Unemployment and Inflation

i.e. two evils of the economy will be

discussed.

Component Parts GDPConsumptionInvestment

Government SpendingExports- Imports (Net Exports)

C+I+G+(X-M) = GDP

Revised

GDP 2007 to 2010 – Non-revised

Unemployment to August 2011

Now- was that a bad recession????

Why does growth matter?

Allows wages and incomes to rise.

Standard of living increases

Takes the pressure of scarce resources… (why?)

Main Sources of GrowthTwo ways that society can increase its

real output and income:1) increase inputs of resources2) increase productivity of those inputs

BLS Latest Numbers

Macroeconomic Problems High inflation rate High unemployment rate High interest rates Low economic growth or stagnation

Macroeconomic Policies Fiscal Policy deals with

changes in government expenditures and/or taxes. to achieve particular macroeconomic goals.

Monetary Policy deals with. changes in the money supply, or the rate of growth of the money supply, to achieve particular macroeconomic goals.

Different Views of How the Economy Works-Stable-Unstable The economy is

inherently stable and self-regulating.-Classical

The economy is inherently unstable and requires intervention to correct problems.-Keynesian

Macro deals with entire economySubject matter includes: Macroeconomic problems – high

unemployment Macroeconomics theories – government

spending Macroeconomics policies- use fiscal policy Different view on how the economy works-

self-correcting, government stimulus

The Idealized Course of Business Fluctuations

Consensus among Economists says swings due to:Changes in REAL levels of output

and employment brought about by changes in levels of TOTAL SPENDING.

Spending

Businesses no longer produce at current level

Output, employment and income fall

In reverse… the opposite results.

What are component parts of GDP?

?

Important economic fact:

As the economy gets close to FULL EMPLOYMENT

It is more difficult to obtain further gains in REAL OUTPUT.

Continued increasing levels of spending bring about INFLATION

REAL GDP (as opposed to what???)

Real GDP The value of

the entire output produced annually within a country’s borders, adjusted for price changes.

REAL VS NOMINAL GDP

What is the difference??

Inflation-----------

Inflation is BAD!

What will we focus on?

This will focuses on economic growth, the business cycle, unemployment and inflation. When is a person “unemployed”? What are the costs of unemployment? -When will money not buy as much?

Unemployment since 1990

Current Unemployment Rate today is????????

8.2%

What is 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. When is a person “unemployed”? What are the costs of unemployment?

How is unemployment measured?

U.S. Census Bureau surveys about 60,000 households a month to determine how many people are actually unemployed.

This translates into approximately 110,000 individuals, a large sample compared to public opinion surveys which usually cover fewer than 2,000 people.

Sampling for unemployment Every month, one-fourth of the households in the

sample are changed, so that no household is interviewed more than 4 consecutive months.

Similarly, interviewers do not decide the respondents' labor force classification. They simply ask the questions in the prescribed way and record the answers. Based on information collected in the survey and definitions programmed into the computer, individuals are then classified as employed, unemployed, or not in the labor force.

Bureau Labor Statistics determines perimeters for unemployment. Persons over 16 are considered

employed IF: They worked at all for pay or

profit even if for an hour Worked 15 hours or more w/out

pay in a family-operated enterprise.

Have a job which they did not work during (survey week) due to illness, vacation, industrial disputes, bad weather, time off or personal reasons.

BLS Continued

Persons are considered unemployed IF: (during the survey week)

Do not have a job Are available for work Have actively looked & looked

for work during past four weeks (this requirement is very weak…)

Reason for unemployment

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

What happens if you can’t find work……. If unemployment persists… workers often give-up

looking. Discouraged workers are not counted as part of

the unemployment problem after they give up looking for a job.

Some people are forced to take any job available which means…no longer unemployed, but now“underemployed.”

How could one be underemployed?Underemployment exists when people

seeking full-time paid employment, work only part time, or are employed at jobs below their capability.

Underemployed workers represent labor resources that are not being fully utilized.

Unemployment Cont.

Seasonal unemployment is the unemployment due to seasonal changes in employment or labor supply. What would be an example?

At the end of each season, thousands of workers must go searching for new jobs, experiencing seasonal unemployment in the process.

Three basic kinds of unemployment:

1. 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:

Demand is there Frictionally unemployed have the skills

required Job search relatively short

3 Kinds of Unemployment Cont.

2. 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.

Periods between jobs will be lengthened when the unemployed lack the skills that employers require.

3 Kinds of Unemployment Cont.

3. Cyclical Unemployment Cyclical unemployment is the

unemployment attributable to the lack of job vacancies – i.e., to an inadequate level of aggregate demand.

Cyclical unemployment occurs when there are simply not enough jobs to go around.

Source: U.S. Department of Labor, Bureau of Labor Statistics

More Than a Century of Unemployment

OKUN’S Law

Okun’s Law Arthur Okun quantified the relationship between

the shortfall in real output and unemployment.

High unemployment in 1992 left the U.S. $240 billion short of its production possibilities — a loss of $920 of goods and services for every American.

Labor Force? Okun’s Law Slow Growth…. The economy must grow at least as fast as the

labor force to avoid cyclical unemployment. Relationship between the shortfall in

output and unemployment. When you have unemployment of any

significance, your economy will have reduced output. Ratio accepted today is 1% of unemployment yields 2% less output.

A 2/1ratio then allows economists to put a $$$ amount on the cost of unemployment to the economy.

Think about this!

Unemployment = 5% (NARU)Unemployment = 8% (x 2 = 16% less

production)Unemployment = 25% (depression era x

2) = 50% less production!Today (2010) = 8.2 x 2 =16.4% less

So… what is full employment?

Full employment is not the same as zero unemployment.

The economy strives to reach its potential which means that full employment is essential.

When the actual rate of unemployment exceeds the natural rate, the actual output of the economy will fall below its potential.

Resources are underutilized (inside production possibility curve.)

Full Employment

The condition that exists when the unemployment rate is equal to the natural unemployment rate.

Image Cylinder= Economy…

Businesses, factories, economynot working at full capacity

Full Employment

AS AD

LRAS

Full Employment Act of 1946

The Full-Employment Goal

In the Employment Act of 1946, Congress committed the federal government to pursue a goal of “maximum” employment.

Congress didn’t specify what the rate of unemployment should be.

Congress creates confusion

First attempt to define “full employment” came about 1960- Council of Advisors decided that full employment meant “watching prices” …..

Rising prices they said would signal that full employment was being reached.*** believed inverse relationship unemployment/inflation

In 1970-80 Full employment potential was considered overly optimistic.

Unemployment rates stayed far above 4% even when the economy expanded.

Inflation began to accelerate at higher levels of unemployment.

Confusion Continued The redefinition of full employment goal

needed to be addressed. Needed to realize more youth and women in

the labor force Needed to acknowledge the increased transfer

payments Needed to acknowledge the structural changes

in demand (for such things as technology and trade) old industries were not in such demand (steel, textiles, auto)\

Most economists say 5% today

Humphrey-Hawkins Act of 1978

This Act was passed to require the Federal Reserve to maintain a 4% rate of unemployment without inflation while holding the inflation to a goal of 3% by implementing monetary policy where needed.

Fiscal policy might undo this law, but it is still a focus of the Fed and the Fed has to report to Congress twice a year on the health of the American economy.

Natural Rate of UnemploymentNARUNARU = the difference between full

employment and 100% employment. A level of unemployment that will not trigger

inflation. i.e. this figure will not bid up wages.

The natural rate of unemployment is not a temporary high or low… it is a rate that is sustainable into the future.

Depression Unemployment

Our greatest failure occurred during the Great Depression, when as much as one-fourth of the labor force was unemployed.

The Historical Record Unemployment rates fell dramatically during

World War II — the civilian unemployment rate reached a rock bottom 1.2 percent.

Since 1950, unemployment rate has fluctuated from a low of 2.8 percent during the Korean War (1953) to a high of 10.8 percent during the 1981-82 recession.

From 1982 to 1989, unemployment fell, but shot up again in the 1990-91 recession.

In…2002…unemployment was circa 5.7%

In…2004…unemployment was circa 6.5% February, 2005… 5.4% September, 2005….5.1% February, 2006….. 4.8% January, 2007…….4.6% October, 2007…….4.7% October, 2008…….6.1% February, 2009 …..7.6% July, 2009 ………. 9.5% September 2009….9.7% October, 2009 – 10.1 February. 2010 – 9.7 May, 2010 – 9.3 June, 2010- 9.7

October, 2010 9.6

What about the other evil?

Inflation and Deflation

Inflation A sustained increase in the average of all

prices of goods and services in an economy

Deflation A sustained decrease in the average of all

prices of goods and services in an economy

Looking at the past

In 1923, prices in Germany rose a trillion times over.

Prices in Russia, Bulgaria, and some other nations have witnessed a tenfold increase in a year.

In the 1990’s the U.S. inflation rate has risen 1 to 4 percent a year.

Inflation…is bad…is bad..is bad!What is inflation?A continuing rise in the average level of

prices.(it costs more to purchase the typical “bundle” of goods and services that is produced or consumed or both.)

Bottom line: Too many $$$$ chasing too few goods.

The CPI is based on what it costs an average family to live.

Just think… Inflation enables us to live in more expensive neighborhoods without having to move

Inflation is bad… see???Shortened Time Horizons During the German hyperinflation, workers

were paid two or three times a day so that they could buy goods in the morning before prices increased in the afternoon.

Speculation People may be encouraged to withhold resources

from the production process, hoping to sell them later at higher prices.

Bracket Creep Under our progressive tax system, taxes go up

when prices rise. Savings, investment, and work effort decline.

Inflation discussionNotice we said an increase in the Average Level of prices. Not a change in any specific price…

Statisticians calculate the average then look for changes in the average. The Consumer Price Index for All Urban Consumers (CPI-U) decreased 0.4 percent in August, before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The August level of 219.086 (1982-84=100) was 5.4 percent higher than in August 2007. A decline in average prices = deflation.

Relative price means an increase in the price of apples (relative to other fruits) apples cost more than pears.

Inflation does not make ALL persons worse off. .

Nominal Income vs. Real Income What is the difference between nominal income

and real income.Nominal = income you receive in a particular

periodReal income = what you can use for

purchasing stuff.***If you nominal income does not change and

there is an increase in the average level of prices….. You cannot buy as much “stuff.”

If the number of dollars you receive every year is always the same, your nominal income doesn’t change- but your real income will rise or fall with price changes.

Another rule: If you put your money into savings and

keep it there rather than spending it, and inflation comes along…

your money in savings will not buy as much as it would prior to the wave of inflation that hit.

Uncertainty and Misconception

Money Illusion Even people whose nominal incomes keep up

with inflation often feel oppressed by rising prices.

They feel cheated when they discover that their higher nominal wages don’t buy additional goods.

Uncertainty One of the most immediate consequences of

inflation is uncertainty. Uncertainties created by changing price levels

affect consumption and production decisions.

Inflation discussion

Uncertainty on the part of the consumer in trying to outguess the price of goods and services.

If consumers or producers postpone or cancel their expenditure plans, the demand for g & s will fall. Eventually production falls, and unemployment occurs…

What Causes Inflation?

Nearly all economists believe that rapid expansion in the supply of money is the cause of inflation.

What happens if incomes go up to keep pace with inflation?

Bracket creep is the movement of taxpayers into higher tax brackets (rates) as nominal incomes grow.

Deflation Dangers Deflation — a falling price level —

might not make people happy either. Deflation reverses the redistributions

caused by inflation. (Example: people today – upside down on their houses.)

Speculations from consumption and production

If you expect prices to rise, it makes sense to buy things now for resale later.

People may be encouraged to withhold resources from the production process, hoping to sell them later at higher price

As such behavior becomes widespread, production declines and unemployment rises.

Measuring Inflation

Measuring inflation serves two purposes: Gauges the average rate of inflation. Identifies its principal victims.

Consumer Price Index (CPI) The CPI is the most common measure of

inflation. The consumer price index (CPI) is a

measure (index) of changes in the average price of consumer goods and services.

Macroeconomic Measures - Prices Price Level - A weighted average of the

prices of all goods and services. Price Index - A measure of the price level. Consumer Price Index (CPI) - A widely

cited index number for the price level; the weighted average of prices of a specific set of goods and services purchased by a typical household.

How to measure rate of inflationMeasuring the Rate of Inflation Market Basket

Representative bundle of goods and services

Base Year The point of reference for comparison of prices

in other years

Macroeconomic Measures - Prices

Base Year - The year chosen as a point of reference or basis of comparison for prices in other years; a benchmark year.

Computing the Consumer Price Index

Consumer Price Index (CPI)

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.

Changes in Prices

In 2005 the CPI was 195.3; in 2006 the index was 201.6. What was the percentage change in prices from 2005-2006?

Click below for answer.

3.22 %Here’s a little hint if you forget…C-L/L

Percentage change in prices = Current year - later year x100 later year

CPI determined Calculates the inflation rate Market basket of goods

and services (same each year.)

Bureau of Labor Statistics determines cost in 85 cities by shopping 184 items.

19,000 stores visited and 60,000 landlords,renters and homeowners surveyed each month

Statistics released each month.

Yearly average compiled.

CPI expressed in base year ’82-84

Constructing the CPI The base period is

the time period used for comparative analysis — the basis of indexing, for example, of price changes.

Shopping for CPI

CPI is constructed by identifying a typical bundle of goods that the average consumer buys. This bundle stays the same each year.

The base year is changed periodically. The base year used is ’82-’84 and prior to that it was ’63.The price level in the base period is designated as 100.

The market basket (bundle) can be changed if BLS research shows that the “average” consumer no longer is purchasing that good or service.

Each item in the bundle is weighted percent-wise in the market basket figures.

The Market Basket

Transportation19.0%

Housing32.6% Food

13.6%

Clothing 4.7%

Miscellaneous 10.5%

Health care 5.3%

Entertainment 5.1%

Insurance and pensions 9.3%

What is the difference?

So………if it cost you $225 in 2002 to buy the same bundle of goods that you bought in 1983, you would be paying 225% more for the same “stuff.”

Look at the inflationary costs of: cars, health care, housing, (house 4 bedrooms, 2 baths, in Highland Park in 1960 cost approximately $30,000.) (Today?????)

Calculations

Rate of Inflation = % of PI(price index) from one year to the next.

When prices are rising, on average, the price index will rise.

i = This year’s PI – Last year’s PI Last year’s PI x100If price index this year was 220 compared to 200

last year, the inflation rate would equal 10% 220 – 200 200 x 100 = 10 Formula hint: c-l/l x 100 (current-last/last x 100)

Let’s try another calculationIn 2008 – CPI measured 215.3In 2004 – CPI measured 188.9What was the rate of inflation from 04 – 08?

Ans. 13.9

Is there a safety shield against inflation?

Answer: not much!!!But Congress has passed the Cost-of-

living adjustment (COLA) provision for those receiving Social Security Checks.

Checks are indexed each January…in the amount equal to inflation the previous year.

If inflation was 3% then the checks are adjusted accordingly.

Unions also negotiate for this COLA in their pay proposals…

Bankers in business to make a profit.

Some bankers build in that same philosophy- Adjustable-rate mortgage (ARM) stipulates an interest rate that changes during the term of the loan.

Actually, banks build the inflation factor into all their loans…the number of points depends on many variables we will discuss later.

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

Inflation and Deflation (cont'd) Real-world price indexes

Consumer Price Index (CPI)

Producer Price Index (PPI)

GDP deflator

Personal Consumption Expenditure (PCE)

What is stagflation?

High inflation and high unemployment….

A period during which an economy is experiencing both substantial inflation and either declining or slow growth in output.

Economists used to say this would and could never happen… it did in the 80’s

Paul Volker entered the scene as Fed chairman and held court on monetary policy.. More of this story later…

CAUSES of inflation

1. Demand pull (too much aggregate demand and not enough aggregate supply.

Cost Push (production costs rise) supply decreases…

DD1

S

D

SS1

Explanations

Demand pull: Economy producing at capacity Consumers willing and able to buy more goods Can buy goods because of accumulated

savings or easy access to credit (refinancing the house, second mortgages in Texas, low interest loans, credit card interest rates low, prime rate very low.)

Pull to have more goods and only limited amount of goods available… causes prices to rise!

Hence, a demand-driven rise in average prices or demand-pull

Explanations Continued

Cost Push: When producers have to pay more for inputs

(resources for production), the price of the good produced increases.

OPEC- prices of crude escalates any product dependent on crude (including heating costs, increases).-News Flash! Winter of 2007-2008 heating home costs rose 22%

Explanation of Dollars in Cost-push

Labor has generally been the most expensive of inputs for production up till now in our economy.

If wage rates are pushed upward…. The good or service would have an increase in price (longshoreman’s union, pilots,) Note that most of these are union connected. Tech industry workers took about a 50% cut to get jobs in 2002 as opposed to their salaries in 1999.

If the Fed releases too much money in the economy (continually pushing down interest rates, the value of that money is not as solid as if there were less circulating… more later on that)

Check the current inflation rate………..

http://inflationdata.com/inflation/

Bureau of Labor Statistics

Another way to measure U.S. economic healthProducer Price Index: The PPIs keep track of average prices received

by producers. October 20, 2005….PPI up highest in 15 years. 3 indices…crude materials, intermediate

goods, finished goods. Identified in monthly surveys just like CPI is. In SR, PPI increases before CPI (takes a little

while for the prices to be reflected in products we buy.

Is the Growth of GDP real or inflated?

This is the real test!!!!!!! Was there actual increase in production

and services or did the prices just skew the GDP statistics when C+I+G was added?

Have to correct GDP for price changes so we can measure actual production.

CPI tells the consumer if they have to spend more dollars to get that loaf of bread… but other measures have to be evaluated.

Still another way to test the health of the U.S. economy

The GDP Deflator…. The broadest price index and covers all output including consumer goods, investment goods and government services. (C+I+G)

The GDP deflator isn’t a pure measure of price change. Its value reflects both price changes AND market responses to those price changes as reflected in new expenditure patterns.

The GDP deflator typically registers a lower inflation rate than CPI and the government watchdogs use this barometer more readily than current CPI

Bottom Line

CPI is designed to measure the impact of price changes on the cost of a typical bundle of goods purchased by households(remember, market basket and only for urban purchasers.)

GDP deflator is a broader price index and is designed to measure the change in the average price of the market basket of goods included in GDP (in addition to consumer goods it includes capital goods, & g & s by government.)

CPI measures money income of consumers in relation to rising prices (only consumer goods.)

GDP deflator measures economy wide inflation- more g & s included in measurement.

Personal Consumption Expenditure CPE More accurate than CPI Quantifies changing expenditure patterns

for consumers. Is a weighted measure Doesn’t always have same items calculated BEA uses continually updated surveys of

consumer purchases to determine index Federal Reserve uses this measure for their

predictions and assessments.

Historical Record Graph

20

16

12

8

4

0

4

8

12

1920 1930 1940 1950 1960 1970 1980 1990 2000

Inflation

B

A

Deflation

What really is the goal of fiscal and monetary planners?

The CPI’s market basket of goods and services was overhauled in 1998.

Price Stability….. Major changes in the general level of prices

indicate upsets in the economic system. Prices act as allocators of economic goods,

they are the mechanism that determines the answer to the three basic questions, What, How and For Whom.

Prices act as the basic force in a capitalistic economy

What does a pair of Nike shoes cost compared to a pair of Keds?