

3% - 4% frictional employment is considered normal.

Structural UnemploymentStructural Unemployment

When changes in market supply or demand conditions affect major industries or regions.

The part of unemployment that results from the mismatch of skills and jobs.

Causes of Structural Causes of Structural UnemploymentUnemployment

Decline in demand for a product

Increased foreign competition

Automation of production Increased raw material

costs Lack of labor mobility

between occupations or regions.

Seasonal UnemploymentSeasonal UnemploymentNot included in your book – but in most Not included in your book – but in most

other Econ textsother Econ texts Most seasonal

unemployment is tends to occur in certain industries. – Hotel and catering – Tourism – Fruit picking – Christmas

Suspicious Unemployment Suspicious Unemployment StatisticsStatistics

Natural Rate of Unemployment– Level of unemployment at

which there is no cyclical unemployment.

Full Employment– Level of employment that

occurs when the unemployment rate is at the “natural rate.”

QOD:QOD:

Why do we need unemployment to make the economy healthy?

The Natural Rate of The Natural Rate of UnemploymentUnemployment

Depending on whom you talk to …

4% to 5% is considered the natural rate.– Consists of only

structural and frictional unemployment.

Historic Unemployment RatesHistoric Unemployment Rates

1933 during the Great Depression – 25%

1998 – Unemployment fell to 3.9%

October 2009 – 10.2% - highest in 26 years!

3.9% Unemployment3.9% Unemployment

Why wouldn’t this be good for the economy???

Wage InflationWage Inflation

How do employers attract or keep employees if there is not enough workers? – Higher Wages– More Benefits

– 1999, Amigos was paying $9 per hour and McDonalds offered $500 signing bonuses.

Why would that be bad?Why would that be bad?

Costs go up (labor), so prices have to be upped to cover labor.

Higher prices make workers demand more money.

Cost – Push Inflation

BTW: Current Data on BTW: Current Data on Unemployment for the USUnemployment for the US

According to the Bureau of Labor Statistics (www.bls.gov)– Unemployment Rate

in October – 10.2%

Average Hourly Earnings are up $ .01 in September.

Unemployment DataUnemployment Data

Previously: 303,000 new jobless claims were filed in March 2009.

October 2009 claims dropped 3000 to 523700.

How does the US compare?How does the US compare?07-September 0907-September 09

BRIC Country UnemploymentBRIC Country Unemployment

Brazil – 9.7% (est.) Russia – 6.4% (est.) India – 6.8% (DOWN) China – 4.0%

(UNRELIABLE!)

BTW:BTW:

Top 3 of unemployment:– Nauru– Liberia– Zimbabwe

Stuff I know Christa wants to Stuff I know Christa wants to know - know -

Countries with the lowest unemployment– Andorra– Monaco– Qatar

ReviewReview

How do economists measure the unemployed?

Previously unemployed individuals who have stopped looking for work are called ____ workers.

What are the types of unemployment?The natural rate of unemployment consists

solely of _______ and ____ unemployment.

The Consumer Price Index The Consumer Price Index and the Cost of Livingand the Cost of Living

The INFLATION Indicators

What do you think?What do you think?

1976: Starting salary for an economics professor was $15,000

2001: Starting salary for an econ prof was $55,000.

Considering the REALITY PRICIPLE, who had a better life?

Reality PrincipleReality Principle

What matters to people is the real value of money – its PURCHASING POWER – not the nominal or face value of money.

CPI: CPI:

Consumer Price Index A price index that

measures the cost of a fixed basket of goods chosen to represent the consumption pattern of individuals.– Tracks the cost of

living over time.

What is in the “market What is in the “market basket”?basket”?

Food and Beverages Housing Apparel Transportation Medical Care Recreation Education Other goods and services

Food and BeveragesFood and Beverages

Breakfast Cereal Milk Chicken Wine Coffee Service meals Snacks

HousingHousing

Rent for primary residences

Owners equivalent rent

Fuel Oil (home heating)

Bedroom furniture

ApparelApparel

Men’s shirts and sweaters

Women’s dresses Jewelry

TransportationTransportation

New cars Airline fares Gasoline Car insurance

Medical CareMedical Care

Prescription drugs Medical supplies Doctor services Eyeglasses Eyeglass services Hospital care

RecreationRecreation

Television Pets Pet products Sports equipment Admissions

Education and Education and CommunicationCommunication

College Tuition Postage Telephone Services Computer Software Computer accessories

Other Goods and ServicesOther Goods and Services

Tobacco and smoking products

Haircuts Other personal

services Funeral Expenses

BTWBTW

CPI - U for 2009: UP .1% so far for the year.

CPI – U for 2009 w/o fuel

costs and food. – UP .2%

How does that compare with our wages?

Statistics from bls.gov

CPICPI

Used by both government and the private sector to measure changes in prices facing consumers.

SEE PAGE 122 to calculate CPI

CPI versus Chained GDPCPI versus Chained GDP

CPI measures goods produced in prior years (older cars) as well as imported goods.

Chained GDP does not measure either of these. ONLY new goods and those produced in the country.

CPI v. Chained GDPCPI v. Chained GDP

Because consumers will cut back on goods that cost more – the CPI will tend to overstate true changes in cost of living.– If chicken goes up in

price, we switch to hamburger.

CPI ProblemsCPI Problems

Does not “cut back” on higher priced goods like consumers do.

Would still count the same share of chicken as it did before the price index.

What Economists THINKWhat Economists THINK

CPI may be overestimated by .5% to 1.5% each year.

BIG argument among the econ community.

Cost of Living AdjustmentsCost of Living Adjustments

Automatic increases in wages or other payments that are tied to a price index.

For Future Reference on contract negotiations: Called COLA.

COLA and CPICOLA and CPI

As CPI goes up, our wages or Social Security makes adjustments to keep up with the cost of living.– SEE PAGE 124 THE

CPI AND SOCIAL SECURITY

INFLATION!!!INFLATION!!! Inflation Rate:

– The percentage rate of change of the price level of the economy.

Calculating Inflation RatesCalculating Inflation Rates

Inflation Rate = percentage rate of change of a price index.

See page 124 for more on how to calculate!

Looking AheadLooking Ahead

Two “Schools” of Macroeconomics– Classical Economics– Keynsian Economics

Classical Economics Classical Economics

A school of economic thought that provides insights into the economy when it operates at or near full employment.– Popular thought so far in

2006.– Picture of David Ricardo

(Travis’ favorite economist) Darwin meets Economics

Keynsian EconomicsKeynsian Economics

A school of economic thought that provides insights into the economy when it operates away from full employment.– Economic fluctuations,

business cycles, sharp changes in the economy.

THIS Concludes what the book has THIS Concludes what the book has on unemployment and inflationon unemployment and inflation

I THINK you need and deserve more info on inflation!

So what is so wrong if everyone who So what is so wrong if everyone who wants a job has a job?wants a job has a job?

THE ANSWER????THE ANSWER????

INFLATION– The trade-off with

more employment.

                                                                                   

                                                             

What is the CPI pattern in What is the CPI pattern in 2009?2009?

CPI measures the dollar’s worth.– Check out the website

http://minneapolisfed.org/Research/data/us/calc/index.cfm

TRY THE professor’s salary from the beginning with this site!

Types of InflationTypes of Inflation

Demand-Pull Inflation Cost-Push Inflation Monetary Inflation Stagflation Hyperinflation

Demand-Pull InflationDemand-Pull Inflation

When the demand for goods and services exceeds the production capacity.– Prices rising because

of shortages.

Cost-Push InflationCost-Push Inflation

Inflation can arise from changes in the costs of production of goods and services.– Increase in the price of raw

materials– Increase in the price of

labor– Increase in the cost of

capital.

Cost-Push v. Demand Pull Cost-Push v. Demand Pull

They push and pull prices up.– Labor contracts

containing COLA clauses.

Cost-Of-Living

Adjustments.

Monetary InflationMonetary Inflation

Inflation caused by excessive growth in the money supply.– Value of money

decreases if it isn’t that “rare.”

Rule for Monetary Inflation: Rule for Monetary Inflation: VELOCITYVELOCITY

Quantity Equation– M x V = T x P– Money supply times

the velocity at which it changes hands equals the number of transactions times the average level of prices.

M x V = T x PM x V = T x P

Direct relationship between the money supply and the price level.

What happens when the What happens when the quantity equation is “off”?quantity equation is “off”?

Hyperinflation Money supply

increases much, much faster than an economy’s output of goods and services.– THINK RUSSIA in

1990s.– Zimbabwe in 2000s– Germany post WWI

Phillips Curve: The Phillips Curve: The relationship between relationship between

unemployment and inflation.unemployment and inflation.INVERSE relationship.

Unemployment goes UP, then inflation goes DOWN.

Stagflation: When things Stagflation: When things REALLY go wrong on the REALLY go wrong on the

Phillips CurvePhillips Curve Inflation and

unemployment were at higher levels.– Combination of

stagnation and inflation.

– Both were increasing.

1970s: What caused 1970s: What caused Stagflation?Stagflation?

Spending on the Vietnam War PLUS spending on domestic social programs.

Inflationary expectations

Rise in energy costs caused by OPEC

Monopolistic pricing

What is wrong with Inflation?What is wrong with Inflation?

Inflation reduces REAL INCOME of those whose incomes do not rise as fast as the price level.

Hurts:– People holding assets

in MONEY– Lenders

Special Note: Phillips Curve Special Note: Phillips Curve InternationalInternational

– Europe 1970s had higher inflation and unemployment.

– Worse because: Labor union practices Tax structures Government economic

policies

Consequences of Consequences of UnemploymentUnemployment

Real Output Effects– Each 1% of unemployment

results in a reduction of $100-billion in output.

– Lower real investment means less growth and reduced future output.

– OKUN’S LAW!

Consequences of Unemployment

Income EffectsIncome Effects Loss of income and Loss of income and

benefits (Health benefits (Health insurance)insurance)

Loss of income to Loss of income to others because of others because of reduced purchasing reduced purchasing powerpower

Reduced tax income Reduced tax income and increased outlays and increased outlays of government.of government.

Consequences of Consequences of UnemploymentUnemployment

Social Effects– Health Problems– Increased suicides– Break up of families– Increased child abuse– Increased crime

Consequences of INFLATIONConsequences of INFLATION

Income Effects:– Reduced purchasing

power of the dollar– Reduced real income

for fixed income receivers

– Reduced real wealth of savings

Income Effects of Inflation Income Effects of Inflation (cont.)(cont.)

Benefits those whose incomes rise faster than the inflation rate.

Benefits owners of real assets (real estate, precious metals (kinda!))

Benefits debtors

How Inflation effects Real How Inflation effects Real OutputOutput

Inflation initially stimulates output

Near full employment, there arise bottlenecks in supplies

Costs begin rising faster than prices

Interest rates accelerate, discouraging new investment.