2. Objectives
After studying this chapter, you will able to
Explain how we date business cycles
Define the unemployment rate, the labor force
participation rate, the employment-to-population ratio,
and aggregate hours
Describe the sources of unemployment, its duration, the
groups most affected by it, and how it fluctuates over a
business cycle
Explain how we measure the price level and the inflation
rate using the CPI
3. Vital Signs
A recession started in March 2001 and ended in
November 2001.
What defines a recession, who makes the decision that we
are in one, and how?
How do we measure unemployment and what other data
do we use to monitor the labor market?
Being employed alone does not determine standard of
living; the cost of living also matters, so we also need to
know what the Consumer Price Index is, and how that is
measured and used.
4. The Business Cycle
The business cycle is the periodic but irregular up-and-
down movement in production and jobs.
The NBER defines the phases and turning points of the
business cycle as follows:
A recession is a significant decline in activity spread
across the economy, lasting more than a few months,
visible in industrial production, employment, real income,
and wholesale-retail trade. A recession begins just after
the economy reaches a peak of activity and ends as the
economy reaches its trough. Between trough and peak,
the economy is in an expansion.
5. The Business Cycle
Business Cycle Dates
Figure 22.1 shows the percentage change in real
GDP over each cycle between 1928 and 2003.
6. The Business Cycle
The 2001 Recession
The 2001 recession was one of the mildest recession on
record.
But the recovery from that recession was unusually slow
and weak—a jobless recovery.
7. Jobs and Wages
Population Survey
The U.S. Census Bureau conducts monthly surveys to
determine the status of the labor force in the United
States.
The population is divided into two groups:
The working-age population—the number of people
aged 16 years and older who are not in jail, hospital, or
other institution.
People too young to work (less than 16 years of age) or
in institutional care.
8. Jobs and Wages
The working-age population is divided into two groups:
People in the labor force
People not in the labor force
The labor force is the sum of employed and unemployed
workers.
9. Jobs and Wages
To be considered unemployed, a person must be:
without work and have made specific efforts to find a job
within the past four weeks, or
waiting to be called back to a job from which he or she
was laid off, or
waiting to start a new job within 30 days.
11. Jobs and Wages
Three Labor Market Indicators
The unemployment rate is the percentage of the labor
force that is unemployed.
The unemployment rate is (Number of people
unemployed/Labor force) × 100.
The unemployment rate reaches its peaks during
recessions.
12. Jobs and Wages
Three Labor Market Indicators
The labor force participation rate is the percentage of
the working-age population that is in the labor force.
The labor force participation rate is (Labor force/Working-
age population) × 100.
The labor force participation rate has increased from 59
percent in the 1960s to 67 percent in the 1990s.
The labor force participation rate for men has declined, but
for women has increased.
13. Jobs and Wages
Three Labor Market Indicators
The labor force participation rate falls during recessions as
discouraged workers—people available and willing to
work but who have not made an effort to find work within
the last four weeks—leave the labor force.
14. Jobs and Wages
Three Labor Market Indicators
The employment-to-population ratio is the percentage of
working-age people who have jobs.
The employment-to-population ratio is (Number of people
employed/Working-age population) × 100.
The employment-to-population ratio has increased from 55
percent in the early 1960s to 67 percent in 2000.
The employment-to-population ratio has declined for men
and increased for women.
15. Jobs and Wages
Three Labor Market Indicators
Figure 22.3 shows the three labor market indicators
for 1963–2003.
16. Jobs and Wages
Figure 22.4 shows the
changing face of the labor
market– participation rates
and employment-to-
population ratios for males
and females separately.
17. Jobs and Wages
Aggregate Hours
Aggregate hours are the total number of hours worked by
all workers during a year.
Aggregate hours have increased since 1960 but less
rapidly than the total number of workers because the
average workweek has shortened.
19. Jobs and Wages
Aggregate Hours
Figure 22.5 shows
aggregate hours …
and average weekly hours
per person, 1963–2003.
20. Jobs and Wages
Real Wage Rate
The real wage rate is the quantity of goods and services
that can be purchased with an hour’s work.
The real wage rate equals the money wage rate divided by
the price level—the GDP deflator.
Three measures are
Hourly earnings in manufacturing
Total wages and salaries per hour
Total wages, salaries, and supplements per hour
21. Jobs and Wages
Figure 22.6 shows the
three measures of real
wage rates for 1963–2003.
22. Unemployment and Full Employment
The Anatomy of Unemployment
Three types of people are unemployed
Job losers—workers who have been laid off or fired and
are searching for new jobs.
Job leavers—workers who have voluntarily quit their jobs
to look for new ones. Job leavers are the smallest fraction
of the unemployed.
Entrants and reentrants—people entering the labor force
for the first time or returning to the labor force and
searching for work.
23. Unemployment and Full Employment
The Anatomy of Unemployment
People end a spell of unemployment for two reasons
Hired or recalled workers gain jobs.
Discouraged unemployed workers withdraw from the labor
force.
24. Unemployment and Full Employment
Figure 22.7 illustrates the
labor market flows
between the different
states.
25. Unemployment and Full Employment
Figure 22.8 shows
unemployment by
reason, 1963–2003.
Job leavers are the
smallest group.
Job losers are the
largest and the most
cyclical group.
26. Unemployment and Full Employment
The duration of
unemployment increases
during recessions and
Figure 22.9 shows
unemployment by
duration close to a
business cycle peak in
2000…
… and close to a trough
in 2002.
27. Unemployment and Full Employment
Figure 22.10 shows the
unemployment rates of
teenagers and adults,
whites and blacks close to
a business cycle peak in
2000…
… and close to a trough in
1992.
Young black men
experience the highest
unemployment rates.
28. Unemployment and Full Employment
Types of Unemployment
Unemployment can be classified into three types:
Frictional
Structural
Cyclical
29. Unemployment and Full Employment
Types of Unemployment
Frictional unemployment is unemployment that arises
from normal labor market turnover.
The creation and destruction of jobs requires that
unemployed workers search for new jobs.
Increases in the number of young people entering the
labor force and increases in unemployment benefit
payments raise frictional unemployment.
30. Unemployment and Full Employment
Types of Unemployment
Structural unemployment is unemployment created by
changes in technology and foreign competition that
change the match between the skills necessary to perform
jobs and the locations of jobs, and the skills and location of
the labor force.
Cyclical unemployment is the fluctuation in
unemployment caused by the business cycle.
31. Unemployment and Full Employment
Full Employment
Full employment occurs when there is no cyclical
unemployment or, equivalently, when all unemployment is
frictional or structural.
The unemployment rate at full employment is called the
natural rate of unemployment.
The natural rate of unemployment is estimated to have
been around 6 percent on the average in the United
States, but during the 1990s, the natural unemployment
rate fell below 6 percent.
32. Unemployment and Full Employment
Real GDP and Unemployment Over the Cycle
Potential GDP is the quantity of real GDP produced at full
employment.
It corresponds to the capacity of the economy to produce
output on a sustained basis; actual GDP fluctuates around
potential GDP with the business cycle.
33. Unemployment and
Full Employment
Figure 22.11 shows real
GDP, and the
unemployment rate...
…and estimates of
potential GDP and the
natural unemployment
rate, for 1983–2003.
34. The Consumer Price Index
The price level is the “average” level of prices and is
measured by using a price index.
The consumer price index, or CPI, measures the
average level of the prices of goods and services
consumed by an urban family.
35. The Consumer Price Index
Reading the CPI Numbers
The CPI is defined to equal 100 for the reference base
period.
The value of the CPI for any other period is calculated by
taking the ratio of the current cost of a market basket of
goods to the cost of the same market basket of goods in
the reference base period and multiplying by 100.
36. The Consumer Price Index
Constructing the CPI
Constructing the CPI involves three stages:
Selecting the CPI basket
Conducting a monthly price survey
Using the prices and the basket to calculate the CPI
37. The Consumer Price Index
Figure 22.12 illustrates the
CPI basket.
Housing is the largest
component.
Transportation and food
and beverages are the
next largest components.
The remaining
components account for
only 26 percent of the
basket.
38. The Consumer Price Index
The CPI basket is based on a Consumer Expenditure
Survey.
The current CPI is based on a 1993-95 survey, although
the reference base period is still 1982-84.
Every month, BLS employees check the prices of 80,000
goods and services in 30 metropolitan areas.
The CPI is calculated using the prices and the contents of
the basket.
39. The Consumer Price Index
For a simple economy that consumes only oranges
and haircuts, we can calculate the CPI.
The CPI basket is 10 oranges and 5 haircuts.
Item Quantity Price Cost of CPI
basket
Oranges 10 $1.00 $10
Haircuts 5 $8.00 $40
Cost of CPI basket at base period prices $50
40. The Consumer Price Index
This table shows the prices in the base period.
The cost of the CPI basket in the base period was $50.
Item Quantity Price Cost of CPI
basket
Oranges 10 $1.00 $10
Haircuts 5 $8.00 $40
Cost of CPI basket at base period prices $50
41. The Consumer Price Index
Item Quantity Price Cost of CPI
basket
Oranges 10 $2.00 $20
Haircuts 5 $10.00 $50
Cost of CPI basket at base period prices $70
This table shows the prices in the current period.
The cost of the CPI basket in the current period is $70.
42. The Consumer Price Index
The CPI is calculated using the formula:
CPI = (Cost of basket in current period/Cost of basket in
base period) 100.
Using the numbers for the simple example, the CPI is
CPI = ($70/$50) 100 = 140.
The CPI is 40 percent higher in the current period than in
the base period.
43. The Consumer Price Index
Measuring Inflation
The main purpose of the CPI is to measure inflation.
The inflation rate is the percentage change in the price
level from one year to the next.
The inflation formula is:
Inflation rate = [(CPI this year – CPI last year)/CPI last
year] × 100.
44. The Consumer Price Index
Figure 22.13 shows the CPI and the inflation rate, 1973–
2003.
45. The Consumer Price Index
The Biased CPI
The CPI may overstate the true inflation for four reasons
New goods bias
Quality change bias
Commodity substitution bias
Outlet substitution bias.
46. The Consumer Price Index
The Biased CPI
New goods bias New goods that were not available in the
base year appear and, if they are more expensive than the
goods they replace, the price level may be biased higher.
Similarly, if they are cheaper than the goods they replace,
but not yet in the CPI basket, they bias the CPI upward.
Quality change bias Quality improvements generally are
neglected, so quality improvements that lead to price hikes
are considered purely inflationary.
47. The Consumer Price Index
The Biased CPI
Commodity substitution bias The market basket of
goods used in calculating the CPI is fixed and does not
take into account consumers’ substitutions away from
goods whose relative prices increase.
Outlet substitution bias As the structure of retailing
changes, people switch to buying from cheaper sources,
but the CPI, as measured, does not take account of this
outlet substitution.
48. The Consumer Price Index
The Biased CPI
A Congressional Advisory Commission estimated that the
CPI overstates inflation by 1.1 percentage points a year.
The bias in the CPI distorts private contracts, increases
government outlays (close to a third of government outlays
are linked to the CPI), and biases estimates of real
earnings.
To reduce the bias in the CPI, the BLS will undertake
consumer expenditure surveys more frequently and revise
the CPI basket every two years.
The business cycle and its dating can be made interesting to students. If you have the capacity to show or assign Web pages, look at the NBER Business Cycle Dating Committee’s page at http://www.nber.org/cycles/recessions.html. (The link is on the Economics Place Web site.)
You might like to look at the dating of the cycle in other countries. This dating is done by the Economic Cycle Research Institute (ECRI). You can find their Web site at http://www.businesscycle.com/research/intlcycledates.asp (also on the Economics Place Web site).
Another page on the ECRI Web site (at http://www.businesscycle.com/pdfs/0012-businessChron.PDF and also on the Economics Place Web site) shows the cycle peak and trough dates for 18 countries from 1948 through 2001 nicely aligned in a table.
You can compare the timing of cycles internationally. You can also compare the severity of U.S. cycles over time. Note that the recession that the NBER dates as beginning in March 2001 is incredibly mild on all criteria except the labor market. It will be interesting to watch for the next announcement of the end of the recession and beginning of recovery. This event should occur during 2002.
The Establishments survey: The textbook doesn’t talk about the Establishments survey that measure nonfarm jobs. But it is the numbers from this survey that have shown zero job growth since the last recession. It might be worth mentioning those numbers and getting your students to get the data for that past year from the BLS website.
Positive versus normative. Unemployment is an emotionally charged subject and is a good one for reinforcing the important point that economics is positive in contrast to normative. Economists do not make normative judgments as to whether unemployment is good or bad; rather they explain why unemployment exists and what determines its rate.
The benefits of unemployment. It comes as a shock to most students that unemployment has benefits as well as costs and that there is an efficient amount of unemployment that is greater than zero. (Note that this statement is positive!) You might like to spend a bit of class time on this topic. If you do, here are some ideas about what to do:
A good way to introduce the idea that unemployment brings benefits is to think about the unemployment of things rather than people. Look around the campus and notice all the unemployed automobiles in the parking lots/stations. Notice the unemployed class rooms early in the morning and late at night. Notice the unemployed coffee shop seats at peak lecture times. Look around the city and notice all the unemployed automobiles in the car sales lots. Try to make a reservation at any of the hotels in the city and notice that you can almost always get a room—hence, lots of unemployed hotel rooms.
[Continued on the note for the next slide.]
Now ask: does all this unemployment bring benefits? The students quickly see that it would be very costly to organize rental markets in which cars don’t sit idle all day, and so on.
Now ask: do the same ideas apply to unemployed people? (Be sure to be compassionate about the misery that unemployment can bring. You are not claiming that it is not costly. You’re trying to identify the benefits, if any.)
You’ll quickly get your students to see that imagining an economy without any unemployment is nearly impossible. If consumers are free to change their decisions about what they want to buy, some goods and services must fall out of favor when others come into favor. The firms making the unfavored products fall on hard times and often their workers are fired or laid off.
Sure, these laid off workers could start work right away, cleaning shoes or selling flowers at intersections. But they are better off (in their own opinion) being frictionally unemployed and searching for new jobs. To eliminate this source of unemployment we would need to forbid consumers from changing their buying plans or insist that no one remain idle and get on with doing any job even if it doesn’t earn a wage.
Note that if this is how we ran our economy, we’d still be using coal-fired stoves and the pony express, and we’d be wearing coonskin caps. There would be no McDonald’s, Federal Express, or Nike shoes.
Male-female differences in the labor market. Students are interested in the different behavior of the male labor force participation rate and the female labor force participation rate. Students will probably believe that the reason for the increasing female participation rate is social, not economic. They will identify changing social attitudes toward women as the major source and probably see the women’s liberation movement as the driving force for this change. While not to deny the importance of attitudes, this area is a good one in which to get students to explore the economic forces that lie behind social attitudes and change. Get them to think about the technological advances that have contributed to more women being in the labor force. Many goods that were previously produced in the household are now mass-produced and available for purchase—most items of prepared food, for example. New appliances have increased productivity in the home enabling household production in less time—laundry, kitchen, and cleaning equipment for example. The market provides new goods and services that households want but can’t readily make at home—home entertainment equipment (TV, CD, DVD, etc) for example. These changes lead to many families deciding to have two income-earners rather than the older tradition of one. It is interesting to let students discuss what they think will happen to the labor force participation rates in the future and whether or not they think they will ever be equal—or unequal in the opposite direction!
Jobs and home production. It is interesting to ask students to think about appropriate measures of labor force participation over long periods of time or in very different economic arrangements. The technical definition involves spending time working for gain, or seeking work for gain. In the United States, this usually equates to work outside the home. Ask students whether women who are unpaid family workers on farms are in or out of the labor force; and then ask whether they are if they don’t work outside the home, but cook, make and wash clothing, and otherwise maintain the household for a large family.
Labor turnover and unemployment. Ask in class how many students have jobs and how many of them have changed their job within the last 12 months. You can now discuss the constant movement in and out of the labor market and the consequence that frictional unemployment will always exist.
Identifying frictional, structural, and cyclical unemployment. Ask your class if anyone they know has been laid off. Then discuss whether losing a job creates frictional, structural, or cyclical unemployment. Look at your local examples. If you live in a steel-producing area, for example, you can talk about local structural unemployment arising from the closing of a steel manufacturer due to international competition. For cyclical unemployment, ask students how they think the business cycle and cyclical unemployment is related to full-time enrollments at higher education institutions. Students often don’t think there is any relationship. But nationally during a recession, the growth rate of full-time enrollments increases. Ask students if they can explain this relationship. The answer is that during a recession and due to the increase in cyclical unemployment, the opportunity cost of school decreases. This is a great way to keep students thinking about marginal benefits and costs.
The CPI—an average. It is important for students to understand that the CPI is based on the average expenditure basket, not the expenditure pattern of any given household. Displaying the detailed press releases on the BLS Web site helps make this point very forcibly: students often do not realize until they see the numbers that the CPI must include both costs of owning a house and costs of renting one; costs of buying a car and costs of public transportation; and so on.
Making the CPI personal. If you have time (or want to make time) you can get your students to construct their own CPI basket. Each student makes a statement of her/his expenditure in the same categories as the CPI basket in the figure on this slide. Students then compare their expenditure patterns to the average of the CPI basket.
CPI biases—concrete illustrations. New goods bias can be illustrated with MP3 music rather than CDs; quality change with computers and cars; commodity substitution with movies versus videos; and outlet substitution by the growth of Wal-mart, Target, and shopping on the internet.
