Unemployment and Inflation

1

• Unemployment and Inflation
• i.e. two evils of the economy will be discussed.

2
Component Parts GDP

• Consumption
• Investment
• Government Spending
• Exports- Imports (Net Exports)
• CIG(X-M) GDP

3
GDP to 2009 2nd quarter
4
Why does growth matter?

• Allows wages and incomes to rise.
• Standard of living increases
• Takes the pressure of scarce resources (why?)

5
Macroeconomic Problems

• High inflation rate
• High unemployment rate
• High interest rates
• Low economic growth or stagnation

6
Macroeconomic Policies

• Fiscal Policy deals with changes in government
  expenditures and/or taxes. to achieve particular
  macroeconomic goals.
• Monetary Policy deals with. changes in the money
  supply, or the rate of growth of the money
  supply, to achieve particular macroeconomic
  goals.

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The Idealized Course of Business Fluctuations
8
What are component parts of GDP?

• ?

9
Consensus among Economists says swings due to

• Changes in REAL levels of output and employment
  brought about by changes in levels of TOTAL
  SPENDING.
• Spending
• Businesses no longer produce at current level
• Output, employment and income fall
• In reverse the opposite results.

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Important economic fact

• As the economy gets close to
• FULL EMPLOYMENT
• It is more difficult to obtain further gains in
  REAL OUTPUT.
• Continued increasing levels of spending bring
  about INFLATION

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SRAS
P R I C E L E V E L
AD
GDP
QF
LRAS
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Countries Compare

• Countries can assess the growth of other
  countries for means of
• Foreign investment
• Trade potential
• Currency stabilization

13
What will we focus on?

• This will focuses on economic growth, the
  business cycle, unemployment and inflation.
• When is a person unemployed?
• What are the costs of unemployment?
• -When will money not buy as much?

14
What is the labor force?

• The labor force includes all persons over age
  sixteen who are either working for pay or
  actively seeking paid employment.
• People who are not employed or are not actively
  seeking work are not considered part of the labor
  force.
• When is a person unemployed?
• What are the costs of unemployment?

15
What is unemployment?

• To make full use of available production
  capacity, the labor force must be fully employed.
• Unemployment is the inability of labor-force
  participants to find jobs.

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How is unemployment measured?

• U.S. Census Bureau surveys about 60,000
  households a month to determine how many people
  are actually unemployed.
• A person is considered unemployed if he or she is
  not employed and is actively seeking a job.
• The unemployment rate is the proportion of the
  labor force that is unemployed.

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Bureau Labor Statistics determines perimeters for
unemployment.

• Persons over 16 are considered employed IF
• They worked at all for pay or profit even if for
  an hour
• Worked 15 hours or more w/out pay in a
  family-operated enterprise.
• Have a job which they did not work during (survey
  week) due to illness, vacation, industrial
  disputes, bad weather, time off or personal
  reasons.

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BLS Continued

• Persons are considered unemployed IF (during the
  survey week)
• Do not have a job
• Are available for work
• Have actively looked looked for work during
  past four weeks (this requirement is very weak)

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Reason for unemployment

• How long a person remains unemployed is affected
  by the nature of the joblessness.
• Job leavers
• Job losers
• Re-entrants
• New entrants

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What happens if you cant find work.

• If unemployment persists workers often give-up
  looking.
• Discourage workers are not counted as part of the
  unemployment problem after they give up looking
  for a job.
• Some people are forced to take any job available
  which meansno longer unemployed, but now
• underemployed.

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How could one be underemployed?

• Underemployment exists when people seeking
  full-time paid employment, work only part time,
  or are employed at jobs below their capability.
• Underemployed workers represent labor resources
  that are not being fully utilized.

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Unemployment Cont.

• Seasonal unemployment is the unemployment due to
  seasonal changes in employment or labor supply.
  What would be an example?
• At the end of each season, thousands of workers
  must go searching for new jobs, experiencing
  seasonal unemployment in the process.

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Three basic kinds of unemployment

• 1. Frictional Unemployment
• Frictional unemployment is the brief periods of
  unemployment experienced by people moving between
  jobs or into the labor market.
• Frictional unemployment differs from other
  unemployment in three ways
• Demand is there
• Frictionally unemployed have the skills required
• Job search relatively short

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3 Kinds of Unemployment Cont.

• 2. Structural Unemployment
• Structural unemployment is the unemployment
  caused by a mismatch between the skills (or
  location) of job seekers and the requirements (or
  location) of available jobs.
• Periods between jobs will be lengthened when the
  unemployed lack the skills that employers
  require.

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3 Kinds of Unemployment Cont.

• 3. Cyclical Unemployment
• Cyclical unemployment is the unemployment
  attributable to the lack of job vacancies i.e.,
  to an inadequate level of aggregate demand.
• Cyclical unemployment occurs when there are
  simply not enough jobs to go around.

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FED Statistics 2009
27
More Than a Century of Unemployment
Source U.S. Department of Labor, Bureau of Labor
Statistics
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OKUNS Law

• Okuns Law
• Arthur Okun quantified the relationship between
  the shortfall in real output and unemployment.
• High unemployment in 1992 left the U.S. 240
  billion short of its production possibilities a
  loss of 920 of goods and services for every
  American.

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Labor Force? Okuns Law

• Slow Growth.
• The economy must grow at least as fast as the
  labor force to avoid cyclical unemployment.
• Relationship between the shortfall in output and
  unemployment.
• When you have unemployment of any significance,
  your economy will have reduced output. Ratio
  accepted today is 1 of unemployment yields 2
  less output.
• A 2/1ratio then allows economists to put a
  amount on the cost of unemployment to the
  economy.

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Think about this!

• Unemployment 5 (NARU)
• Unemployment 8 (x 2 16 less production)
• Unemployment 25 (depression era x 2) 50
  less production!
• Today (2009) 9.7 x 2 19.4 less

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So what is full employment?

• Full employment is not the same as zero
  unemployment.
• The economy strives to reach its potential which
  means that full employment is essential.
• When the actual rate of unemployment exceeds the
  natural rate, the actual output of the economy
  will fall below its potential.
• Resources are underutilized (inside production
  possibility curve.)

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Full Employment

• The condition that exists when the
  unemployment rate is equal to the natural
  unemployment rate.

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Full Employment
AD
AS
LRAS
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Full Employment Act of 1946

• The Full-Employment Goal
• In the Employment Act of 1946, Congress committed
  the federal government to pursue a goal of
  maximum employment.
• Congress didnt specify what the rate of
  unemployment should be.

35
Congress creates confusion

• First attempt to define full employment came
  about 1960- Council of Advisors decided that full
  employment meant watching prices ..
• Rising prices they said would signal that full
  employment was being reached. believed inverse
  relationship unemployment/inflation
• In 1970-80 Full employment potential was
  considered overly optimistic.
• Unemployment rates stayed far above 4 even when
  the economy expanded.
• Inflation began to accelerate at higher levels of
  unemployment.

36
Confusion Continued

• The redefinition of full employment goal needed
  to be addressed.
• Needed to realize more youth and women in the
  labor force
• Needed to acknowledge the increased transfer
  payments
• Needed to acknowledge the structural changes in
  demand (for such things as technology and trade)
  old industries were not in such demand (steel,
  textiles, auto)\
• Most economists say 5 today

37
Humphrey-Hawkins Act of 1978

• This Act was passed to require the Federal
  Reserve to maintain a 4 rate of unemployment
  without inflation while holding the inflation to
  a goal of 3 by implementing monetary policy
  where needed.
• Fiscal policy might undo this law, but it is
  still a focus of the Fed and the Fed has to
  report to Congress twice a year on the health of
  the American economy.

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Natural Rate of UnemploymentNARU

• NARU the difference between full employment and
  100 employment.
• A level of unemployment that will not trigger
  inflation. i.e. this figure will not bid up
  wages.
• The natural rate of unemployment is not a
  temporary high or low it is a rate that is
  sustainable into the future.

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Depression Unemployment

• Our greatest failure occurred during the Great
  Depression, when as much as one-fourth of the
  labor force was unemployed.
• The Historical Record
• Unemployment rates fell dramatically during World
  War II the civilian unemployment rate reached a
  rock bottom 1.2 percent.
• Since 1950, unemployment rate has fluctuated from
  a low of 2.8 percent during the Korean War (1953)
  to a high of 10.8 percent during the 1981-82
  recession.

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• From 1982 to 1989, unemployment fell, but shot up
  again in the 1990-91 recession.
• In2002unemployment was circa 5.7
• In2004unemployment was circa 6.5
• February, 2005 5.4
• September, 2005.5.1
• February, 2006.. 4.8
• January, 2007.4.6
• October, 2007.4.7
• October, 2008.6.1
• February, 2009 ..7.6
• July, 2009 . 9.5
• September 2009.9.7

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• New Jobs
• The new jobs of tomorrow will require increasing
  levels of education and skill.
• And, new type skills no doubt.
• Old Skills
• As the skills gap widens, structural unemployment
  increases.
• The skills gap is the gap between skills required
  for emerging jobs and the skills of workers.

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What about the other evil?

Inflation
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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

44
Looking at the past

• In 1923, prices in Germany rose a trillion times
  over.
• Prices in Russia, Bulgaria, and some other
  nations have witnessed a tenfold increase in a
  year.
• In the 1990s the U.S. inflation rate has risen 1
  to 4 percent a year.

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Inflationis badis bad..is bad!

• What is inflation?
• A continuing rise in the average level of
  prices.(it costs more to purchase the typical
  bundle of goods and services that is produced
  or consumed or both.)
• Bottom line Too many chasing too few goods.

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• The CPI is based on what it costs an average
  family to live.
• Just think Inflation enables us to live in more
  expensive neighborhoods without having to move

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Inflation is bad see???

• Shortened Time Horizons
• During the German hyperinflation, workers were
  paid two or three times a day so that they could
  buy goods in the morning before prices increased
  in the afternoon.
• Speculation
• People may be encouraged to withhold resources
  from the production process, hoping to sell them
  later at higher prices.
• Bracket Creep
• Under our progressive tax system, taxes go up
  when prices rise.
• Savings, investment, and work effort decline.

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Inflation discussion

• Notice we said an increase in the Average Level
  of prices. Not a change in any specific price
• Statisticians calculate the average then look for
  changes in the average. The Consumer Price Index
  for All Urban Consumers (CPI-U) decreased 0.4
  percent in August, before seasonal adjustment,
  the Bureau of Labor Statistics of the U.S.
  Department of Labor reported today. The August
  level of 219.086 (1982-84100) was 5.4 percent
  higher than in August 2007.
• A decline in average prices deflation.
• Relative price means an increase in the price of
  apples (relative to other fruits) apples cost
  more than pears.
• Inflation does not make ALL persons worse off.
• .

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Nominal Income vs. Real Income

• What is the difference between nominal income and
  real income.
• Nominal income you receive in a particular
  period
• Real income what you can use for purchasing
  stuff.
• If you nominal income does not change and
  there is an increase in the average level of
  prices.. You cannot buy as much stuff.
• If the number of dollars you receive every year
  is always the same, your nominal income doesnt
  change- but your real income will rise or fall
  with price changes.

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Another rule

• If you put your money into savings and keep it
  there rather than spending it, and inflation
  comes along
• your money in savings will not buy as much as it
  would prior to the wave of inflation that hit.

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Uncertainty and Misconception

• Money Illusion
• Even people whose nominal incomes keep up with
  inflation often feel oppressed by rising prices.
• They feel cheated when they discover that their
  higher nominal wages dont buy additional goods.
• Uncertainty
• One of the most immediate consequences of
  inflation is uncertainty.
• Uncertainties created by changing price levels
  affect consumption and production decisions.

52
Inflation discussion

• Uncertainty on the part of the consumer in trying
  to outguess the price of goods and services.
• If consumers or producers postpone or cancel
  their expenditure plans, the demand for g s
  will fall. Eventually production falls, and
  unemployment occurs

• What Causes Inflation?
• Nearly all economists believe that rapid
  expansion in the supply of money is the cause of
  inflation.

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What happens if incomes go up to keep pace with
inflation?

• Bracket creep is the movement of taxpayers into
  higher tax brackets (rates) as nominal incomes
  grow.
• Deflation Dangers
• Deflation a falling price level might not
  make people happy either.
• Deflation reverses the redistributions caused by
  inflation. (Example people today upside down
  on their houses.)

54
Speculations from consumption and production

• If you expect prices to rise, it makes sense to
  buy things now for resale later.
• People may be encouraged to withhold resources
  from the production process, hoping to sell them
  later at higher price
• As such behavior becomes widespread, production
  declines and unemployment rises.

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Measuring Inflation

• Measuring inflation serves two purposes
• Gauges the average rate of inflation.
• Identifies its principal victims.
• Consumer Price Index (CPI)
• The CPI is the most common measure of inflation.
• The consumer price index (CPI) is a measure
  (index) of changes in the average price of
  consumer goods and services.

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Macroeconomic Measures - Prices

• Price Level - A weighted average of the prices of
  all goods and services.
• Price Index - A measure of the price level.
• Consumer Price Index (CPI) - A widely cited index
  number for the price level the weighted average
  of prices of a specific set of goods and services
  purchased by a typical household.

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How to measure rate of inflation

• 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

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Macroeconomic Measures - Prices

• Base Year - The year chosen as a point of
  reference or basis of comparison for prices in
  other years a benchmark year.

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Computing the Consumer Price Index
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Consumer Price Index (CPI)

• By observing the extent of price increases, we
  can calculate the inflation rate.
• The inflation rate is the annual percentage rate
  of increase in the average price level.

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Changes in Prices
Percentage change in prices Current year -
later year later year x100
later
year
In 2005 the CPI was 195.3 in 2006 the index was
201.6. What was the percentage change in prices
from 2005-2006? Click below for answer.
3.22
Heres a little hint if you forgetC-L/L
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CPI determined

• Calculates the inflation rate
• Market basket of goods and services (same each
  year.)
• Bureau of Labor Statistics determines cost in 85
  cities by shopping 184 items.
• 19,000 stores visited and 60,000
  landlords,renters and homeowners surveyed each
  month
• Statistics released each month.
• Yearly average compiled.

• CPI expressed in base year 82-84
• Constructing the CPI
• The base period is the time period used for
  comparative analysis the basis of indexing, for
  example, of price changes.

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Shopping for CPI

• CPI is constructed by identifying a typical
  bundle of goods that the average consumer buys.
  This bundle stays the same each year.
• The base year is changed periodically. The base
  year used is 82-84 and prior to that it was
  63.The price level in the base period is
  designated as 100.
• The market basket (bundle) can be changed if BLS
  research shows that the average consumer no
  longer is purchasing that good or service.
• Each item in the bundle is weighted percent-wise
  in the market basket figures.

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The Market Basket
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What is the difference?

• Soif it cost you 225 in 2002 to buy the same
  bundle of goods that you bought in 1983, you
  would be paying 225 more for the same stuff.
• Look at the inflationary costs of cars, health
  care, housing, (house 4 bedrooms, 2 baths, in
  Highland Park in 1960 cost approximately
  30,000.) (Today?????)

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Calculations

• Rate of Inflation of PI(price index)
  from one year to the next.
• When prices are rising, on average, the price
  index will rise.
• i This years PI Last years PI
• Last years PI x100
• If price index this year was 220 compared to 200
  last year, the inflation rate would equal 10
• 220 200
• 200 x 100 10
• Formula hint c-l/l x 100 (current-last/last x
  100)

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Lets try another calculation

• In 2008 CPI measured 215.3
• In 2004 CPI measured 188.9
• What was the rate of inflation from 04 08?
• Ans. 13.9

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Is there a safety shield against inflation?

• Answer not much!!!
• But Congress has passed the Cost-of-living
  adjustment (COLA) provision for those receiving
  Social Security Checks.
• Checks are indexed each Januaryin the amount
  equal to inflation the previous year.
• If inflation was 3 then the checks are adjusted
  accordingly.
• Unions also negotiate for this COLA in their pay
  proposals

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Bankers in business to make a profit.

• Some bankers build in that same philosophy-
  Adjustable-rate mortgage (ARM) stipulates an
  interest rate that changes during the term of the
  loan.
• Actually, banks build the inflation factor into
  all their loansthe number of points depends on
  many variables we will discuss later.
• The real interest rate is the nominal interest
  rate minus the anticipated inflation rate.

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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)

71
What is stagflation?

• High inflation and high unemployment.
• A period during which an economy is experiencing
  both substantial inflation and either declining
  or slow growth in output.
• Economists used to say this would and could never
  happen it did in the 80s
• Paul Volker entered the scene as Fed chairman and
  held court on monetary policy.. More of this
  story later

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CAUSES of inflation

• 1. Demand pull (too much aggregate demand and
  not enough aggregate supply.
• Cost Push (production costs rise) supply
  decreases

S1
S
S
D1
D
D
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Explanations

• Demand pull
• Economy producing at capacity
• Consumers willing and able to buy more goods
• Can buy goods because of accumulated savings or
  easy access to credit (refinancing the house,
  second mortgages in Texas, low interest loans,
  credit card interest rates low, prime rate very
  low.)
• Pull to have more goods and only limited amount
  of goods available causes prices to rise!
• Hence, a demand-driven rise in average prices or
  demand-pull

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Explanations Continued

• Cost Push
• When producers have to pay more for inputs
  (resources for production), the price of the good
  produced increases.
• OPEC- prices of crude escalates any product
  dependent on crude (including heating costs,
  increases).-News Flash! Winter of 2007-2008
  heating home costs rose 22

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Explanation of Dollars in Cost-push

• Labor has generally been the most expensive of
  inputs for production up till now in our economy.
• If wage rates are pushed upward. The good or
  service would have an increase in price
  (longshoremans union, pilots,) Note that most of
  these are union connected. Tech industry workers
  took about a 50 cut to get jobs in 2002 as
  opposed to their salaries in 1999.
• If the Fed releases too much money in the economy
  (continually pushing down interest rates, the
  value of that money is not as solid as if there
  were less circulating more later on that) ?

76

• Check the current inflation rate..
• www.inflationdata.com

77
Another way to measure U.S. economic health

• Producer Price Index
• The PPIs keep track of average prices received by
  producers.
• October 20, 2005.PPI up highest in 15 years.
• 3 indicescrude materials, intermediate goods,
  finished goods.
• Identified in monthly surveys just like CPI is.
• In SR, PPI increases before CPI (takes a little
  while for the prices to be reflected in products
  we buy.

78
Is the Growth of GDP real or inflated?

• This is the real test!!!!!!!
• Was there actual increase in production and
  services or did the prices just skew the GDP
  statistics when CIG was added?
• Have to correct GDP for price changes so we can
  measure actual production.
• CPI tells the consumer if they have to spend more
  dollars to get that loaf of bread but other
  measures have to be evaluated.

79
Still another way to test the health of the U.S.
economy

• The GDP Deflator. The broadest price index and
  covers all output including consumer goods,
  investment goods and government services. (CIG)
• The GDP deflator isnt a pure measure of price
  change. Its value reflects both price changes AND
  market responses to those price changes as
  reflected in new expenditure patterns.
• The GDP deflator typically registers a lower
  inflation rate than CPI and the government
  watchdogs use this barometer more readily than
  current CPI

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Year (base Price of good Quantity GDP Real GDP
1 10 100 1,000 1,000
2 12 120 12x120 1,440 10 x 120 1,200
3 14 140 14 x 140 1,960 10 x 140 1,400
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Bottom Line

• CPI is designed to measure the impact of price
  changes on the cost of a typical bundle of goods
  purchased by households(remember, market basket
  and only for urban purchasers.)
• GDP deflator is a broader price index and is
  designed to measure the change in the average
  price of the market basket of goods included in
  GDP (in addition to consumer goods it includes
  capital goods, g s by government.)
• CPI measures money income of consumers in
  relation to rising prices (only consumer goods.)
• GDP deflator measures economy wide inflation-
  more g s included in measurement.

82
Historical Record Graph
83
What really is the goal of fiscal and monetary
planners?

• The CPIs market basket of goods and services was
  overhauled in 1998.
• Price Stability..
• Major changes in the general level of prices
  indicate upsets in the economic system.
• Prices act as allocators of economic goods, they
  are the mechanism that determines the answer to
  the three basic questions, What, How and For
  Whom.
• Prices act as the basic force in a capitalistic
  economy ?

84
What does a pair of Nike shoes cost compared to a
pair of Keds?