Unemployment and Inflation
EVERYONE’S NIGHTMARE
Chapter 6
Unemployment and Inflation

The two key concepts
of Macroeconomics
– Either can destabilize
the economy.
– When BOTH happen
together – REALLY,
REALLY BAD.

STAGFLATION
Unemployment

People who are
looking for work but
have no jobs.
– ACTIVELY
LOOKING is critical
to the definition.
Definitions 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 Unemployment


Discouraged Workers
– People who left the
labor force because
they could not find
jobs.
Underemployed
– Workers holding parttime work, but prefer
full-time work OR
hold jobs that are far
below their
capabilities.
The reasons for
unemployment

Frictional
Unemployment
 Structural
Unemployment
 Seasonal
Unemployment
 Cyclical
Unemployment
Cyclical Unemployment

When GDP fluctuates
demand in the
economy is not
sufficient to provide
jobs for all those who
seek work.
– Recession
– Depression
Frictional Unemployment

People in between
jobs.
 Short period of time
while changing jobs.
 3% - 4% frictional
employment is
considered normal.
Structural 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
Unemployment

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 Unemployment
Not included in your book – but in most
other Econ texts

Most seasonal
unemployment is
tends to occur in
certain industries.
–
–
–
–
Hotel and catering
Tourism
Fruit picking
Christmas
Suspicious Unemployment
Statistics

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:
 Why
do we need
unemployment to
make the
economy
healthy?
The Natural Rate of
Unemployment

Depending on whom
you talk to …

4% to 5% is
considered the natural
rate.
– Consists of only
structural and frictional
unemployment.
Historic Unemployment Rates

1933 during the Great
Depression – 25%
 1998 – Unemployment
fell to 3.9%
3.9% Unemployment

Why wouldn’t this be
good for the
economy???
Wage 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?

Costs go up (labor), so
prices have to be
upped to cover labor.
 Higher prices make
workers demand more
money.
– Push
Inflation
 Cost
BTW: Current Data on
Unemployment for the US

According to the
Bureau of Labor
Statistics
(www.bls.gov)
– Unemployment Rate
in February: 4.8%
Average Hourly
Earnings are up $ .05
in February.
Unemployment Data

Previously: 303,000 new
jobless claims were filed.

On March 16, new
numbers will be posted.
– See www.usatoday.com /
money and click on
economic calendar for the
latest posting.
Review

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
and the Cost of Living
The INFLATION Indicators
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 Principle

What matters to
people is the real value
of money – its
PURCHASING
POWER – not the
nominal or face value
of money.
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
basket”?








Food and Beverages
Housing
Apparel
Transportation
Medical Care
Recreation
Education
Other goods and services
Food and Beverages







Breakfast Cereal
Milk
Chicken
Wine
Coffee
Service meals
Snacks
Housing

Rent for primary
residences
 Owners equivalent
rent
 Fuel Oil (home
heating)
 Bedroom furniture
Apparel
Men’s shirts and
sweaters
 Women’s dresses
 Jewelry

Transportation

New cars
 Airline fares
 Gasoline
 Car insurance
Medical Care






Prescription drugs
Medical supplies
Doctor services
Eyeglasses
Eyeglass services
Hospital care
Recreation





Television
Pets
Pet products
Sports equipment
Admissions
Education and
Communication





College Tuition
Postage
Telephone Services
Computer Software
Computer accessories
Other Goods and Services

Tobacco and smoking
products
 Haircuts
 Other personal
services
 Funeral Expenses
BTW

CPI for 2006:
 UP .7% so far for the
year.

How does that
compare with our
wages?
 Statistics from bls.gov
CPI

Used by both
government and the
private sector to
measure changes in
prices facing
consumers.

SEE PAGE 122 to
calculate CPI
CPI 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 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 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 THINK

CPI may be
overestimated by .5%
to 1.5% each year.

BIG argument
among the econ
community.
Cost 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 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 Rate:
– The percentage rate
of change of the
price level of the
economy.
Calculating Inflation Rates

Inflation Rate = percentage rate of change
of a price index.
 See page 124 for more on how to calculate!
Looking Ahead

Two “Schools” of
Macroeconomics
– Classical Economics
– Keynsian 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 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
on unemployment and inflation
I THINK you need and deserve more
info on inflation!
So what is so wrong if everyone who
wants a job has a job?
THE ANSWER????
INFLATION
– The trade-off with
more employment.
What is the CPI pattern in
2005?

CPI measures the
dollar’s worth.
– Check out the website
http://minneapolisfed.org/
Research/data/us/calc/i
ndex.cfm
TRY THE professor’s
salary from the
beginning with this
site!
Types of Inflation





Demand-Pull Inflation
Cost-Push Inflation
Monetary Inflation
Stagflation
Hyperinflation
Demand-Pull Inflation

When the demand for
goods and services
exceeds the production
capacity.
– Prices rising because
of shortages.
Cost-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

They push and pull
prices up.
– Labor contracts
containing COLA
clauses.
 Cost-Of-Living
Adjustments.
Monetary Inflation

Inflation caused by
excessive growth in
the money supply.
– Value of money
decreases if it isn’t that
“rare.”
Rule for Monetary Inflation:
VELOCITY

Quantity Equation
– MxV=TxP
– Money supply times
the velocity at which it
changes hands equals
the number of
transactions times the
average level of prices.
MxV=TxP

Direct relationship
between the money
supply and the price
level.
What happens when the
quantity equation is “off”?

Hyperinflation
 Money supply
increases much, much
faster than an
economy’s output of
goods and services.
– THINK RUSSIA in
1990s.
Phillips Curve: The
relationship between
unemployment and inflation.
INVERSE relationship.
Unemployment goes
UP, then inflation goes
DOWN.
Stagflation: When things
REALLY go wrong on the
Phillips Curve

Inflation and
unemployment were at
higher levels.
– Combination of
stagnation and
inflation.
– Both were increasing.
1970s: What caused
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?

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
International
– Europe 1970s had higher
inflation and
unemployment.
– Worse because:



Labor union practices
Tax structures
Government economic
policies
Consequences of
Unemployment

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.
Consequences of Unemployment

Income Effects
 Loss of income and
benefits (Health
insurance)
 Loss of income to
others because of
reduced purchasing
power
 Reduced tax income
and increased outlays
of government.
Consequences of
Unemployment

Social Effects
– Health Problems
– Increased suicides
– Break up of families
– Increased child abuse
– Increased crime
Consequences 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
(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
Output

Inflation initially
stimulates output
 Near full employment,
there arise bottlenecks in
supplies
 Costs begin rising faster
than prices
 Interest rates accelerate,
discouraging new
investment.