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1. Macroeconomics
Module 7: Macroeconomic Measures: Unemployment and Inflation

2. Who Counts in Unemployment?
• Discouraged Workers: those who have stopped looking for employment due to the
lack of suitable positions available
• Out of the Labor Force: those who are not working and not looking for work –
whether they want employment or not; also termed “not in the labor force”
• Underemployed: individuals who are employed in a job that is below their skills

3. Who’s In or Out of the Labor Force?
• Employed: currently working for
pay
• Unemployed: out of work and
actively looking for a job
• Out of the Labor Force: out of
paid workforce and/or not actively
looking for a job
• Labor Force: the number of
employed plus the unemployed

4. Calculating the Unemployment Rate
• Labor Force Participation Rate: this is the percentage of adults in an economy
who are either employed or who are unemployed and looking for a job
• Unemployment Rate: the percentage of adults who are in the labor force and thus
seeking jobs, but who do not have jobs

5. Calculating the Unemployment Rate cont.
𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 =
𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑𝑝𝑒𝑜𝑝𝑙𝑒
𝑇𝑜𝑡𝑎𝑙𝐿𝑎𝑏𝑜𝑟𝐹𝑜𝑟𝑐𝑒
x 100
Based on the data in Table 1, what’s the
unemployment rate in 2016? In this
example, the unemployment rate can be
calculated as 7.7 million unemployed
people divided by 159.1 million people in
the labor force, which works out to an
4.8% rate of unemployment. Read on to
walk through the steps of calculating this
percentage.
Table 1. U.S. Employment and Unemployment, 2016
Total adult population over the age of 16 253.5 million
In the labor force 159.1 million (62.8%)
Employed 151.4 million
Unemployed 7.7 million
Out of the labor force 94.4 million (37.2%)
Source: www.bls.gov

6. The Historical U.S. Unemployment
As we look at this data, several patterns
stand out:
1. Unemployment rates do fluctuate over
time
2. Unemployment rates in the late 1990s
and into the mid-2000s were rather low
by historical standards
3. The unemployment rate never falls all
the way to zero
4. The timing of rises and falls in
unemployment matches fairly well with
the timing of upswings and downswings
in the overall economy
5. No significant upward or downward
trend in unemployment rates is apparent

7. International Unemployment Comparisons
Country 1991 1996 2001 2006 2012
United States 6.8% 5.4% 4.8% 4.4% 8.1%
Canada 9.8% 8.8% 6.4% 6.2% 6.3%
Japan 2.1% 3.4% 5.1% 4.5% 3.9%
France 9.5% 12.5% 8.7% 10.1% 10.0%
Germany 5.6% 9.0% 8.9% 9.8% 5.5%
Italy 6.9% 11.7% 9.6% 7.8% 10.8%
Sweden 3.1% 9.9% 5.0% 5.2% 7.9%
United Kingdom 8.8% 8.1% 5.1% 5.5% 8.0%
Table 3. International Comparisons of Unemployment Rates

8. Cyclical Unemployment
• In a labor market with flexible wages,
the equilibrium will occur at wage We
and quantity Qe, where the number of
people looking for jobs (shown by S)
equals the number of jobs available
(shown by D)
• Equilibrium in the labor
market occurs at the wage rate
where the quantity of labor demanded
equals the quantity of labor supplied

9. Cyclical Unemployment: Why Wages May be Sticky
Downward
• Adverse Selection of Wage Cuts Arguments: if employers reduce wages for all
workers, the best workers will leave
• Cyclical Unemployment: unemployment closely tied to the business cycle, like
higher unemployment during a recession
• Efficiency Wage Theory: the theory that the productivity of workers, either
individually or as a group, will increase if they are paid more
• Implicit Contract: an unwritten agreement in the labor market that the employer
will try to keep wages from falling when the economy is weak or the business is
having trouble, and the employee will not expect huge salary increases when the
economy or the business is strong
• Insider-Outsider Model: those already working for the firm are “insiders” who
know the procedures; the other workers are “outsiders” who are recent or
prospective hires
• Relative Wage Coordination Argument: across-the-board wage cuts are hard for
an economy to implement, and workers fight against them

10. Frictional and Structural Unemployment
• Frictional Unemployment: unemployment that occurs as workers move between
jobs
• Natural Rate of Unemployment: the unemployment rate that would exist in a
growing and healthy economy from the combination of economic, social, and political
factors that exist at a given time; the sum of frictional plus structural unemployment
• Structural Unemployment: unemployment that occurs because individuals lack
skills valued by employers

11. The Natural Rate of Unemployment
• The natural rate of unemployment includes only frictional and structural
unemployment, and not cyclical unemployment
• related to two other important concepts: full employment and potential real GDP
• Unexpected shifts in productivity can have a powerful effect on the natural rate of
unemployment
• On the supply side of the labor market, public policies to assist the unemployed can
affect how eager people are to find work
• On the demand side of the labor market, government rules social institutions, and
the presence of unions can affect the willingness of firms to hire

12. The Natural Rate of Unemployment in Recent Years
The underlying economic, social, and political factors that determine the natural rate of
unemployment can change over time:
1. The Internet has provided a remarkable new tool through which job seekers can
find out about jobs at different companies and can make contact with relative ease
2. The growth of the temporary worker industry has probably helped to reduce the
natural rate of unemployment
3. The aging of the “baby boom generation”

13. Inflation
• Hyperinflation: an extremely high rate of inflation, in the 100s or 1000s
percent per year
• Inflation: a general and ongoing rise in the level of prices in an economy
Table 1. Price Comparisons, 1970 and 2014
Items 1970 2014
Pound of ground beef $0.66 $4.16
Pound of butter $0.87 $2.93
Movie ticket $1.55 $8.17
Sales price of new home (median) $22,000 $280,000
New car $3,000 $32,531
Gallon of gasoline $0.36 $3.36
Average hourly wage for a manufacturing
worker
$3.23 $19.55
Per capita GDP $5,069 $53,041.98

14. Calculating Inflation with Index Numbers
• Base Year: arbitrary year whose value as an index number is defined as 100;
inflation from the base year to other years can easily be seen by comparing the
index number in the other year to the index number in the base year—i.e., 100; so, if
the index number for a year is 105, then there has been exactly 5% inflation between
that year and the base year
• Index Number: a unit-free measure of an economic indicators; index numbers are
based on a value of 100, which makes it easy to measure percent changes
• Inflation Rate: the percentage change in some price index
• Market Basket: hypothetical collection of goods and services (or more precisely,
the quantities of each good or service) consumers typically buy
• Price Indices: essentially the weighted average of prices of a certain type of good or
service; price indices are created to calculate the inflation rate, i.e. the percent
change in prices over time
• Price Level: the average of prices

15. Index Numbers
• A price index is essentially the
weighted average of prices of a
certain type of good or service
• Price indices can measure a
narrow range of goods and
services or a broader range of
goods and services
• Price indices are created to
help calculate the percent change
in prices over time

16. The Consumer Price Index
Consumer Price Index: the average price of the goods and services
typically purchased by urban consumers
The Eight Major Categories in the Consumer Price Index
1. Food and beverages
2. Housing
3. Apparel
4. Transportation
5. Medical Care
6. Recreation
7. Education and communication
8. Other goods and services

17. Shortcomings of the Consumer Price Index as a
Measure of the Cost of Living
• Core Inflation Index: version of the CPI excluding volatile economic components
like energy and food prices.
• Improved Quality/New Goods Bias: As the quality of goods improves over time,
and as new goods become invented, the prices of those goods naturally increase
reflecting their increased value; the result is that the CPI overstates the cost of living
since some of the price increases it measures represent increases in value, not cost.
• Substitution Bias: As one good or service becomes more expensive relative to
others, consumers tend to substitute away from the more expensive item towards
the cheaper item; this means that the weights used to calculate the CPI are no
longer accurate, causing the CPI to overstate the cost of living.

18. Shortcomings in the CPI as a Measure of the Cost of Living
• A core inflation index is typically calculated by taking the CPI and excluding volatile
economic variables.
• The cost of living represents how much it costs for a person to feel that his or her
consumption provides an equal level of satisfaction or utility.
• Substitution bias tends to overstate the rise in a consumer’s true cost of living.
• The CPI tends to understate consumers’ standard of living, as measured by
nominal income/CPI.

19. The GDP Deflator and Other Major Price Indices
• Employment Cost Index: estimate of the average cost of labor compensation to
employers, including wages, salaries and fringe benefits.
• GDP Deflator: price index which measures the average price of all goods and
services included in GDP; used to convert nominal into real GDP.
• Producer Price Index: price index based on prices paid for supplies and inputs by
producers of goods and services.

20. The GDP Deflator and Producer Price Index
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 =
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
𝐺𝐷𝑃 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟
• The GDP Deflator goes by several names, such as the Implicit Price Deflator for
GDP, and the GDP Price Index, but they all mean the price index which is used to
convert nominal into real GDP.
• Producer Price Index can be broken down into price indices for different industries,
commodities, and stages of processing (like finished goods, intermediate goods,
crude materials for further processing, and so on)

21. Problems with Inflation
• 401(k): a defined contribution retirement program to which the employee and often
the employer contribute
• Nominal Interest Rate: the actual interest rate charged on a loan
• Pension: a defined benefit retirement payment
• Real Interest Rate: the interest rate after inflation is taken into account; the nominal
interest rate minus the rate of inflation

22. Confusion over Inflation
Inflation can cause three types of problems:
1. Blurred price signals
2. Unintended redistributions of purchasing power
3. Difficulties in long-term planning

23. Unintended Redistributions of Purchasing Power
• People who are hurt by inflation include those who are holding a lot of cash
• When inflation happens, the buying power of cash is diminished
• Cash is only an example of a more general problem: anyone who has financial
assets invested in a way that the nominal return does not keep up with inflation will
tend to suffer from inflation

24. Benefits of Low Inflation
• An annual inflation rate of 2%, 3%, or 4% is a long way from a national crisis
• If variability in inflation rates is a problem, then moderate and high inflations are
more likely to have significant variability than are low inflations
• Low inflation is also better than deflation which occurs with severe recessions
• Moderate inflation may help the economy by making wages in labor markets more
flexible

25. Quick Review
• Define and differentiate between employed, unemployed, and being in or out of the
labor force
• How do you calculate labor force percentages and the unemployment rate?
• Explain historical patterns and trends of unemployment in the U.S
• Evaluate global unemployment rates
• What is cyclical unemployment?
• What is the relationship between sticky wages and employment using various
economic arguments?
• What is frictional unemployment and structural unemployment?
• What is natural unemployment?
• What is the relationships between the natural rate of employment and potential real
GDP, productivity, and public policy.

26. More Quick Review
• What is an example of inflation? Explain
• What is a price index is? How do you compute one?
• How do you calculate inflation rates using price indices?
• Using Consumer Price Index (CPI), how do you calculate U.S. inflation rates
• What are the major shortcomings of the CPI as a measure of the cost of living?
• Explain how the substitution bias and the quality improvement/new goods bias
causes the CPI to overstate the cost of living
• Contrast the CPI with other price indices, including the PPI and GDP Deflator

27. More More Quick Review
• What are the ways inflation can blur the perception of supply and demand?
• How can inflation cause redistributions of purchasing power
• Explain the possible economic benefits of inflation