1.10 Monitoring Jobs and the Price Level
** This note is summarized by Hui Wang.
Important reference Study Guides of Stalla Review for CFA Exams
Learning Outcomes:
The candidate should be able to:
a. define an unemployed person, and interpret the main labor market indicators;
b. define aggregate hours and real wage rates, and explain their relation to gross
domestic product (GDP);
c. explain the types of unemployment, full employment, the natural rate of
unemployment, and the relation between unemployment and real GDP;
d. explain and calculate the consumer price index (CPI) and the inflation rate, describe
the relation between the CPI and the inflation rate, and explain the main sources of
PCI bias.
Reference reading CFA Curriculum Volume2 Reading22
Working age population
Working age population is the total population in a region, within a set range of ages, that
is considered to be able and likely to work. Each region may have a different range of
ages, but typically the ages of 20 to 65 are used. Working age population considers all
individuals in a region within the age range, but doesn’t differentiate between those who
are actually working and those who are currently unemployed. The working age
population of an economy is always shifting as the demographics of a region change,
with large changes having the potential to significantly impact the economy.
Labor force
Labor force are people of working age who are available for paid employment, including
the unemployed looking for work, but excluding categories such as full-time students,
caregivers, and the long-term sick and disabled.
Labor force= Number of people employed + Number of people unemployed
Employed and unemployed in the Current Population Survey
To be counted as employed, a person must have either a full-time job or part-time job.
To be counted as unemployed, a person must be available for work and must be in one of
three categories:
(1) without work but has made specific efforts to find a job within the previous four
weeks;
(2) waiting to be called back to a job from which he or she has been laid off
(3) waiting to start a new job within 30 days.
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Unemployment rate
Unemployment rate is the percentage of the civilian labor force which is unemployed:
Labor force participation rate
The labor force participation rate is the percentage of the working-age population who
are members of the labor force:
Discouraged workers are used to describe people who are eligible fro employment and
willing to work, but currently unemployed. Discouraged workers have not attempted to
find employment in the previous four weeks. Since discouraged workers are no longer
looking for employment, they are not counted as active in the labor force, which means
that unemployment rates do not consider discouraged workers as unemployed.
The employment-to-population ratio
The employment-to-population ratio is the percentage of people of working age who are
employed:
Employment-to-population ratio
Aggregate hours
Aggregate hours are the sum of the hours worked by all employed people, either full or
part time, during the course of a year. Aggregate hours can also refer to the total hours
worked by one sector or group of workers.
Aggregate hours are a measure of the total labor required to produce real GDP. Because it
reports a total number of hours, it generally provides a better measure for total labor than
the number of people employer.
Real wage rate
The real wage rate is the wage rate adjusted for inflation. It depends by how much the
inflation rate increases as well as the nominal wage rate:
Where w is real wage, W is nominal wage and P is price level.
If nominal wage increases at same rate as inflation- real wage remains the same.
If nominal wage increases at slower than inflation- real wage falls.
If nominal wage increases at faster than inflation- real wage increases.
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The anatomy of unemployment
People become unemployed if they:
(1) Lose their jobs and search for new employment opportunity.
(2) Leave their jobs and search for new employment opportunity.
(3) Enter or reenter the labor force to search for employment opportunity.
People are not counted as unemployed if they:
(1) Are hired or recalled.
(2) Withdraw from the labor force.
Frictional unemployment
Frictional unemployment is the temporary unemployment arising from the inevitable time
lags in the functioning of labor markets, such as the time taken in moving from one job to
another. This type of unemployment is beneficial because it encourages people to seek
out the jobs for which they are best suited, while giving companies the option to find the
best employees. The frictional unemployment rate can fluctuate, depending on the time of
year and economic circumstances.
Structural Unemployment
Structural unemployment is unemployment that results from a mismatch between the
skills needed by employers and the skills possessed by workers. Rapidly changing
technology requires employees with new skills at the same time it makes old skills
obsolete. Structural unemployment can exist in a strong economy that is near full
employment.
Cyclical unemployment
Cyclical unemployment is unemployment that results from reduced demand for goods
and services and varies inversely with economic activity, that is cyclical unemployment
increases during a recession and decreases during an expansion.
Full employment
Full employment occurs when there is no cyclical unemployment in economy or,
equivalently, when all the unemployment is frictional and structural.
Natural unemployment rate
The natural rate of unemployment is the rate of unemployment that occurs when the
economy is at full employment. This rate is primarily composed of frictional and
structural unemployment. It is a certain amount of unemployment due to job turnover,
mismatch between jobs and skills, and minimum wage laws.
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Actual GDP and Potential GDP
Actual GDP is the sum of the value added by all the economic activities in an economy.
Potential GDP is the quantity of real GDP realized at full employment. When the
unemployment rate is less than the natural unemployment rate, actual GDP is greater than
potential GDP. And when the unemployment rate is greater than the natural
unemployment rate, actual GDP is less than potential GDP.
Consumer Price Index
Consumer Price Index (CPI) is a measure of the average change over time in the prices
paid by urban consumers for a market basket of consumer goods and services.
Measuring inflation
Inflation is the sustained increase in the general level of prices for goods and services. It
is measured as an annual percentage increase:
Main sources of bias in the CPI
(1) New goods bias. New products may cost more to purchase and thus put an
upward bias into the CPI and inflation rate.
(2) Quality change bias. Improvement in products’ quality may cause the prices of
such products to rise, but this part of price rise shouldn’t be counted as inflation.
(3) Commodity substitution bias. CPI overlooks the fact that people will turn to a
product’s substitute when this product’s price rises.
(4) Outlet substitution bias. People will use discount stores more frequently when
they face high prices. This phenomenon is called outlet substitution. The CPI
surveys do not monitor outlet substitutions.
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Exercise Problems: (provided by Stalla PassMaster for CFA Exams.)
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EXPLANATION
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