345
C h a p t e r
05
MONITORING
CYCLES, JOBS, AND
THE PRICE LEVEL
Outline
Vital Signs
A. A recession started in March 2001. What defines a
recession, who makes the decision that we are in one, and
how?
B. How do we measure unemployment and what other data do we
use to monitor the labor market?
C. Being employed alone does not determine standard of
living; the cost of living also matters, so we also need
to know what the Consumer Price Index is, and how that is
measured and used.
I.
The Business Cycle
A. The business cycle is the periodic but irregular up-and-down
movement in production and jobs.
1. The NBER defines the phases – recession and expansion –
and turning points – peak and trough – of the cycle.
2. Its Business Cycle Dating Committee identifies and
dates them for the United States.
B. Business Cycle Dates
1. The 16 cycles since 1920 are briefly described.
2. Table 20.1 (page 454/108) lists the months of troughs
and peaks for each.
C.
The 2001–2002 Recession
1. The 2001-2002 recession, as seen from early 2002, is
described with alternative visions of how it would
evolve.
2. Figure 20.1 (page 455/109) shows business cycle
patterns with a stylized graph of annual percentage
change in real GDP against time, 1921 through 2000.
II. Jobs and Wages
A. Population Survey
1. The U.S. Census Bureau conducts monthly surveys to
determine the status of the labor force in the United
States.
2. United States population is divided into two groups:
a) The working-age population, which is the number of
people aged 16 years and older who are not in jail,
hospital, or other institution (in 2001, the
working-age population was 211.8 million).
b) People too young to work (less than 16 years of
age) or in institutional care.
3. The working-age population is
people in the labor force and
force. In 2001, 142.3 million
force and 69.5 million people
force.
divided into two groups:
people not in the labor
people were in the labor
were not in the labor
3. The labor force is the sum of employed and unemployed
workers. To be considered unemployed, a person must
be:
a) without work and have made specific efforts to find
a job within the past four weeks, or
b) waiting to be called back to a job from which he or
she was laid off, or
c) waiting to start a new job within 30 days.
4. Figure 20.2 (page 110) shows the population labor
force categories for 2001.
B. Three Labor Market Indicators
1. The unemployment rate is the percentage of the labor
force that is unemployed.
a) The unemployment rate is (Number of people
unemployed/Labor force)  100.
b) The unemployment rate reaches its peaks during
recessions.
2. The labor force participation rate is the percentage of the
working-age population that is in the labor force.
a) The labor force participation rate is (Labor
force/Working-age population)  100.
b) Overall, the labor force participation rate has
increased from 59 percent in the 1960s to 67
percent in the 1990s. The labor force participation
rate for men has declined, but for women has
increased.
c) The labor force participation rate falls during
recessions as discouraged workers —people available
and willing to work but who have not made an effort
to find work within the last four weeks —leave the
labor force.
3. The employment-to-population ratio is the percentage of
working-age people who have jobs.
a) The employment-to-population ratio is (Number of
people employed/Working-age population)  100.
b) The employment-to-population ratio
from 55 percent in the early 1960s
2000. The employment-to-population
declined for men and increased for
has increased
to 67 percent in
ratio has
women.
4. Figure 20.3 (page 457/111) shows the labor force
participation rate, employment to population ratio,
and unemployment rate, 1961–2001.
5. Figure 20.4 (page 458/112) shows the changing face of
the labor market, 1961–2001, by time series line
graphs of labor force participation rates and
employment-to-population ratios for males and females
separately.
C. Aggregate Hours
1. Aggregate hours are the total number of hours worked by
all workers during a year.
2. Aggregate hours have increased since 1960 but less
rapidly than the total number of workers because the
average workweek has shortened.
3. Figure 20.5 (page 113) shows aggregate hours and
average weekly hours per person, 1961–2001.
D. Real Wage Rate
1. The real wage rate is the quantity of goods and services
that can be purchased with an hour’s work.
2. The real wage rate equals the money wage rate divided
by the price level and three measures are discussed.
a) hourly earnings in manufacturing deflated by the
GDP deflator
b) wages and salaries, deflated by the GDP deflator
and divided by aggregate hours
c) total labor compensation, from the national income
accounts, deflated by the GDP deflator and divided
by aggregate hours
3. The growth rate of the average real wage rate slowed
during the 1970s and early 1980s, a reflection of the
productivity growth slowdown.
a) The real wage rate of private manufacturing
nonsupervisory workers peaked in 1973 and has
trended downward since then.
b) The growth of the real wage rate, measured by total
wages and salaries divided by total hours, slowed
substantially after 1973.
c) The real wage rate, measured by total labor
compensation (which includes fringe benefits)
divided by total hours, also grew more slowly after
1973, but the slowdown was less than for the real
wage rate measured by wages and salaries only.
d) If the real wage rate is calculated using total
compensation divided by the CPI adjusted to remove
the bias identified by the government commission,
then the productivity growth slowdown was less
severe.
4. Figure 20.6 (page 460/114) shows the three measures of
real wage rates listed above, 1961–2001.
III. Unemployment and Full Employment
A. The Anatomy of Unemployment
1. Three types of people are unemployed:
a) Job losers are workers who have been laid off or
fired and are searching for new jobs. Job losers
account for the largest fraction of the unemployed
and the fraction rises during recessions.
b) Job leavers are workers who have voluntarily quit
their jobs to look for new ones. Job leavers are
the smallest fraction of the unemployed.
c) Entrants and reentrants are people entering the labor
force for the first time or returning to the labor
force and searching for work. The primary source of
reentrants is (formerly) discouraged workers.
2. People end a spell of unemployment for two reasons:
a) Hired or recalled workers gain jobs.
b) Discouraged unemployed workers withdraw from the
labor force.
3. Figure 20.7 (page 461/115) illustrates the labor
market flows between the different states.
4. Figure 20.8 (page 462/116) shows unemployment by
reason, 1961–2001.
5. The duration of unemployment increases during
recessions and Figure 20.9 (page 462/116) shows
unemployment by duration close to a business cycle
peak in 2000 and close to a trough in 1992.
6. The unemployment rates for young workers and black
workers are higher than the unemployment rates for
older workers and white workers and Figure 20.10 (page
463/117) shows the unemployment rates of teenagers and
adults, whites and blacks close to a business cycle
peak in 2000 and close to a trough in 1992
B. Types of Unemployment
Unemployment can be classified into three types:
1. Frictional unemployment is unemployment that arises from
normal labor market turnover.
a) The creation and destruction of jobs requires that
unemployed workers search for new jobs.
b) Increases in the number of young people entering
the labor force and increases in unemployment
benefit payments raise frictional unemployment.
2. Structural unemployment is unemployment created by
changes in technology, the amount of foreign
competition, and other changes in the structure of the
economy and labor force, that change the goodness of
fit between the skills necessary to perform jobs and
the locations of jobs, and the skills and location of
the labor force.
3. Cyclical unemployment is the fluctuation in unemployment
caused by the business cycle.
C. Full Employment
1. Full employment occurs when there is no cyclical
unemployment or, equivalently, when all unemployment
is frictional or structural.
2. The unemployment rate at full employment is called the
natural rate of unemployment. The natural rate of
unemployment is estimated to be somewhat less than 6
percent today in the United States.
D. Real GDP and Unemployment Over the Cycle
1. Potential GDP is the quantity of real GDP produced at
full employment.
2. It corresponds to the capacity of the economy to
produce output on a sustained basis; actual GDP
fluctuates around potential GDP with the business
cycle.
3. Figure 20.11 (page 465/119) shows potential GDP and
real GDP, and the unemployment rate and the natural
unemployment rate, for 1981–2001.
IV. The Consumer Price Index
A. The price level is the “average” level of prices and is
measured by using a price index.
1.
The consumer price index, or CPI, measures the average
level of the prices of goods and services consumed by
an urban family.
B. Reading the CPI Numbers
1. The CPI is defined to equal 100 for the reference base
period.
2. The value of the CPI for any other period is
calculated by taking the ratio of the current cost of a
market basket of goods to the cost of the same market
basket of goods in the reference base period and
multiplying by 100.
B. Constructing the CPI
1. Constructing the CPI involves three stages:
a) Selecting the CPI basket, the set of goods and
services represented in the index and the weight on
each. There are two baskets, one for all urban
workers and one for wage-earners and clerical
workers. They are based on a Consumer Expenditure
Survey; the current CPI is based on a 1993-95
survey, although the reference base period is still
1982-84. Figure 20.12 (page 120) illustrates the
CPI basket.
b)
Conducting a monthly price survey, in which BLS
employees check the prices of 80,000 goods and
services in 30 metropolitan areas.
c)
Using the prices and the contents of the basket to
calculate the CPI. The formula is:
CPI = (Cost of CPI basket at current period
prices/Cost of CPI basket at base period prices)
100.
2. Table 20.2 (page 467/121) works a simplified CPI
calculation.

C. Measuring Inflation
1. The main purpose of the CPI is to measure inflation.
The inflation rate is the percentage change in the price
level from one year to the next.
2. The inflation formula is:
Inflation rate = [(CPI this year – CPI last year)/CPI
last year]  100.
2. Figure 20.13 (page 468/122) shows the CPI and the
inflation rate, 1971–2001.
D. The Biased CPI
1. The CPI may overstate the true inflation for four
reasons: new goods bias, quality change bias,
commodity substitution bias, and outlet substitution
bias.
a) New goods bias: New goods that were not available
in the base year appear and, if they are more
expensive than the goods they replace, the price
level may be biased higher. Similarly, if they are
cheaper than the goods they replace, but not yet in
the CPI basket, they bias the CPI upward.
b) Quality change bias: Quality improvements generally
are neglected, so quality improvements that lead to
price hikes are considered purely inflationary.
c) Commodity substitution bias: The market basket of
goods used in calculating the CPI is fixed and does
not take into account consumers’ substitutions away
from goods whose relative prices increase.
d) Outlet substitution bias: As the structure of
retailing changes, people switch to buying from
cheaper sources, but the CPI, as measured, does not
take account of this outlet substitution.
2. A Congressional Advisory Commission estimated that the
CPI overstates inflation by 1.1 percentage points a
year.
3. The bias in the CPI distorts private contracts,
increases government outlays (close to a third of
government outlays are linked to the CPI), and biases
estimates of real earnings.
4. To reduce the bias in the CPI, the BLS will undertake
consumer expenditure surveys more frequently and
revise the CPI basket every two years.