MACROECONOMICS
By
Dr. Nimantha Manamperi
Chapter 8
Unemployment and Inflation
WHAT YOU
WILL LEARN
IN THIS
CHAPTER
• How unemployment is measured and
how the unemployment rate is
calculated
• The significance of the unemployment
rate for the economy
• The relationship between the
unemployment rate and economic
growth
• The factors that determine the natural
rate of unemployment
• The economic costs of inflation
• Why policy makers try to maintain a
stable rate of inflation
• http://money.cnn.com/2014/10/03/news/economy/septem
ber-jobs-report-unemployment-below-6-percent/
• http://www.foxbusiness.com/economypolicy/2014/10/03/us-added-248000-jobs-in-septemberunemployment-rate-falls-to-5/
• http://www.bls.gov/web/laus/laumstrk.htm
• http://www.bls.gov/web/metro/laulrgma.htm
Unemployment Rate
Unemployment Rate
• Population:
• Working Age Population:
• Labor Force:
• Not in the Labor force:
• Employed is the number of people currently employed in
the economy, either full time or part time.
• Unemployed is the number of people who are actively
looking for work but aren’t currently employed.
• In other words: The labor force is equal to the sum of
employment and unemployment.
Unemployment Rate
• The labor force participation rate is the percentage of the
population aged 16 or older that is in the labor force.
 The unemployment rate is the percentage of the total
number of people in the labor force who are unemployed.
Unemployment Rate
Example :
The labor force is 100,000 and the number of people employed is 96000.
The number of people aged over 16 years of age is 160,000. Calculate the
Followings.
1.
2.
3.
4.
Number of people not in the labor force.
Number of people Unemployed.
Labor force participation Rate.
Unemployment Rate.
Unemployment Rate
• Discouraged workers are nonworking people who are
capable of working but have given up looking for a job
because of the state of the job market.
• Marginally attached workers would like to be employed
and have looked for a job in the recent past but are not
currently looking for work.
• Underemployment is the number of people who work part
time because they cannot find full-time jobs.
Unemployment Rate
Unemployment Rate
Unemployment Rates of Different Groups, 2007
Unemployment
rate
35%
33.1%
30
25
20
14.4%
15
10
5
9.0%
5.0%
0
Overall
African-American
White
teenager
AfricanAmerican
teenager
Unemployment Rate
Unemployment and Recessions, 1978-2011
The Types of Unemployment
• Workers who spend time looking for employment are
engaged in job search.
• Frictional unemployment is unemployment due to the time
workers spend in job search.
E.g.
• Frictional Unemployment depends on ;
 Information Availability
 Government Policies ( e.g. Unemployment Benefits)
 Personnel Incentives
Frictional Unemployment
The Nature of the Duration of Unemployment
The Types of Unemployment
Structural unemployment is unemployment caused by the
changes in the industrial structure of the economy.
This can occur due to,
1. Minimum Wage Rate
2.
Labor Union Activities
3.
Efficiency Wages
The Types of Unemployment
The Effect of a Structural Unemployment on the Labor Market
Labor Supply
Wage
Rate
Structural
unemployment
W
F
New
Wage Limit
W
E
QD
QE
QS
Quantity of
Labor
The Types of Unemployment
• Cyclical unemployment is the unemployment due to the
downturns in the business cycle.
e.g.
 Layoffs in recessions increases the Cyclical
`
unemployment
 Seasonal Unemployment is also included here.
 New hiring opportunities in Expansions decreases cyclical
unemployment.
The Natural Rate of Unemployment
• The Natural rate of Unemployment is the normal
unemployment rate around which the actual
unemployment rate fluctuates.
 It is the unemployment rate that arises from the effects of
frictional plus structural unemployment.
• Natural unemployment = Frictional unemployment +
Structural unemployment
• Actual unemployment = Natural unemployment + Cyclical
unemployment
The Natural Rate of Unemployment
• E.g.
Actual rate of Unemployment 10%
Natural rate of unemployment 8%
Frictional Unemployment 3%
Then calculate;
1. Structural rate of unemployment
2. Cyclical rate of Unemployment
Price Indexes and the Aggregate Price Level
• The aggregate price level is a measure of the overall level of
prices in the economy.
• To measure the aggregate price level, economists calculate
the cost of purchasing a market basket.
• A price index is the ratio of the current cost of that market
basket to the cost in a base year, multiplied by 100.
• The consumer price index measures the cost of the market
basket of a typical urban American family.
Market Baskets and Price Indexes
Calculating Price Index in a Simple Economy
Inflation Rate, CPI, and other Indexes
• Producer Price Index (PPI) :
Measures the changes in the prices of goods purchased
by the producers. (i.e. Coal, Steel, electricity, raw
materials etc …)
• GDP Deflator :
GDP Deflator = ( Nominal GDP / Real GDP ) * 100
Measures of Inflation: Trend
Inflation and Deflation
• Real wage is the wage rate divided by the price level.

Real Wage = (Nominal Wage Rate / Price Level)* 100
• Real income is income divided by the price level.

Real Income = ( Nominal Income / Price Level) * 100
Inflation Rate, CPI, and other Indexes
• The inflation rate is the yearly percentage change in a price
index, typically based on the Consumer Price Index, or CPI,
the most common measure of the aggregate price level.
𝑰𝒏𝒇𝒍𝒂𝒕𝒊𝒐𝒏 𝑹𝒂𝒕𝒆 =
𝑷𝒓𝒊𝒄𝒆 𝑳𝒆𝒗𝒆𝒍 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒀𝒆𝒂𝒓 − 𝑷𝒓𝒊𝒄𝒆 𝑳𝒆𝒗𝒆𝒍 𝑳𝒂𝒔𝒕 𝒀𝒆𝒔𝒓
𝑷𝒓𝒊𝒄𝒆 𝑳𝒆𝒗𝒆𝒍 𝑳𝒂𝒔𝒕 𝒀𝒆𝒔𝒓
*100
Calculating Inflation
• Example :
Inflation and Deflation
Costs of Inflation
• Shoe-leather costs are the increased costs of transactions
caused by inflation.
• Menu cost is the real cost of changing a listed price.
• Unit-of-account costs arise from the way inflation makes
money a less reliable unit of measurement.
Summary
1. Inflation and unemployment are the main concerns of
macroeconomic policy.
2. Employment is the number of people employed;
unemployment is the number of people unemployed and
actively looking for work.
Their sum is equal to the labor force, and the labor force
participation rate is the percentage of the population age
16 or older that is in the labor force.
Summary
3. The unemployment rate can overstate because it counts as
unemployed those who are continuing to search for a job
despite having been offered one (that is, workers who are
frictionally unemployed).
It can understate because it ignores frustrated workers,
such as discouraged workers, marginally attached
workers, and the underemployed.
Summary
4. The unemployment rate is affected by the business cycle.
The unemployment rate generally falls when the growth
rate of real GDP is above average and generally increases
when the growth rate of real GDP is below average.
Summary
5. Job creation and destruction, as well as voluntary job
separations, lead to job search and frictional
unemployment.
In addition, a variety of factors (such as minimum wages,
unions, efficiency wages, and government policies
designed to help laid-off workers) result in a situation in
which there is a surplus of labor at the market wage rate,
creating structural unemployment.
As a result, the natural rate of unemployment, the sum of
frictional and structural employment, is well above zero,
even when jobs are plentiful.
Summary
6. The actual unemployment rate is equal to the natural rate
of unemployment plus cyclical unemployment.
7. The natural rate of unemployment changes over time.
8. Policy makers worry about inflation, as well as
unemployment.
Summary
9. Inflation does not, as many assume, make everyone
poorer by raising the level of prices. That's because wages
and incomes are adjusted to take into account a rising
price level, leaving real wages and real income unaffected.
However, a high inflation rate imposes overall costs on the
economy: shoe-leather costs, menu costs, and unit-ofaccount costs.
Summary
10. Inflation can produce winners and losers within the
economy, because long-term contracts are generally
written in dollar terms.
Loans typically specify a nominal interest rate, which
differs from the real interest rate due to inflation.
A higher-than-expected inflation rate is good for borrowers
and bad for lenders. A lower-than-expected inflation rate is
good for lenders and bad for borrowers.
11. Disinflation is very costly, so policy makers try to prevent
inflation from becoming excessive in the first place.