Chapter 7
Unemployment, Inflation, and Long-Run Growth
CHAPTER OUTLINE
Unemployment
Measuring Unemployment
Components of the
Unemployment Rate
The Costs of Unemployment
Inflation
The Consumer Price Index
The Costs of Inflation
Long-Run Growth
Output and Productivity Growth
Unemployment
Measuring Unemployment
Employed Any person 16 years old or older:
(1) who works for pay, either for someone else or in his or her own business for 1
or more hours per week,
(2) who works without pay for 15 or more hours per week in a family enterprise, or
(3) who has a job but has been temporarily absent with or without pay.
unemployed A person 16 years old or older who is not working, is available for
work, and has made specific efforts to find work during the previous 4 weeks.
Labor Force
not in the labor force A person who is not looking for work because
he or she does not want a job or has given up looking.
labor force The number of people employed plus the number of
unemployed.
labor force = employed + unemployed
population = labor force + not in labor force
unemployment rate The ratio of the number of people unemployed to the total
number of people in the labor force.
unemployment rate =
unemployed
employed + unemployed
labor force participation rate The ratio of the labor force to the total
population 16 years old or older.
labor force participation rate =
labor force
population
How the BLS Measures Employment Status
Includes part time
workers
5
Employment Status of the U.S. Population—August 2011
6
How Unemployment is Measured
unemployment rate The percentage of the
labor force that is unemployed.
Computing the unemployment rate for the months of July 2009,
July 2011 and July 2015:
2009
Labor force: 154.5 million
Employed: 140.0 million
Unemployed: 14.5 million
2011
153.2 million
139.3 million
13.9 million
Unemployment rate2009
=
Unemployment rate2011
=
Unemployment rate2015
2015
157.1 million
148.8 million
8.27 million
14.5
 .094  9.4%
154.5
13.9
 .091  9.1%
153.2
= 8.27  .053  5.3%
157.1
TABLE 7.1 Employed, Unemployed, and the Labor Force, 1950–2012
(1)
Population
16 Years
Old or Over
(Millions)
(2)
Labor
Force
(Millions)
(3)
(4)
(5)
(6)
Employed
(Millions)
Unemployed
(Millions)
Labor Force
Participation
Rate
(Percentage
Points)
Unemployment
Rate
(Percentage
Points)
1950
105.0
62.2
58.9
3.3
59.2
5.3
1960
117.2
69.6
65.8
3.9
59.4
5.5
1970
137.1
82.8
78.7
4.1
60.4
4.9
1980
167.7
106.9
99.3
7.6
63.8
7.1
1990
189.2
125.8
118.8
7.0
66.5
5.6
2000
212.6
142.6
136.9
5.7
67.1
4.0
2012
243.3
155.0
142.5
12.5
63.7
8.1
Note: Figures are civilian only (military excluded).
Unemployment Rate for Various Groups
July 2015
5.3%
4.6%
6.8%
9.1%
8.3%
5.5%
2.6%
Problems in Measuring Unemployment
• Official measure of unemployment underestimates
the extent of unemployment
– Treatment of involuntary part-time workers
– Treatment of discouraged workers
10
Problems in Measuring Unemployment
• Involuntary part-time workers
– Individuals who would like a full-time job but who
are working only part time
• Discouraged workers
– Individuals who would like a job but have given
up searching for one
11
Problems in Measuring Unemployment
• BLS defines discouraged worker
Not working
2. Searched for a job at some point in the last 12
months
3. Currently want a job
4. State that the only reason they are not currently
searching for work is their belief that no job is
available for them
1.
• discouraged-worker effect
The decline in the
measured unemployment rate that results when people who
want to work but cannot find jobs grow discouraged and stop
looking, thus dropping out of the ranks of the unemployed
and the labor force.
• It lowers the unemployment rate!
12
Problems in Measuring Unemployment
• Marginally attached to the labor force
– Meet the first three requirements of discouraged
workers
– But not necessarily the fourth:
• They can give any reason for not currently searching
for work
13
Alternative Measures of Employment Conditions
• The Six “U”s
– Six different unemployment rates
• Each labeled with a “U” followed by a number
– “U-3”: the official unemployment rate
14
The Six “U”s
http://www.bls.gov/news.release/pdf/empsit.pdf Table A-15
15
U-4
U-3
U-6
U-5
U-6
U-5
U-3
U-4
The Duration of Unemployment
TABLE 7.4 Average Duration of Unemployment, 1970–2012
Weeks
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
8.6
11.3
12.0
10.0
9.8
14.2
15.8
14.3
11.9
10.8
11.9
13.7
15.6
20.0
18.2
Weeks
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
15.6
15.0
14.5
13.5
11.9
12.0
13.7
17.7
18.0
18.8
16.6
16.7
15.8
14.5
13.4
Weeks
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
http://www.bls.gov/news.release/pdf/empsit.pdf
12.6
13.1
16.6
19.2
19.6
18.4
16.8
16.8
17.9
24.4
33.0
39.3
39.4
Alternative Measures of Employment Conditions
• The employment-population ratio
– Total employment divided by the total population
over age 16
– Tracks the fraction of the adult population that is
working
– not affected by job-searching behavior
18
The Employment Population Ratio: 1948–2015
19
The Employment Population Ratio: 1948–2015
20
Labor Force Participation Rate: 1948–2015
21
Its Not Just Demographics
22
Labor Force Participation Rate:
Overall in Blue Along With age 25-54 in Red
The Costs of Unemployment
Some Unemployment Is Inevitable
When we consider the various costs of unemployment,
it is useful to categorize unemployment into three
types:
Frictional unemployment
Structural unemployment
Cyclical unemployment
Frictional Unemployment includes:
• people who are between jobs
• people who are just entering or reentering
the labor market
• this is short-term unemployment
• these people have skills and they will get
jobs
25
Structural Unemployment
• Skill mismatch: between workers’ skills and
employers’ requirements
• Geographic mismatch: between workers’
locations and employers’ locations
• Unemployment due to structural changes in the
economy that eliminate some jobs and create
other jobs for which the unemployed do not have
required skills.
• This is a stubborn, long-term problem
26
Cyclical Unemployment
• Arising from changes in production over the
business cycle
• A problem for macroeconomic policy
27
Employment and Unemployment
• Natural Rate of Unemployment
• Sum of Frictional and Structural
Unemployment
• Full employment
•
•
Zero cyclical unemployment
Unemployment at full employment is equal to
the natural rate of unemployment
Potential output
Level of output the economy could produce if operating at
full employment
28
Average Unemployment Rates in Several Countries,
1995–2005, 2007 and 2013
2013
10.8%
12.7%
7.2%
7.1%
5.2%
8.0%
6.7%
Unemployment rate higher in Europe - primarily structural.
•Higher unemployment benefits, for longer periods of time
which reduce incentives to accept jobs or acquire skills.
•Legal obstacles laying off workers
29
Unemployment rates in the EU compared
to Japan and the US
•http://epp.eurostat.ec.e
uropa.eu/statistics_expl
ained/index.php/Unempl
oyment_statistics
30
The Costs of Unemployment
When the level of real GDP is below potential
output
• Unemployment rises above the natural rate and
employment falls below full-employment rate
31
The Costs of Unemployment
Slump
A period during which real GDP is below potential and/or
the employment rate is below normal
Last US Recession
End of 2007 through June 2009
32
Real GDP in 2009 Dollars
Potential GDP
Actual GDP
33
The Costs of Unemployment
Economic cost
 opportunity cost of lost output, output produced is less
than the economy’s potential output
 which means less Income and
less consumption
34
The Costs of Unemployment
Broader costs
•
Psychological and physical effects
•
Setbacks in achieving important social goals
• Burden of unemployment not shared equally among
different groups in the population
• Most heavily: minorities, especially minority
youth
35
Measuring Price Level and Inflation
• Price Level - average of the prices of all good
and services in the economy
• Price Index – a measure of the price level
• GDP deflator is a price index used to track rise
and fall in the price level over time.
36
Index in General
• Index - A series of numbers used to
track a variable’s rise or fall over time
• An index number is calculated as:
37
Example: Index Number for House Prices
Year
House Price
1
2
3
4
$105,000
$110,000
$125,000
$135,000
Index of House
Price
100.00
104.76
119.05
128.57
Note: $110,000/$105,000 = 1.0476
$135,000/$105,000 = 1.2857
The convention is to multiply by 100.
Which year is the base period?
http://research.stlouisfed.org/fred2/series/SPCS20RSA
38
The Consumer Price Index
• Consumer Price Index (CPI)
– An index of the cost over time of a market
basket of goods purchased by a typical
household
• CPI includes
– the part of GDP that consumers purchase
as final users
– household purchases of used goods such
as used cars or used computers
– household purchases of imports
39
The Consumer Price Index
• CPI does not include
– Goods and services purchased by anyone
other than consumers
– Prices of assets, such as stocks, bonds,
and homes
• CPI market basket
– The collection of goods and services that
the typical consumer buys
40
Broad Categories and Relative Importance in the CPI, December
2010
41
Calculating the Consumer Price Index
(1) define a market basket
(2) determine how much it would cost to
purchase the market basket in the current
year and in the base year
(3) divide the dollar cost of purchasing the
market basket in the current year by the
dollar cost of purchasing the market basket
in the base year
(4) multiply the quotient by 100.
42
Calculating the Consumer Price Index
43
Calculating the Consumer Price Index
Market Basket using 2011 as the Base Year
44
CPI in 2012 using 2011 as the based period
45
Consumer Price Index, December, selected years, 1970–2010
1983 = 100
46
From Price Index to Inflation Rate
• Inflation rate
– Percentage change in the price level from
one period to the next
• Deflation
– A decrease in the price level from one
period to the next
47
Consumer Price Index, December, selected years, 1970–2010
Year
Rate of Inflation
2006
2007
2008
2009
2010
48
Consumer Price Index: 1940 - 2014
49
The Rate of Inflation Using the Consumer Price Index, 1950–2014
50
Three Ways the CPI Is Used
• (1) As a policy target;
• (2) To index payments;
• (3) To translate from nominal to real
values
• Policy target
– One macroeconomic goal is stable prices
• Index payments
– A payment that is periodically adjusted in
proportion with a price index such as
Social Security retirement income.
51
Translate from Nominal to Real Values
• Nominal wage
– Number of dollars you earn
• Real wage
– Purchasing power of your wage
52
Nominal and Real Weekly Earnings (December of Each Year)
2014
$796
236.2
http://www.bls.gov/news.release/wkyeng.t01.htm
$337
53
How the CPI Is Used
• When comparing dollar values over time
– We care not about the number of dollars,
but about their purchasing power
– Translate nominal values into real values
Nominal Value
Real Value=
 100
Price Index
54
There are Many price indexes
• The GDP price index measures the
prices of all final goods and services that
are included in U.S. GDP
• The CPI measures the prices of all
goods and services bought by U.S.
households including used goods and
imports
55
CPI vs. GDP Deflator
Prices of capital goods (Investment):
– included in GDP deflator (if produced
domestically)
– excluded from CPI
Prices of imported consumer goods:
– included in CPI
– excluded from GDP deflator
The basket of goods:
– CPI: fixed
– GDP deflator: changes every year
The Costs of Inflation
• The inflation myth
– “Inflation, by making goods and services more
expensive, erodes the average purchasing
power of income in the economy”
• Inflation does not directly decrease the
average real income in the economy
– because people’s income increase during
inflations. Prices and income tend to rise
together. Not really hurt.
57
The CPI and Average Hourly Earnings,
1965-2009
900
800
1965 = 100
700
600
500
Real average
hourly earnings
in 2009 dollars,
right scale
$10
400
Nominal average
hourly earnings,
(1965 = 100)
300
200
100
$15
$5
CPI
(1965 = 100)
0
$0
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Hourly wage in May 2009 dollars
$20
The Costs of Inflation
• But, Inflation changes the distribution
of income.
– People living on fixed incomes are
particularly hurt by inflation.
– And the poor have not fared so well. Welfare
benefits are relatively fixed and have not kept
pace with inflation.
Benefits Indexed to Inflation
• To address the distribution problem,
benefits received by many retired workers,
including social security, are fully indexed
to inflation.
– when prices rise, benefits rise.
• If inflation is correctly anticipated
– and if both parties take it into account,
then inflation will not redistribute
purchasing power
The Costs of Inflation
One way of thinking about the effects of inflation on the
distribution of income is to distinguish between anticipated
and unanticipated inflation.
The effects of anticipated inflation on the distribution of
income are likely to be fairly small, since people and
institutions will adjust to the anticipated inflation.
Unanticipated inflation, on the other hand, may have large
effects, depending, among other things, on how much
indexing to inflation there is.
real interest rate The difference between the
interest rate on a loan and the inflation rate.
Interest Rates
• Nominal interest rate
The actual interest rate borrower’s pay and
lender’s earn from making a loan
• Real interest rate
The nominal interest rate adjusted for
inflation
• Calculation:
- real interest rate = nominal interest rate - inflation
Example:
I borrow $100 from a lender and agree to
pay $105 after one year:
Loan amount
= $100
Interest payment
= $5
Nominal Interest rate = $5/ $100 = 5%
The lender now has $105
Suppose inflation is 2%. What cost $100 a
year earlier now cost $102.
The lender’s purchasing power increases by
$3 not $5.
The real interest rate is 5% - %2 = 3%
= Nominal interest rate - Rate of inflation
63
The Costs of Inflation
• The real interest rate represents the
increase in purchasing power to the
lender and the real cost of the loan to the
borrower.
• If borrowers and lenders know the rate of
inflation, they know the real cost and
purchasing power of the loan
• Unexpected inflation shifts purchasing
power
The Costs of Inflation
• Inflation rate higher than expected
– Harms those awaiting payment (lenders)
– Benefits the payers (borrowers)
• Inflation rate lower than expected
– Harms the payers (borrowers)
– Benefits those awaiting payment (lenders)
Is the CPI Accurate?
• Sources of bias in CPI
–
–
–
–
Substitution bias
New technologies
Changes in quality
Growth in discounting
66
Is the CPI Accurate?
• Substitution bias
– Quantity is fixed
• New technology
– CPI: as new products are introduced, CPI
overstates inflation
• Changes in quality
– CPI: fails to fully account for quality
improvements in the goods and services in
its market basket
• Overestimates the price of the basket of
goods and services
67
Is the CPI Accurate?
• Growth in discounting
– CPI: does not recognize that a new
discount outlet lowers the prices on many
items
– As discount outlets expand into new
areas, the CPI overstates the inflation rate
• Food, electronic appliances, clothing, and
other items sold there
68
Is the CPI Accurate?
• Consequences of CPI bias
– Errors in calculating real wages
– Errors in indexing
• Retirement benefits, wages, interest
payments, or federal tax brackets
69
The Controversy Over Indexing Social
Security Benefits
• Social Security system
– Benefits to about 60 million retired
workers in U.S.
– One of the largest and most expensive of
all federal government programs
• More than $770 billion in 2012
• Estimated to grow to $1,400 billion in 2023
• Payments are indexed to CPI
70
The Controversy …
• Because the CPI overstate inflation
– Nominal payment rises by more than the
actual rise in the price level
– Benefits payments in real terms increase
over time
– Purchasing power is automatically shifted toward
those who are indexed and away from the rest of
society
71
Indexing and “Overindexing” Social Security Benefits
72
Long-Run Growth
output growth The growth rate of the output of the entire economy.
per-capita output growth The growth rate of output per person in the
economy.
productivity growth The growth rate of output per worker.
Output and Productivity Growth
▲ FIGURE 7.2 Output per Worker Hour (Productivity), 1952 I–2012 IV
Productivity grew much faster in the 1950s and 1960s than it has since.
▲ FIGURE 7.3 Capital per Worker, 1952 I–2012 IV
Capital per worker grew until about 1980 and then leveled off somewhat.
Looking Ahead
This ends our introduction to the basic concepts and problems of
macroeconomics.
The first chapter of this part introduced the field; the second chapter discussed
the measurement of national product and national income; and this chapter
discussed unemployment, inflation, and long-run growth.
We are now ready to begin the analysis of how the macroeconomy works.
REVIEW TERMS AND CONCEPTS
consumer price index (CPI)
productivity growth
cyclical unemployment
real interest rate
discouraged-worker effect
structural unemployment
employed
unemployed
frictional unemployment
unemployment rate
labor force
Equations:
labor force participation rate
labor force = employed + unemployed
natural rate of unemployment
population = labor force + not in labor force
not in the labor force
output growth
per-capita output growth
producer price indexes (PPIs)
unemployme nt rate 
unemployed
employed  unemployed
labor force participat ion rate 
labor force
population