Unemployment And Inflation


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Unemployment And Inflation

  1. 1. Unemployment and Inflation <ul><li>Chapter 23 </li></ul>© 2006 Thomson/South-Western
  2. 2. Costs of Unemployment <ul><li>Personal Cost </li></ul><ul><ul><li>Loss of paycheck </li></ul></ul><ul><ul><li>Loss of self-esteem </li></ul></ul><ul><ul><li>Increase in stress related psychological problems </li></ul></ul><ul><ul><li>Increase in incidence of crime, suicide, and mental illness </li></ul></ul><ul><li>Economic Cost </li></ul><ul><ul><li>Loss in output </li></ul></ul>
  3. 3. Measuring Unemployment <ul><li>Civilian Noninstitutional Adult Population </li></ul><ul><ul><li>All civilians 16 years of age and older </li></ul></ul><ul><ul><li>Excludes institutionalized in prisons or mental hospitals </li></ul></ul><ul><ul><li>Excludes those in military </li></ul></ul><ul><li>Labor force </li></ul><ul><ul><li>Those in the adult population who are either working or looking for work </li></ul></ul>
  4. 4. Measuring Unemployment <ul><li>Unemployed </li></ul><ul><ul><li>Those with no job who are looking for work </li></ul></ul><ul><li>Unemployment rate </li></ul><ul><ul><li>Measures the percentage of those in the labor force who are unemployed </li></ul></ul><ul><ul><li>Equals the number unemployed divided by the number in the labor force </li></ul></ul><ul><ul><li>Does not include discouraged workers </li></ul></ul><ul><li>Discouraged workers </li></ul><ul><ul><li>Those who are no longer looking for work but are unemployed </li></ul></ul>
  5. 5. Exhibit 1: The Adult Population Sums the Employed, the Unemployed, and Those Not in the Labor Force
  6. 6. Labor Force Participation Rate <ul><li>The number in the labor force divided by the adult population </li></ul><ul><li>On average, two out of three adults are in the labor force </li></ul><ul><li>Increased from about 60% in 1970 to approximately 67% in 1990 and has remained relatively constant since </li></ul><ul><li>Convergence of the participation rates of men and women over last 40 years as more women enter the labor force </li></ul>
  7. 7. Trend of Unemployment Rate <ul><li>Decline in the unemployment rate over last 20 years </li></ul><ul><ul><li>Overall growth in the economy </li></ul></ul><ul><ul><li>Relatively fewer teenagers in the work force </li></ul></ul><ul><li>Unemployment rate says nothing about who is unemployed or for how long – differs across </li></ul><ul><ul><ul><li>Race </li></ul></ul></ul><ul><ul><ul><li>Gender </li></ul></ul></ul><ul><ul><ul><li>Age </li></ul></ul></ul><ul><ul><ul><li>Geographical area </li></ul></ul></ul><ul><ul><ul><li>Occupational group </li></ul></ul></ul>
  8. 8. Exhibit 2: The U.S. Unemployment Rate Since 1900
  9. 9. Exhibit 3: Unemployment Rates for Various Groups
  10. 10. Exhibit 3: Unemployment Rates for Various Groups
  11. 11. Exhibit 4: Unemployment Rates Differ Across U.S. Metropolitan Areas
  12. 12. Sources of Unemployment <ul><li>Frictional </li></ul><ul><li>Seasonal </li></ul><ul><li>Structural </li></ul><ul><li>Cyclical </li></ul>
  13. 13. Frictional Unemployment <ul><li>Caused by time required to bring together labor suppliers and labor demanders </li></ul><ul><ul><li>Employers need time to learn about the talent available </li></ul></ul><ul><ul><li>Job seekers need time to learn about employment opportunities </li></ul></ul><ul><li>Generally short-term and voluntary </li></ul>
  14. 14. Seasonal Unemployment <ul><li>Caused by seasonal changes in labor demand during the year </li></ul><ul><li>To eliminate the impact of such changes, monthly unemployment statistics are seasonally adjusted, which smoothes out these factors </li></ul>
  15. 15. Structural Unemployment <ul><li>Exists because unemployed workers often </li></ul><ul><ul><li>Do not have the skills demanded by employers, or </li></ul></ul><ul><ul><li>Do not live where their skills are in demand </li></ul></ul><ul><li>Occurs because changes in tastes, technology, taxes, or competition reduce the demand for certain skills and increase the demand for other skills </li></ul>
  16. 16. Cyclical Unemployment <ul><li>Fluctuates with the business cycle, increasing during contractions and decreasing during expansions </li></ul><ul><li>Means the economy is operating inside its PPF </li></ul><ul><li>Government policies to stimulate aggregate demand recessions is aimed at reducing this type of unemployment </li></ul>
  17. 17. Full Employment <ul><li>Occurs only if there is no cyclical unemployment </li></ul><ul><ul><li>Occurs when the only unemployment is frictional, structural, or seasonal </li></ul></ul><ul><ul><li>Does not mean zero unemployment </li></ul></ul><ul><ul><li>Frictional, seasonal, and structural unemployment can still occur </li></ul></ul><ul><li>Occurs when from 4% to 6% of the labor force is unemployed </li></ul>
  18. 18. Unemployment Compensation <ul><li>Cash transfers for those who lose their jobs and actively seek employment </li></ul><ul><li>Applies to unemployed workers who meet certain qualifications </li></ul><ul><li>Problems with unemployment compensation: </li></ul><ul><ul><li>Workers who receive benefits tend to search less actively than those who don’t </li></ul></ul><ul><ul><li>May reduce the urgency of finding work </li></ul></ul>
  19. 19. International Comparisons <ul><li>Why are unemployment rates so high in Europe? </li></ul><ul><ul><li>Ratio of unemployment benefits to average pay is higher </li></ul></ul><ul><ul><li>Unemployment benefits last longer, sometimes years, so workers have less incentive to find new jobs </li></ul></ul><ul><ul><li>Government regulations make employers in Europe reluctant to hire new workers because firing them is difficult </li></ul></ul>
  20. 20. Exhibit 5: In the Last Two Decades, Unemployment Rates Fell in the United States, Rose in Japan, and Remained High in Europe
  21. 21. Problems with Unemployment Figures <ul><li>Understate the actual amount of unemployment because they do not include discouraged workers and underemployed </li></ul><ul><li>Underemployment occurs when </li></ul><ul><ul><li>people are counted as employed even if they can find only part-time jobs or </li></ul></ul><ul><ul><li>Are vastly overqualified for their job </li></ul></ul>
  22. 22. Problems with Unemployment Figures <ul><li>Tend to overstate unemployment because </li></ul><ul><ul><li>Employment insurance and most welfare programs require recipients to seek employment </li></ul></ul><ul><ul><li>Some who would prefer to work part time can find only full-time work </li></ul></ul><ul><ul><li>Some are forced to work overtime and weekends, but would prefer to work fewer hours </li></ul></ul><ul><ul><li>People in the underground economy may not readily acknowledge such jobs because their intent is to evade taxes </li></ul></ul>
  23. 23. Inflation <ul><li>Inflation : a sustained increase in the average price level </li></ul><ul><li>Hyperinflation : extremely high inflation </li></ul><ul><li>Deflation : a sustained decline in the average price level </li></ul><ul><li>Disinflation : a reduction in the rate of inflation </li></ul>
  24. 24. Inflation <ul><li>Inflation is typically measured annually </li></ul><ul><li>Annual inflation rate is the percentage increase in the average price level from one year to the next </li></ul><ul><li>Two sources of inflation </li></ul><ul><ul><li>Demand-pull inflation </li></ul></ul><ul><ul><li>Cost-push inflation </li></ul></ul>
  25. 25. Exhibit 6a: Inflation Caused by Shifts of AD and AS Curves Increase in the AD curve pulls up the price level. To generate continuous demand-pull inflation, the AD curve must keep shifting outward along a given AS curve Increase in costs of production push up the price level. To generate continuous cost-push inflation, the AS curve must keep shifting to the left along a given AD curve.
  26. 26. Exhibit 7a: Consumer Price Index Since 1913
  27. 27. Exhibit 7b: CPI Since 1913 – Annual Percentage Change
  28. 28. Anticipated versus Unanticipated Inflation <ul><li>Unanticipated inflation creates more problems for the economy than does anticipated inflation </li></ul><ul><li>To the extent that inflation is higher or lower than anticipated, it arbitrarily creates winners and losers </li></ul><ul><ul><li>If it is higher than expected, the winners are all those who had contracted to pay a price that anticipates lower inflation </li></ul></ul><ul><ul><li>The losers are all those who agreed to sell at that price </li></ul></ul><ul><ul><li>If inflation is lower is lower than expected, the situation is reversed </li></ul></ul>
  29. 29. Transaction Costs of Inflation <ul><li>When prices are stable, people correctly believe they can predict future prices and can plan accordingly </li></ul><ul><ul><li>But, if inflation changes unexpectedly, planning gets harder which undermines the ability of money to serve as a link between the present and the future </li></ul></ul><ul><li>When dealing with the rest of the world, they must also anticipate how the value of the dollar might change relative to foreign currencies </li></ul>
  30. 30. Obscures Relative Price Changes <ul><li>Relative prices describe the exchange rate between goods—how much one good costs compared to another </li></ul><ul><li>Inflation does not necessarily cause the change in relative prices, but it can obscure them </li></ul><ul><li>Occurs because of the greater uncertainty about the price of one good relative to another </li></ul>
  31. 31. Inflation Across Metropolitan Areas <ul><li>Inflation rates differ across regions mostly because of differences in housing prices, which grow faster in some places than in others </li></ul><ul><li>Federal government tracks separate CPIs for each of 26 metropolitan areas. </li></ul>
  32. 32. Exhibit 8: Average Annual Inflation from 1994 to 2004 Differed Across U.S. Metropolitan Areas
  33. 33. Inflation Across Countries Exhibit 9: Inflation Rates in Major Economies Have Trended Lower Over the Past Two Decades
  34. 34. Inflation and Interest Rates <ul><li>Interest is the dollar amount paid by borrowers to lenders because lenders must be rewarded for forgoing present consumption </li></ul><ul><li>The interest rate is the interest per year as a percentage of the amount loaned </li></ul>
  35. 35. Exhibit 10: The Market for Loanable Funds <ul><li>Greater the interest rate, the greater the reward for loaning money: supply curve slopes downward </li></ul><ul><li>The higher the interest rate, the higher cost of borrowing – the quantity of loanable funds demanded decreases as the interest rate increases, other things constant: demand curve for loanable funds is downward sloping </li></ul><ul><li>Equilibrium interest rate is at the intersection of the supply of and demand for loanable funds </li></ul>
  36. 36. Interest Rates <ul><li>Nominal interest rate </li></ul><ul><ul><li>Measures interest in terms of the current dollars paid </li></ul></ul><ul><ul><li>The interest rate that appears on the borrowing agreement </li></ul></ul><ul><ul><li>The rate quoted in the news media </li></ul></ul><ul><li>Real interest rate </li></ul><ul><ul><li>Equals the nominal rate of interest minus the inflation rate </li></ul></ul><ul><ul><li>Expressed in dollars of constant purchasing power </li></ul></ul>
  37. 37. Interest Rates <ul><li>With no inflation, the nominal and real interest rates would be identical </li></ul><ul><li>With inflation, the nominal interest rate exceeds the real interest rate </li></ul><ul><ul><li>If the inflation rate is high enough, the real interest rate can actually be negative </li></ul></ul><ul><ul><li>The nominal interest would not even offset the loss in spending power because of inflation – lenders would lose purchasing power </li></ul></ul><ul><ul><li>Why lenders and borrowers are concerned more about the real interest rate than the nominal interest rate </li></ul></ul>
  38. 38. Interest Rates <ul><li>The higher the expected rate of inflation, the higher the nominal rate of interest that lenders require and that borrowers are willing to pay </li></ul><ul><li>Expected real interest rate equals the nominal rate of interest minus the expected inflation rate </li></ul>
  39. 39. Why is Inflation Unpopular? <ul><li>Problems with unanticipated inflation </li></ul><ul><ul><li>Hits those whose incomes are fixed in nominal terms </li></ul></ul><ul><ul><li>Arbitrarily redistributes income and wealth from one group to another </li></ul></ul><ul><ul><li>Reduces the ability to make long-term plans </li></ul></ul><ul><ul><li>Forces buyers and sellers to pay more attention to prices - less time for production - overall productivity of economy falls </li></ul></ul>
  40. 40. COLA <ul><li>Cost of Living Adjustment: the increase in a transfer payment or wage that reflects the increase in the price level </li></ul>