Chapter 7 The Macroeconomy: Unemployment and Inflation Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Figure 7-1 More Than a Century of Unemployment Source: U.S. Department of Labor, Bureau of Labor Statistics 7-5 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Figure 7-2 Adult Population Source: U.S. Department of Labor, Bureau of Labor Statistics. 7-6 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Major Types of Unemployment • The major types of unemployment – Frictional – Structural – Cyclical – Seasonal (seasonal, regular pattern) 7-10 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Inflation and Deflation (cont'd) • Purchasing Power – The value of money for buying goods and services – Varies with prices and income 7-17 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Anticipated versus Unanticipated Inflation (cont'd) • Real interest rate – Nominal interest rate = 10% – Expected inflation rate = 6% – Real rate = 10% – 6% = 4% 7-22 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Changing Inflation and Unemployment: Business Fluctuations Figure 7-5 7-25 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Changing Inflation and Unemployment • Recession – Inflation (high or low?) – Unemployment (high or low?) • Expansion – Inflation (high or low?) – Unemployment (high or low?) 7-27 Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 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 Copyright © 2010 Pearson Addison-Wesley. All rights reserved.