Goal #2
Limit Unemployment
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ACDC Leadership 2015
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26-2
The Business Cycle
Peak
Level of Real Output
Peak
Peak
Trough
Trough
Time
Durable and nondurable industries
affected differently
26-3
Causes of Business Cycles
• Shocks and price stickiness
• Change in output instead of price
• Supply and productivity shocks
• innovation
• Monetary shocks
• Financial bursts and bubbles
• Unexpected political events
• Common link
• Unexpected changes in spending
26-4
Unemployment
• Twin problems of the business cycle
• Unemployment
• Inflation
• Who is in the Labor Force?
• Above 16 years old
• Able and willing to work
• Not institutionalized (in jails or hospitals)
• Not in military, in school full time, or retired
• Why is a stay at home mom not unemployed?
• Problems with the unemployment rate
• Part-time employment counts
• Discouraged workers
Unemployment Rate
=
Unemployed
Labor Force
x 100
26-5
Unemployment
2007 data
Under 16
And/or
Institutionalized
(71.8 Million)
Not in
Labor Force
(78.7 Million)
Total
Population
(303.6 Million)
Employed
(146.0 Million)
Unemployed
(7.1 Million)
Labor
Force
(153.1 Million)
Source: Bureau of Labor Statistics
Three Types of
Unemployment
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26-7
Unemployment
• Types of unemployment
• Frictional (search and wait)
• I Quit! --- You’re Fired!
• Structural (occupational
and geographical)
• Cyclical
• Full employment redefined
• No cyclical unemployment
• Natural rate of unemployment
• Stay tuned
• Full employment rate
SOME JOBS
DISAPPEAR
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The Natural Rate of Unemployment
•Frictional and structural unemployment are
present at all times because people will always be
between jobs or replaced by technology.
•So, the economy is doing great if there is only
frictional and structural unemployment.
Natural Rate of Unemployment (NRU)Frictional plus structural unemployment. The
amount of employment that exists when the
economy is healthy and growing.
•Full Employment Output (Y)- The Real GDP
created when there is no cyclical unemployment
The US is at full employment when there is
4-6% unemployment
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26-10
Unemployment
• Natural rate of unemployment
• 2000’s 4-5%
• Today 5-6%
• Changing structure of U.S.
economy
• Why do you think the NRU is higher
nowadays?
• Much Human Capital misaligned
with industries with Labor demand
The PPC and the Business Cycle
Capital Goods
Max Capacity
0% Unemployment
Real
GDP
Real
GDP
Consumer Goods
Full Employment
5% Unemployment
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Time
6+% Unemployment
4-6% Unemployment
Super low unemployment
leads to inflation
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26-13
Cost of Unemployment
• Foregone output
• Potential output
• GDP gap
• (Actual output – potential output)
• Negative or positive
• Okun’s Law
• Each 1% above NRU creates negative
2% output gap
26-14
GDP (billions of 1996 dollars)
Unemployment
12,000
12,000
The GDP Gap
11,000
11,000
GDP gap
(positive)
10,000
10,000
9,000
9,000
Potential GDP
8,000
8,000
GDP gap
(negative)
7,000
7,000
6,000
6,000
Actual GDP
5,000
5,000
1985
1987
Unemployment
(percent of civilian
Labor force)
1985
1987
1989
1989
1991
1991
1993
1993
1995
1995
1997
1997
1999
1999
2001
2001
2003
2003
2005
2005
10 10
8
8
6
6
4
4
2
2
0
0
1985
The Unemployment Rate
1985 1987 1987
1989
1989
1991 1991
19931993
1995
1995
1997
1997
1999
1999
2001
2001
2003
2003
2005
2005
Source: Congressional Budget Office & Bureau of Economic Analysis
26-15
Unemployment – Things to consider
• Unequal burdens
• Occupation
• Age
• Race and ethnicity
• Gender
• Education
• Duration
• Noneconomic costs
• Psychological, social, political
26-16
Long-Term Unemployment
26-17
Long-Term Unemployment
26-18
Unemployment
Unemployment Rates in Five Industrial
Nations,1995-2005
Source: Bureau of Labor Statistics
The Natural Rate of Unemployment
The natural rate in France and Germany is
around 8–10%. Why?
• Some economists attribute the difference
to more generous unemployment benefits
in European countries
– In the U.S. unemployment benefits last for 6
months
– Unemployment benefits in some European
countries are indefinite
– The generous benefits reduce incentives to
search for a job
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26-20
Question…..
How can we
reduce
unemployment?
Pain =
Progress?
Review: NAME THAT CONCEPT
1.Macroeconomics
2.Inflation
3.Nominal GDP
4.Structural Unemp.
5.C+I+G+Xn
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Review: NAME THAT CONCEPT
1.REAL GDP
2.FULL EMPLOYM.
3.CYCLICAL UNEMP.
4.NATURAL RATE
5.FRICTIONAL
UNEMPLOYMENT
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Goal #3
LIMIT INFLATION
Country and TimeZimbabwe, 2008
Annual Inflation Rate79,600,000,000%
Time for Prices to Double24.7 hours
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26-25
Inflation
• Rise in general level of prices
• Reduction in Purchasing Power
Examples:
• It takes $2 to buy what $1 bought in 1987
• It takes $6 to buy what $1 bought in 1970
• It takes $24 to buy what $1 bought in 1913
Is Inflation Good or Bad?
Good or Bad?
In general, ramped inflation is bad because
banks don’t lend and people don’t save.
This decreases investment and GDP.
What about deflation?
Deflation- Decrease in general prices or a
negative inflation rate.
Deflation is bad because people will hoard
money (financial assets)
This decreases consumer spending and GDP.
Disinflation- Prices increasing at slower rates
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But inflation doesn’t effect everyone equally.
Identify which people are helped and which
are hurt by unanticipated inflation
1. A man who lent out $500 to his friend in 1960
and gets paid back in 2015.
2. A tenant who is charged $850 rent each year.
3. An elderly couple living off fixed retirement
payments of $2000 a month
4. A man that borrowed $1,000 in 1995 and paid
it back in 2014.
5. A woman who saved $500 in 1950 by putting
it under her mattress
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Effects of Unanticipated Inflation
Hurt by Inflation
• Lenders-People who
lend money (at fixed
interest rates)
• People with fixed
incomes
• Savers
Helped by Inflation
• Borrowers-People
who borrow money
• A business where the
price of the product
increases faster than
the price of resources
Nominal Wage- Wage measured by dollars rather
than purchasing power
Real Wage- Wage adjusted for inflation
If there is inflation, you must ask your boss for a raise
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Historic Inflation Rates
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Inflation
26-33
CPI
• Consumer price index (CPI)
• Market basket
• 300 goods and services
• Typical urban consumer
• 2 year updates
CPI =
Price of the Most Recent Market
Basket in the Particular Year
Price estimate of the Market
Basket in Base Year
x
100
• *****Base year used by Bureau of Labor
Statistics is 1982-1984 (CPI1982-84 = 100)
26-34
Rate of Inflation
This year index – Last year index
Last year index
Problems with the CPI
1. Substitution Bias- As prices increase for the fixed
market basket, consumers buy less of these products
and more substitutes that may not be part of the
market basket. (Result: CPI may be higher than
what consumers are really paying)
2. New Products- The CPI market basket may not
include the newest consumer products. (Result: CPI
measures prices but not the increase in choices)
3. Product Quality- The CPI ignores both
improvements and decline in product quality.
(Result: CPI may suggest that prices stay the same
though the economic well being has improved
significantly)
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Three Causes of
Inflation
1. If everyone suddenly had a million dollars, what
would happen?
2. What two things cause prices to increase? Use
Supply and Demand
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3 Causes of Inflation
1. The Government Prints TOO MUCH
Money (The Quantity Theory)
• Governments that keep
printing money to pay debts
end up with hyperinflation.
• Result: Banks refuse to lend
so investment falls and
people don’t save up to buy
things.
Examples:
• Bolivia, Peru, Brazil
• Germany after WWI
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3 Causes of Inflation
2. Demand- Pull Inflation
DEMAND PULLS UP PRICES!!!
“Too many dollars chasing too few goods”
An overheated economy with excessive
spending but same amount of goods.
3. Cost-Push Inflation
Higher production costs increase prices
A negative supply shock increases the costs of
production and forces producers to increase
prices.
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The Wage-Price Spiral
A Perpetual Process:
1.Workers demand raises
2.Owners increase prices to
pay for raises
3. High prices cause workers
to demand higher raises
4. Owners increase prices to
pay for higher raises
5. High prices cause workers
to demand higher raises
6. Owners increase prices to
pay for higher raises
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Anticipated Inflation and Interest Rates
• Nominal Interest Rate
• Real Interest Rate
• Inflation Premium
6%
11%
=
+
5%
Nominal
Interest
Rate
Real
Interest
Rate
Inflation
Premium
CPI vs. GDP Deflator
The GDP deflator measures the prices of all goods
produced, whereas the CPI measures prices of only
the goods and services bought by consumers.
An increase in the price of goods bought by firms or the
government will show up in the GDP deflator but not in the
CPI.
The GDP deflator includes only those goods and services produced
domestically. Imported goods are not a part of GDP and
therefore don’t show up in the GDP deflator.
GDP
Deflator
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=
Nominal GDP
Real GDP
x 100
Calculations
1. In an economy, Real GDP is $80 billion and the
Nominal GDP is $100 billion. Calculate the GDP
deflator.
125
2. In an economy, Real GDP is $200 billion and the
deflator is 120. Calculate Nominal GDP.
$240B
3. In an economy, Nominal GDP is $300 billion and the
GDP deflator is 150. Calculate the Real GDP .
$200B
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Achieving the Three Goals
The governments role is to prevent unemployment and
prevent inflation at the same time.
•If the government focuses too much on preventing inflation
and slows down the economy we will have unemployment.
•If the government focuses too much on limiting
unemployment and overheats the economy we will have
inflation
Unemployment
Inflation
GDP Growth
Good
6% or less
1%-4%
2.5%-5%
Worry
6.5%-8%
5%-8%
1%-2%
Bad
8.5 % or more
9% or more
.5% or less