Macroeconomics
ECON 2301
Spring 2009
Marilyn Spencer, Ph.D.
Professor of Economics
Chapter 7
Assignment Deadline in
One Week!!!
 Tuesday, March 3 everyone will be turning
in an assignment, BEFORE CLASS
STARTS:
Junior Achievement: Teacher Confirmation
Form (pink ½ sheets), signed by the teacher
Economics in the News: First Research Paper,
emailed to marilyn.spencer@tamucc.edu
Extra Credit Opportunity #4
 Watch a recording, read a transcript, or read
a news story, of Treasury Secretary
Geithner’s new bank bailout plan.
 Summarize the most important parts, in 50100 words (needn’t be in complete
sentences).
 Email this summary to me by Thurs., Feb.
26 at marilyn.spencer@tamucc.edu, for up
to 4 points of extra credit.
Extra Credit Opportunity #5
 Read a thorough news article that explains
the provisions of the stimulus bill that
President Obama just signed.
 Summarize the most important parts, in
100-150 words (needn’t be in complete
sentences).
 Email this summary to me by Thurs.,
Feb. 26 at marilyn.spencer@tamucc.edu,
for up to 4 points of extra credit.
Extra Credit Opportunity #6
 Read a thorough news article that
explains the provisions of the mortgage
bailout plan for home owners.
 Summarize the most important parts, in
50-100 words (needn’t be in complete
sentences).
 Email this summary to me by Thurs.,
Mar. 5, at marilyn.spencer@tamucc.edu,
for up to 4 points of extra credit.
Chapter 7: The Macroeconomy:
Unemployment, Inflation, and Deflation
Learning Objectives
1. Distinguish between average tax rates and
marginal tax rates
2. Explain the structure of the U.S. income
tax system
3. Understand the key factors influencing the
relationship between tax rates and the tax
revenues governments collect
Learning Objectives (cont'd)
4. Explain how the taxes governments levy
on purchases of goods and services affect
market prices and equilibrium quantities
5. Understand how the Social Security
system works and explain the
nature of the problems it poses
for today’s students
Extra Credit Opportunity #4
 Watch a recording, read a transcript, or read
a news story, of Treasury Secretary
Geithner’s new bank bailout plan.
 Summarize the most important parts, in 50100 words (needn’t be in complete
sentences).
 Email this summary to me by Thurs., Feb.
26 at marilyn.spencer@tamucc.edu, for up
to 4 points of extra credit.
Extra Credit Opportunity #5
 Read a thorough news article that explains
the provisions of the stimulus bill that
President Obama just signed.
 Summarize the most important parts, in
100-150 words (needn’t be in complete
sentences).
 Email this summary to me by Thurs.,
Feb. 26 at marilyn.spencer@tamucc.edu,
for up to 4 points of extra credit.
Introduction
How does the U.S. government measure
the overall level of prices?
Why doesn’t the U.S. government use
Wal-Mart prices in calculating inflation?
This chapter will help you answer
these questions.
Learning Objectives - After studying this
chapter, you should be able to:
 Explain how the U.S. government calculates the official
unemployment rate.
 Discuss the types of unemployment.
 Describe how price indexes are calculated and define the
key types of price indexes.
 Distinguish between nominal and real interest rates
 Evaluate who looses and who gains from inflation
 Understand key features of business fluctuations
Did You Know That...
 Trying to understand and better forecast labor
employment and the overall performance of the
national economy is a central objective of
macroeconomics?
 This branch of economics seeks to explain and
predict movements in unemployment, the average
level of prices, and the total production of goods
and services?
Unemployment
 Unemployment
Total number of adults (aged 16 years or older)
willing and able to work and who are actively
looking for work and have not found a job
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
Unemployment (cont'd)
 Question: What are the costs of unemployment?
 Answers:
Lost output
• During early 2000s, unemployment rate rose by 2
percentage points
• Factory output was 80% of potential
• Lost output was $200 billion of goods and services
that could have been produced
Personal psychological impact
Figure 7-1 More Than a Century
of Unemployment
Source: U.S. Department of Labor, Bureau of Labor Statistics
Figure 7-2 Adult Population
Unemployment (cont'd)
 The unemployment rate is the percentage
of the measured labor force that is
unemployed.
Unemployment (cont'd)
Labor force = The employed + The unemployed
152.7*
=
145.4
+
Unemployed
Unemployment rate =
Labor force
7.3
x 100
7.3
x 100 = 4.8%
=
152.7
*U.S., millions of people; as of 2007
Unemployment (cont'd)
 Stock
The quantity of something, measured at
a given point in time—for example, an
inventory of goods
 Flow
A quantity measured over time, such as the
income you make per year, or the number of
individuals fired every month
Unemployment (cont'd)
 Categories of individuals without work
Job loser
Reentrant
Job leaver
New entrant
Unemployment (cont'd)
 Job Loser
An individual whose employment was
involuntarily terminated or who was laid off
• 40–60% of the unemployed
 Reentrant
An individual who has worked a full-time job
before but left the labor force and has now
reentered it looking for a job
• 20–30% of the unemployed
Unemployment (cont'd)
 Job Leaver
An individual who voluntarily quit
• 10 to 15% of the unemployed
 New Entrant
An individual who has never worked a fulltime job for two weeks or longer
• 10 to 15% of the unemployed
Unemployment (cont'd)
 Duration of unemployment - ordinarily
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.
Figure 7-3 The Logic of the
Unemployment Rate
Unemployment (cont'd)
 Question
What is likely to happen to the duration of
unemployment during a downturn in the
economy?
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?
Unemployment (cont'd)
 Labor Force Participation Rate
The proportion of non-institutionalized
working-age individuals who are employed or
seeking employment
The Major Types of
Unemployment
 The major types of unemployment:
Frictional
Structural
Cyclical
Seasonal
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
The Major Types
of Unemployment (cont'd)
 Structural Unemployment
Results from a poor match of workers’ abilities
and skills with current requirements of
employers
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
The Major Types
of Unemployment (cont'd)
 Seasonal Unemployment
Results from the seasonal pattern of work in
specific industries
International Example: Challenges of
Measuring the Unemployment Rate in China
 Measurement of China’s labor force and
unemployment rate fails to encompass all of the
roughly 115 million people who migrate from
rural areas.
 In addition, China’s government has not yet
developed a way to determine how many millions
of people laid off from state-owned firms have
obtained positions with private firms.
Full Employment and the Natural
Rate of Unemployment
 Question: Does full employment mean that
everybody has a job?
 Full Employment
An arbitrary level of unemployment that
corresponds to “normal” friction in the
labor market
Full Employment and the Natural
Rate of Unemployment (cont'd)
 Natural Rate of Unemployment
The unemployment rate that is estimated to
prevail in the long-run macroeconomic
equilibrium
Should not reflect cyclical unemployment
When seasonally adjusted, the natural rate
should include only frictional and structural
unemployment.
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
Inflation and Deflation (cont'd)
 Purchasing Power
The value of money for buying goods
and services
Varies with prices and income
Inflation and Deflation (cont'd)
 Nominal value
Price expressed in today’s dollars
 Real value
Value expressed in purchasing power,
adjusted for inflation
Inflation and Deflation (cont'd)
 Measuring the rate of inflation
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
Inflation and Deflation (cont'd)
 Market Basket
Representative bundle of goods and services
 Base Year
The point of reference for comparison of
prices in other years
Table 7-1 Calculating a Price Index for
a Two-Good Market Basket
Inflation and Deflation (cont'd)
 Real-world price indexes
Consumer Price Index (CPI)
Producer Price Index (PPI)
GDP deflator
Personal Consumption Expenditure (PCE)
Inflation and Deflation (cont'd)
 Consumer Price Index (CPI)
A statistical measure of a weighted average
of prices of a specified set of goods and
services purchased by wage earners in urban
areas
Market basket of goods and services of
typical consumer
Inflation and Deflation (cont'd)
 Producer Price Index (PPI)
A statistical measure of a weighted average of
prices of goods and services that firms produce and
sell
Used as a short-run leading indicator (before CPI)
PPIs for
• Foodstuffs
• Intermediate goods
• Finished goods
Inflation and Deflation (cont'd)
 GDP Deflator
A price index measuring the changes in
prices of all new goods and services
produced in the economy
Broadest measure of prices; reflects both
price changes and the public’s market
responses to those price changes
Inflation and Deflation (cont'd)
 Personal Consumption Expenditure
(PCE) Index
A statistical measure of average price using
annually updated weights based on consumer
spending
Primary inflation index used by the
Federal Reserve
Figure 7-4 Inflation and Deflation
in U.S. History
Source: U.S. Department of Labor, Bureau of Labor Statistics
Anticipated versus
Unanticipated Inflation
 Anticipated versus unanticipated inflation
To determine who is hurt by inflation we
distinguish between the two types.
The effects of inflation on individuals depend
upon which type of inflation exists.
Anticipated versus
Unanticipated Inflation (cont'd)
 Anticipated Inflation
The inflation rate that we believe will occur
 Unanticipated Inflation
Inflation at a rate that comes as a surprise
Anticipated versus
Unanticipated Inflation (cont'd)
 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
Anticipated versus
Unanticipated Inflation (cont'd)
 Real interest rate
Nominal interest rate = 10%
Expected inflation rate = 6%
Real rate = 10% – 6% = 4%
Anticipated versus
Unanticipated Inflation (cont'd)
 Does inflation necessarily hurt everyone?
Inflation affects people differently
 Unanticipated inflation
Creditors lose
Debtors gain
Anticipated versus
Unanticipated Inflation (cont'd)
 Protecting against inflation
Cost-Of-Living Adjustments (COLAs)
• Clauses in contracts that allow for
increases in specified nominal values to
take account of changes in the cost of
living
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
Changing Inflation and Unemployment:
Business Fluctuations
 Business Fluctuations
The ups and downs in business activity
throughout the economy
Changing Inflation and Unemployment:
Business Fluctuations (cont'd)
 Expansion
A business fluctuation in which the pace of
national economic activity is speeding up
 Contraction
A business fluctuation in which the pace of
national economic activity is slowing down
Changing Inflation and Unemployment:
Business Fluctuations (cont'd)
 Recession
A period of time during which the rate of
growth of business activity is consistently
less than its long-term trend or is negative
 Depression
An extremely severe recession
Figure 7-5 The Idealized Course of
Business Fluctuations
Figure 7-6 National Business Activity,
1880 to the Present
Changing Inflation and Unemployment:
Business Fluctuations (cont'd)
 Leading Indicators
Events that have been found to occur before
changes in business activity
• Economic downturns often follow:
Reduction in the average workweek
Rise in unemployment insurance claims
Decrease in prices of raw materials
Drop in the quantity of money
circulating
Issues and Applications:
Wal-Mart, Product Quality, and the CPI
 Wal-Mart offers lower prices on most food items.
 The Bureau of Labor Statistics (BLS) uses prices
charged at a nearby Kroger.
 As far as the BLS is concerned, lower Wal-Mart
prices must reflect lower quality.
 BLS quality adjustments may result in an upward
bias in the rate of CPI inflation.
Summary of Learning Objectives
 How the U.S. government calculates the official
unemployment rate
Percentage of the total number of adults willing and
able to work who are actively looking for work but
have not found a job
 The major types of unemployment
Frictional
Structural
Cyclical
Seasonal
Summary of Learning Objectives (cont'd)
 Full employment
Arbitrary level of unemployment
• Corresponds to “normal” friction in labor market
 Natural rate of unemployment
Estimated to prevail in the long-run
macroeconomic equilibrium
• All workers and employers adjust to any changes in
economy
Summary of Learning Objectives (cont'd)
 How price indexes are calculated and key price
indexes
Multiply 100 times the ratio of the cost of a market
basket of goods in the current year to the cost of the
same basket in a base year
Key price indexes
•
•
•
•
CPI
PPI
GDP deflator
PCE
Summary of Learning Objectives (cont'd)
 Nominal versus real interest rates
Nominal rate is the market rate expressed in
current dollars.
Real rate is net of inflation.
Hence the real interest rate equals the nominal
interest rate minus the expected inflation rate.
Summary of Learning Objectives (cont'd)
 Losers and gainers from inflation
Creditors lose as a result of unanticipated
inflation.
Borrowers gain as a result of unanticipated
inflation.
Summary of Learning Objectives (cont'd)
 Key features of business fluctuations
Increases and decreases in business activity
• Expansion from previous trough to
new peak
• Contraction from previous peak to
new trough
Assignment to be completed
before class March 5:
Read Chapter 8 & also read end-ofchapter Problems 8-2, 8-5, 8-6, 8-8,
8-10, 8-11 & 8-16 on pp. 209-211.