Chapter 7 Powerpoint

Chapter 7
The Macroeconomy:
Unemployment,
Inflation, and
Deflation

Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-2
Introduction
In 2009, Congress used general taxpayer funds to
extend the length of unemployment benefits from 26
weeks to 52 weeks.
A number of economists have suggested that this
policy change has caused an increase in the number of
people unemployed.
In this chapter, you will learn how unemployment is
defined as well as how extending unemployment
benefits many have contributed to the number of
people counted as unemployed.

Learning Objectives
• Explain how the U.S. government calculates
the official unemployment rate
• Discuss the types of unemployment
• Describe how price indexes are calculated
and define the key types of price indexes

Learning Objectives (cont'd)
• Distinguish between nominal and real
interest rates
• Evaluate who looses and who gains from
inflation
• Understand key features of business
fluctuations

Chapter Outline
• Unemployment
• The Major Types of Unemployment
• Full Employment and the Natural Rate of
Unemployment
• Inflation and Deflation
• Anticipated versus Unanticipated Inflation
• Changing Inflation and Unemployment:
Business Fluctuations

Did You Know That ...
• Between 2008 and 2010, the number of people
gainfully employed in the U.S. declined by nearly 9
million?
• Since then, more than 2 million of these people
have regained positions in the workplace.
• Of the remainder, most are still classified as
unemployed, which means that they are looking for
work but have not yet found employment.

Unemployment
• Unemployment
– Total number of adults (aged 16 years or older)
willing and able to work and who are actively
looking for work but have not found a job
– Unemployment creates a cost to the entire
economy in terms of lost output – often ranging
in the billions of dollars

Unemployment (cont'd)
• Labor Force
– Individuals aged 16 years or older who either
have jobs or who are looking and available for
jobs; the number of employed plus the number
of unemployed
• The unemployment rate is the percentage
of the measured labor force that is
unemployed

Figure 7-1 More Than a Century of
Unemployment
Source: U.S. Department of Labor, Bureau of Labor Statistics.

Figure 7-2 Adult Population
Source: U.S. Department of Labor, Bureau of Labor Statistics.

• Stock
– The quantity of something, measured at a given
point in time—for example, an inventory of
goods
• Flow
– A quantity measured over time, such as the
income you make per year, or the number of
individuals fired every month

Figure 7-3 The Logic of the
Unemployment Rate

• Categories of individuals without work
– Job loser
– Reentrant
– Job leaver
– New entrant

• Job Loser
– An individual whose employment was
involuntarily terminated or who was laid off
• 40–60% of the unemployed

• Reentrant
– An individual who has worked a full-time job
before but left the labor force and has now
reentered it looking for a job
• 20–30% of the unemployed

• Job Leaver
– An individual who voluntarily quit
• 10 to 15% of the unemployed

• New Entrant
– An individual who has never worked a full-time
job for two weeks or longer
• 10 to 15% of the unemployed

Unemployment (cont’d)
• Duration of unemployment
– More than a third of job seekers find work within
one month
– Approximately another third find employment
within a second month
– About a sixth are still unemployed after six
months
– Average duration varied between 10 and 20
weeks since the mid-1960s

• Discouraged Workers
– Individuals who have stopped looking for a job
because they are convinced they will not find a
suitable one
• Question
– How does the existence of discouraged workers
bias the unemployment rate?

• Labor Force Participation Rate
– The proportion of non-institutionalized working-
age individuals who are employed or seeking
employment

The Major Types of Unemployment
• The major types of unemployment
– Frictional
– Structural
– Cyclical
– Seasonal

Example: Fewer Men at Work – Or
Even Looking for It
• Since the beginning of 2008, the U.S. labor force
participation rate has decreased by 2 full
percentage points.
• This translates into a departure of 5 million people
from the labor force.
• Men are heavily represented in this group of
discouraged workers.
• During the 2008 – 2009 recession, occupations
dominated by male workers, such as construction
and manufacturing, experienced the largest job
losses.

(cont'd)
• Frictional Unemployment
– Results from the fact that workers must search
for appropriate job offers
– This takes time, so they remain temporarily
unemployed

(cont'd)
• Structural Unemployment
– Unemployment of workers over lengthy intervals
resulting from skill mismatches with position
requirements of employers and from fewer jobs
being offered by employers constrained by
governmental business regulations and labor-
market policies.
– Considerable evidence shows that government
labor market policies influence how many jobs
businesses wish to create, thereby affecting
structural unemployment.

Policy Example: Warning: WARN May
Boost the Natural Unemployment Rate
• In 1989, Congress passed the Worker
Adjustment and Retraining Notification
(WARN) Act.
• The law requires firms to notify employees
and provide benefits when 50 or more full-
time workers are laid off.
• The law rarely applied until the 2008–2009
recession, when many firms initiated large
layoffs just to stay in business.

Policy Example: Warning: WARN May
Boost the Natural Unemployment Rate
• As the number of WARN-related court cases
tripled, managers became more reluctant to
hire new workers, wanting to avoid future
layoffs.
• As a consequence, the unemployment rate
has remained high even as many companies
are experiencing improved performance and
profitability.

(cont'd)
• Cyclical Unemployment
– Results from business recessions that occur when
aggregate (total) demand is insufficient to create
full employment

(cont'd)
• Seasonal Unemployment
– Results from the seasonal pattern of work in
specific industries
– Due to seasonal fluctuations in demand or
changing weather conditions that affect
agriculture, construction, tourism industries and
so on

Full Employment and the Natural
Rate of Unemployment (cont'd)
• Full Employment
– An arbitrary level of unemployment that
corresponds to “normal” friction in the labor
market

• Natural Rate of Unemployment
– The unemployment rate that is estimated to
prevail in the long-run macroeconomic
equilibrium
– Should not reflect cyclical unemployment
– When seasonally adjusted, the natural rate
should include only frictional and structural
unemployment

• Until the late 2000’s, most economists had
considered the natural rate of unemployment to be
about 5 percent.
• Since the end of the 2008-2009 recession,
however, the actual unemployment rate has been
considerably in excess of 5 percent.
• It has been suggested that higher structural
unemployment arises from two sources:
– The loss of jobs in construction, finance, and real estate
– Government regulations that raise the costs of hiring new
employees

Inflation and Deflation
• Inflation
– A sustained increase in the average of all prices
of goods and services in an economy
• Deflation
– A sustained decrease in the average of all prices
of goods and services in an economy

Inflation and Deflation (cont'd)
• Purchasing Power
– The value of money for buying goods and
services
– Varies with prices and income, e.g., if your
money income stays the same but the price of
one good goes up, your effective purchasing
power falls

• Nominal value
– Price expressed in today’s dollars
• Real value
– Value expressed in purchasing power, adjusted
for inflation

What If . . . City Governments Pass More Laws to
Benefit All Employees?
• Beginning in 2013, a new health care law went into
effect that is expected to raise the cost of
businesses providing health insurance coverage to
their employees.
• In addition, new laws are increasing the number of
days that firms must allow employees to take off
from work when they have a new child.
• These regulations reduce the incentive for firms to
hire new workers, thereby adding to structural
unemployment.

Measuring the Rate of Inflation
• Market Basket
– Representative bundle of goods and services
• Base Year
– The point of reference for comparison of prices in
other years

Price index = × 100
cost of market basket today
cost of market basket in base year
• Price Index
–The cost of today’s market basket of goods
expressed as a percentage of the cost of the
same market basket during a base year

Table 7-1 Calculating a Price Index for a Two-
Good Market Basket

• Real-world price indexes
– Consumer Price Index (CPI)
– Producer Price Index (PPI)
– GDP deflator
– Personal Consumption Expenditure (PCE)

• Consumer Price Index (CPI)
– A statistical measure of a weighted average of
prices of a specified set of goods and services
purchased by wage earners in urban areas
– Market basket of goods and services of typical
consumer

International Example: Why the Value of
China’s Consumer Price Index Is Rising
• In China, food accounts for about 35 percent
of items in the consumer price index.
• Food prices have been increasing so rapidly,
however, that they account for most of the
increase in China’s annual inflation rate.

• Producer Price Index (PPI)
– A statistical measure of a weighted average of prices of
goods and services that firms produce and sell
– Used as a short-run leading indicator (before CPI)
– Producer Price Indexes for:
• Foodstuffs
• Intermediate goods
• Finished goods

• GDP Deflator
– A price index measuring the changes in prices of
all new goods and services produced in the
economy
– Broadest measure of prices; reflects both price
changes and the public’s market responses to
those price changes

• Personal Consumption Expenditure (PCE)
Index
– A statistical measure of average price using
annually updated weights based on consumer
spending
– Primary inflation indicator used by the Federal
Reserve

Figure 7-4 Inflation and Deflation in
U.S. History
Source: U.S.
Department of
Labor, Bureau
of Labor
Statistics.

International Policy Example: Argentina
Penalizes Inflation Estimates That Are
“Too High”
• The official government measure of inflation
reported in Argentina is typically lower than the
inflation rate calculated by private firms.
• The Argentine government has criticized the
estimates of private firms and has imposed fines
on inflation estimates that differ substantially from
the inflation forecast.
• Consequently, private firms that provide
independent estimates do so only under the
condition of confidentiality.

Anticipated versus Unanticipated
Inflation
• Anticipated versus unanticipated inflation
– To determine who is hurt by inflation we
distinguish between the two types
– The effects of inflation on individuals depend
upon which type of inflation exists

Inflation (cont'd)
• Anticipated Inflation
– The inflation rate that we believe will occur
• Unanticipated Inflation
– Inflation at a rate that comes as a surprise

Inflation (cont'd)
• Inflation and interest rates
– Nominal Rate of Interest
• The market rate of interest expressed in today’s dollars
– Real Rate of Interest
• The nominal rate of interest minus the anticipated rate
of inflation

Inflation (cont'd)
• Real interest rate
– Nominal interest rate = 5%
– Expected inflation rate = 3%
– Real rate = 5% – 3% = 2%

Inflation (cont'd)
• Does inflation necessarily hurt everyone?
– Inflation affects people differently
• Unanticipated inflation
– Creditors lose
– Debtors gain

Inflation (cont'd)
• Protecting against inflation
– Cost-Of-Living Adjustments (COLAs)
• Clauses in contracts that allow for increases in
specified nominal values to take account of changes in
the cost of living

Inflation (cont'd)
• The resource cost of inflation
– Repricing or Menu Cost of Inflation
• The cost associated with recalculating prices and
printing new price lists when there is inflation

Changing Inflation and Unemployment:
Business Fluctuations
• Business Fluctuations
– The ups and downs in business activity
throughout the economy

Business Fluctuations (cont'd)
• Expansion
– A business fluctuation in which the pace of
national economic activity is speeding up
• Contraction
– A business fluctuation during which the pace of
national economic activity is slowing down

• Recession
– A period of time during which the rate of growth
of business activity is consistently less than its
long-term trend or is negative
• Depression
– An extremely severe recession

Figure 7-5 The Idealized Course of Business
Fluctuations

Figure 7-6 National Business Activity,
1880 to the Present
Sources: American Business Activity from 1790 to Today, 67th ed., AmeriTrust Co., January 1996,
plus author’s estimates.

• Leading Indicators
– Events that have been found to occur before
changes in business activity
• Economic downturns often follow
– Reduction in the average workweek
– Rise in unemployment insurance claims
– Decrease in prices of raw materials
– Drop in the quantity of money circulating

International Policy Example: Internet Search
Activity as a Leading Indicator
• Economists at the Bank of England are studying the
volume of Internet searches as a leading indicator
of economic activity.
• This measure exhibits desirable properties of a
leading indicator:
– The data are available daily
– 60 percent of the adult population in the U.K. engages in
Web searches every day
– The volume of online searches appears to be related to key
measures of economic activity.

You Are There: Struggling to Hire with the
Unemployment Rate Above 9 Percent
• Jack Kelly, CEO of Hamill Manufacturing, is having
a difficult time finding skilled workers to fill open
positions for operators of computer-controlled
metal-shaping equipment.
• A high-school graduate with knowledge of
trigonometry and basic science has the
fundamentals required for these jobs.
• Yet, students with these skills typically go on to
college rather than prepare for a career as a skilled
manufacturing laborer.

Issues & Applications: Have Unemployment
Benefits Boosted Unemployment?
• Following the end of the recession in 2009, the
unemployment rate remained elevated above its
prior level by more than 2 percentage points for at
least three years.
• Some economists argue that this higher level of
structural unemployment is the result of the
significant extension of the length of
unemployment benefits to 99 weeks.
• Unemployed workers now have a greater incentive
to keep looking for jobs that are a good fit for their
preferences.

Summary Discussion of Learning
Objectives
• How the U.S. government calculates the
official unemployment rate
– Percentage of the total number of adults willing
and able to work who are actively looking for
work but have not found a job
• The major types of unemployment
– Frictional
– Structural
– Cyclical
– Seasonal

Objectives (cont'd)
• Full employment
– Arbitrary level of unemployment
• Corresponds to “normal” friction in labor market
• Natural rate of unemployment
– Estimated to prevail in the long-run
macroeconomic equilibrium
• All workers and employers adjust to any changes in
economy

Objectives (cont'd)
• How price indexes are calculated and key
price indexes
– Multiply 100 times the ratio of the cost of a
market basket of goods in the current year to
the cost of the same basket in a base year
– Key price indexes
• CPI
• PPI
• GDP deflator
• PCE

Objectives (cont'd)
• Nominal versus real interest rates
– Nominal rate is the market rate expressed in
current dollars
– Real rate is net of inflation
– Hence the real interest rate equals the nominal
interest rate minus the expected inflation rate

Objectives (cont'd)
• Losers and gainers from inflation
– Creditors lose as a result of unanticipated
inflation
– Borrowers gain

Objectives (cont'd)
• Key features of business fluctuations
– Increases and decreases in business activity
• Expansion from previous trough to new peak
• Contraction from previous peak to new trough

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