ECON2301 Principles of Macroeconomics

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ECON2301 - Principles of Macroeconomics
Instructor Patrick M. Crowley

• Lecture 7 The Macroeconomy, Inflation and
  Deflation

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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

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Unemployment

• Unemployment
• Total number of adults (aged 16 years or older)
  willing and able to work and who are actively
  looking for work and have not found a job
• 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
• Question
• What are the costs of unemployment?

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Unemployment (cont'd)

• Answers
• Lost output
• During early 2000s, unemployment rate rose by 2
  percentage points
• Factory output was 80 of potential
• Lost output was 200 billion of goods and
  services that could have been produced
• Personal psychological impact

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Figure 7-1 More Than a Century of Unemployment
Source U.S. Department of Labor, Bureau of Labor
Statistics
Whats the most recent unemployment rate?
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Figure 7-2 Adult Population
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Unemployment (cont'd)

• The unemployment rate is the percentage of the
  measured labor force that is unemployed.

Labor force The employed The unemployed
152.7 145.4 7.3
Unemployed Labor force
Unemployment rate
?x 100
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Unemployment (cont'd)
Labor force The employed The unemployed

• 152.7 145.4 7.3

Unemployed Labor force
?x 100
Unemployment rate
U.S., millions of people as of 2007
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Unemployment (cont'd)

• Stock
• The quantity of something, measured at a given
  point in timefor 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

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Unemployment (cont'd)

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

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Unemployment (cont'd)

• Job Loser
• An individual whose employment was involuntarily
  terminated or who was laid off
• 4060 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
• 2030 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

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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 is just over 15 weeks throughout
  the last 15 years.

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Figure 7-3 The Logic of the Unemployment Rate
Question What is likely to happen to the duration
of unemployment during a downturn in the
economy?
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Unemployment (cont'd)

• 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 noninstitutionalized
  working-age individuals who are employed or
  seeking employment

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The Major Types of Unemployment

• The major types of unemployment
• Frictional
• Structural
• Cyclical
• Seasonal

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The Major Types of Unemployment (cont'd)

• Frictional Unemployment
• Results from the fact that workers must search
  for appropriate job offers
• This takes time, so they remain temporarily
  unemployed
• Structural Unemployment
• Results from a poor match of workers abilities
  and skills with current requirements of employers
• Cyclical Unemployment
• Results from business recessions that occur when
  aggregate (total) demand is insufficient to
  create full employment

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The Major Types of Unemployment (cont'd)

• Seasonal Unemployment
• Results from the seasonal pattern of work in
  specific industries
• International Example Challenges of Measuring
  the Unemployment Rate in China
• Measurement of Chinas labor force and
  unemployment rate fails to encompass all of the
  roughly 115 million people who migrate from rural
  areas.
• In addition, Chinas government has not yet
  developed a way to determine how many millions
  of people laid off from state-owned firms have
  obtained positions with private firms.

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Full Employment and the Natural Rate of
Unemployment

• Question
• Does full employment mean that everybody has a
  job?
• 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.

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Some recessions are worse for unemployment than
others
http//www.speaker.gov/img/jobsrecessions.jpg
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Unemployment differs markedly over sex, age and
racial group

• National unemployment rate for 2008 is 6.1

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Inflation - terminology

• 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 the economy
• Disinflation
• A consistent reduction in the rate of inflation
  over time
• Hyperinflation
• Very high inflation

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Inflation and Deflation (cont'd)

• Nominal value
• Price expressed in todays dollars
• Real value
• Value expressed in purchasing power, adjusted for
  inflation
• Purchasing Power
• The value of money for buying goods and services
• Varies with prices and income how?

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Inflation and Deflation (cont'd)

• Measuring the rate of inflation
• Price Index
• The cost of todays market basket of goods
  expressed as a percentage of the cost of the same
  market basket during a base year

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Inflation and Deflation (cont'd)

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

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Table 7-1 Calculating a Price Index for a
Two-Good Market Basket
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Inflation and Deflation (cont'd)

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

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Inflation and Deflation (cont'd)

• 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
• 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)
• PPIs for
• Foodstuffs
• Intermediate goods
• Finished goods

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Inflation and Deflation (cont'd)

• 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 publics 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 index used by the Federal
  Reserve

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Figure 7-4 Inflation and Deflation in U.S.
History
Source U.S. Department of Labor, Bureau of Labor
Statistics
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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.
• Anticipated Inflation
• The inflation rate that we believe will occur
• Unanticipated Inflation
• Inflation at a rate that comes as a surprise

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Anticipated versus Unanticipated Inflation
(cont'd)

• Inflation and interest rates
• Nominal Rate of Interest
• The market rate of interest expressed in todays
  dollars
• Real Rate of Interest
• The nominal rate of interest minus the
  anticipated rate of inflation
• Real interest rate
• Nominal interest rate 10
• Expected inflation rate 6
• Real rate 10 6 4

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Anticipated versus Unanticipated Inflation
(cont'd)

• Does inflation necessarily hurt everyone?
• Inflation affects people differently
• Unanticipated inflation
• Creditors lose
• Debtors gain
• 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

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Anticipated versus Unanticipated 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
• Policy Example How Pervasive Is Inflation
  Inequality in the United States?
• Inequality based on consumption of fuel,
  education, and health care
• Households facing higher inflation do so for a
  short period of time.
• To the extent inflation inequality exits, it is
  neither pervasive nor persistent.

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Changing Inflation and Unemployment Business
Fluctuations

• Business Fluctuations
• The ups and downs in business activity throughout
  the economy
• 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

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Figure 7-5 The Idealized Course of Business
Fluctuations
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Figure 7-6 National Business Activity, 1880 to
the Present
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Changing Inflation and Unemployment Business
Fluctuations (cont'd)

• 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

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Issues and Applications Wal-Mart, Product
Quality, and the CPI

• Wal-Mart offers lower prices on most food items.
• The Bureau of Labor Statistics (BLS) uses prices
  charged at a nearby Kroger.
• As far as the BLS is concerned, lower Wal-Mart
  prices must reflect lower quality.
• BLS quality adjustments may result in an upward
  bias in the rate of CPI inflation.

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Summary

• Labor force
• Unemployment rate
• Labor force participation rate
• Full employment
• Natural rate of unemployment
• Nominal vs real interest rate
• Inflation
• Unanticipated vs anticipated inflation
• Business cycle fluctuations