ECONOMICS, 5e
Roger Arnold
CHAPTER 5
Macroeconomic Measurements,
Part I: Prices and Unemployment
Exhibit 1 Three Major Economic Goals
61
MACROECONOMIC
VARIABLES

Price Levels
– The economy's price level refers to a weighted
average of the prices of its goods and services
PRICE STABILITY
INFLATION is an increase in the general
price level over time
 DEFLATION is a decrease in the general
price level over time

INFLATION AND
PURCHASING POWER
If prices on average rise
 a given income buys fewer goods and
services.
 inflation decreases the purchasing power of
the dollar.

MEASURING THE PRICE LEVEL

Measures of the Price Level
– The consumer price index measures the average
nominal prices of goods and services that a
typical family living in an urban area buys
Consumer Price Index




The CPI is calculated by the Bureau of Labor
Statistics (BLS, http://www.bls.gov).
The representative group of goods chosen is called
the Market Basket.
To calculate the CPI we need the total dollar
expenditure in the current year and the base year.
The base year is a benchmark year that serves as
that basis of comparison for prices in other years.
66
CPI’s Basket
The composition of the CPI’s “basket”
Food and bev.
17.6%
Housing
5.8%
5.9%
2.8%
Apparel
2.5%
Transportation
4.5%
4.8%
Medical care
Recreation
16.2%
Education
Communication
40.0%
Other goods and
services
CHAPTER 2
The Data of Macroeconomics
slide 44
Calculating the CPI
CPI = (current expenditure/base
expenditure) X 100
 Current expenditure = the total dollar
expenditure on market basket in current
year
 Base expenditure = the total dollar
expenditure on market basket in base year

68
Exhibit 2 Computing the Consumer Price Index
69
THE INFLATION RATE
Inflation rate =
{CPI (t) - CPI (t-1) } x 100
CPI (t-1)
US Inflation
16
14
% per year
12
10
8
6
4
2
0
1960
1965
1970
1975
1980
1985
inflation rate
1990
1995
2000
COMPUTE THE INFLATION
RATE USING THE
FOLLOWING:
CPI 1997 = 159.1
 CPI 1996 = 156.9
 formula ({CPI 97 - CPI 96} / CPI 96) X 100
 159.1-156.9 / 156.9 = 2.2/156.9 = .014
 .014 X 100 = 1.4%

72
USING THE CPI:
REAL vs. NOMINAL INCOME

NOMINAL INCOME - money income
measured in current period dollars
USING THE CPI:
REAL vs. NOMINAL INCOME

REAL INCOME - money income adjusted
for changes in the price level
real Y = nominal Y x 100

CPI (t)

Are you keeping up with
inflation?







Income in 2000 = $40,000
Income in 1999 = $35,000
CPI in 2000 = 120
CPI in 1999 = 100
Real income 1999 = 35,000/100 x 100 = $35,000
Real income 2000 = 40,000/120 x 100 = $33,334
Real income is falling $33,334 < $35,000
75
MEASURING THE PRICE LEVEL

Other Measures of the Price Level
– The producer price index is a weighted average
of the prices of inputs that producers buy to
make final goods
MEASURING THE PRICE LEVEL
MACROECONOMIC
VARIABLES

Price Levels
– The GDP price deflator equals nominal GDP
divided by real GDP
– Nominal GDP measures the current dollar value
of the economy
– Real GDP measures output valued at constant
prices
– Nominal GDP = Real GDP X GDP price deflator
– Real GDP = Nominal GDP / GDP price deflator
MEASURING THE PRICE LEVEL

Limitations of Price Indexes
– Index and other measures are imperfect and
have limitations
» Ignores such things as changes in quality,
technological advances, and other factors that alter
results
» People substitute other goods when prices rise
SUBSTITUTION BIAS
To avoid a potential bias created by
ignoring consumer substitutions the
US moved to a CHAIN-WEIGHTED
index in Dec. 1995
Exhibit 5 Breakdown of the U.S. Population and
the Labor Force
SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.
81
EMPLOYED
Worked at least 1 hour in a wage/salary
paying position
 Owned his/her own business
 Worked 15 hrs. per week in family business
or farm as “unpaid” worker
 absent due to illness, strike, or vacation

UNDEREMPLOYMENT
Workers are classified as employed
 If they worked as little as one hour for pay
during the survey week and
 Even if they are over qualified for the work
 The reported rate of unemployment may be
understated due to underemployment

UNEMPLOYED
Did not work in the survey week but willing
and able to work and actively looked within
the last 4 weeks.
 Laid off and waiting to be called back
 Waiting to report to a job within 30 days

DISCOURAGED WORKERS
people who have given up on the job search
process
 not considered unemployed because they
are not actively searching for a job
 Cause the reported unemployment rate to
understate the true unemployment problem
because they are not included in the labor
force

Phantom Unemployed
Those who claim to be unemployment,
when in fact they are not
 May be due to qualify for unemployment
benefits
 Cause the reported unemployment rate to
overstate the true unemployment problem
because they are not actively seeking work

THE UNEMPLOYMENT RATE
# people unemployed x 100
# people in labor force
FIND THE UNEMPLOYMENT
RATE
population is 100 million
 labor force is 50 million
 45 million are employed

UNEMPLOYMENT RATE
U = 5m./50m. x 100 = 10%
Types of Unemployment

Frictional
FRICTIONAL
UNEMPLOYMENT
people moving between jobs or into
the labor force.
Types of Unemployment
Frictional
 Structural

STRUCTURAL
UNEMPLOYMENT
skills and/or location of workers does
not match available jobs
Types of Unemployment
Frictional
 Structural
 Natural

NATURAL UNEMPLOYMENT
a certain level of frictional and
structural unemployment that is
considered natural in a changing
economy (usually 4-6.5%)
U.S. Unemployment, 1958-2002
11
Percent of labor force
10
9
8
7
6
5
4
3
2
1955
1960
1965
1970
1975
Unemployment rate
1980
1985
1990
1995
2000
Natural rate of unemployment
96
FULL EMPLOYMENT
The full employment rate is when
unemployment is at its natural rate
(not zero).
Types of Unemployment
Frictional
 Structural
 Natural
 Cyclical

CYCLICAL
UNEMPLOYMENT
unemployment due to downturns in
overall economic activity (recessions)
 The difference between the
existing unemployment rate and the
natural unemployment rate
U.S. Unemployment, 1958-2002
11
Percent of labor force
10
9
8
7
6
5
4
3
2
1955
1960
1965
1970
1975
Unemployment rate
1980
1985
1990
1995
2000
Natural rate of unemployment
100