Chapter 7
The Macroeconomy:
Unemployment and
Inflation
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Unemployment
• Unemployment
– Total number of adults (aged 16 years or older)
willing and able to work and who are actively
looking for work but have not found a job.
– Unemployment creates a cost to the entire
economy in terms of lost output – often ranging
in the billions of dollars.
7-2
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Unemployment (cont'd)
• Labor Force
– Individuals aged 16 years or older who either
have jobs or who are looking and available for
jobs; the number of employed plus the number
of unemployed
• The unemployment rate is the percentage of
the measured labor force that is
unemployed.
7-3
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What are the Costs of Unemployment?
• Answers
– Personal psychological impact
– Lost output
• During early 2000s, unemployment rate rose by 2
percentage points
• Lost output was $200 billion of goods and services that
could have been produced
7-4
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Figure 7-1 More Than a Century of
Unemployment
Source: U.S. Department of Labor, Bureau of Labor Statistics
7-5
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Figure 7-2 Adult Population
Source: U.S. Department of Labor, Bureau of Labor Statistics.
7-6
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Unemployment (cont'd)
Labor force = The employed + The unemployed
155.7*
=
145.3
+
Unemployed
Unemployment rate =
Labor force
10.4
x 100
10.4
x 100 = 6.7%
=
155.7
*U.S., millions of people; as of 2009
7-7
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Unemployment (cont’d)
• Duration of unemployment
– More than a third of job seekers find work within
one month.
– Approximately another third find employment
within a second month.
– About a sixth are still unemployed after six
months.
– Average duration is just over 15 weeks
throughout the last 15 years.
7-8
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Unemployment (cont'd)
• Discouraged Workers
– Individuals who have stopped
looking for a job because they
are convinced they will not find
a suitable one
• Question
– How does the existence of
discouraged workers bias the
unemployment rate?
7-9
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Major Types of Unemployment
• The major types of unemployment
– Frictional
– Structural
– Cyclical
– Seasonal (seasonal, regular pattern)
7-10
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The Major Types of
Unemployment (cont'd)
• Frictional Unemployment
– Results from the fact that workers must search
for appropriate job offers
– This takes time, so they remain temporarily
unemployed
• Structural Unemployment
– Results from a poor match of workers’ abilities
and skills with current requirements of
employers
7-11
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The Major Types of Unemployment
(cont'd)
• Cyclical Unemployment
– Results from business recessions that occur when
aggregate (total) demand is insufficient to create
full employment
7-12
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Full Employment and the Natural
Rate of Unemployment
• Questions
– Does full employment mean that everybody has
a job?
– Is it always possible for everyone who is looking
for a job to find one?
7-13
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Full Employment and the Natural
Rate of Unemployment (cont'd)
• Full Employment
– An arbitrary level of unemployment that
corresponds to “normal” friction in the labor
market
7-14
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Full Employment and the Natural
Rate of Unemployment (cont'd)
• Natural Rate of Unemployment (Full
Employment)
– The normal unemployment rate that prevails
over time
– Should not reflect cyclical unemployment
– When seasonally adjusted, the natural rate
should include only frictional and structural
unemployment.
7-15
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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
7-16
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Inflation and Deflation (cont'd)
• Purchasing Power
– The value of money for
buying goods and services
– Varies with prices and
income
7-17
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Inflation and Deflation (cont'd)
• Nominal value
– Price expressed in today’s
dollars
• Real value
– Value expressed in purchasing
power, adjusted for inflation
7-18
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Inflation and Deflation (cont'd)
– Price Index (Consumer 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
Cost today of market basket
Price index =

100
Cost of market basket in base year
Example: 2009 spending=$200
2010 spending=$220
7-19
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Figure 7-4 Inflation and Deflation
in U.S. History
Source: U.S. Department of Labor, Bureau of Labor Statistics
Copyright © 2010 Pearson Addison-Wesley. All rights reserved.
7-20
How inflation affects you?
• Does it make you “poor”?
• Inflation and interest rates
– Nominal Rate of Interest
• The market rate of interest expressed in today’s dollars
– Real Rate of Interest
• The nominal rate of interest minus the anticipated rate
of inflation
7-21
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Anticipated versus Unanticipated
Inflation (cont'd)
• Real interest rate
– Nominal interest rate = 10%
– Expected inflation rate = 6%
– Real rate = 10% – 6% = 4%
7-22
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Anticipated versus Unanticipated
Inflation (cont'd)
• Does inflation necessarily hurt everyone?
– Inflation affects people differently
• Unanticipated inflation
– Creditors (lenders, savers) lose
– Debtors (borrowers) gain
7-23
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Anticipated versus Unanticipated
Inflation (cont'd)
• The resource cost of
inflation
– Repricing or Menu Cost
of Inflation
• The cost associated with
recalculating prices and
printing new price lists
when there is inflation
7-24
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Changing Inflation and Unemployment:
Business Fluctuations
Figure 7-5
7-25
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Figure 7-6 National Business
Activity, 1880 to the Present
Sources: American Business Activity from 1790 to Today, 67th ed., AmeriTrust Co.,
January 1996, plus author’s estimates.
7-26
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Changing Inflation and Unemployment
• Recession
– Inflation (high or low?)
– Unemployment (high or low?)
• Expansion
– Inflation (high or low?)
– Unemployment (high or low?)
7-27
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Myth #7: Life is getting tougher over
time
• The fact is life is more calm than 50 or 100
years ago … hang around
7-28
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