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CHAPTER
SLIDES
BY
SOLINA LINDAHL
8(23)
Unemployment and
Inflation
FOOD FOR THOUGHT….
SOME GOOD BLOGS AND OTHER SITES TO GET THE JUICES FLOWING:
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What you will
learn in this chapter
▪ How unemployment is measured and how the
unemployment rate is calculated
▪ The significance of the unemployment rate for the
economy
▪ The relationship between the unemployment rate and
economic growth
▪ The factors that determine the natural rate of
unemployment
▪ The economic costs of inflation
▪ How inflation and deflation create winners and losers
▪ Why policy makers try to maintain a stable rate of
inflation
To
To First
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HITTING THE “BRAKING” POINT
The chair of the Federal Reserve (Janet Yellen) must
balance the needs of workers against the need for
price stability
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THE U.S. UNEMPLOYMENT RATE,
1948–2014
Unemployment always rises during recessions and
usually (but not always) falls during periods of
economic expansion.
Sources: Bureau of Labor Statistics; National Bureau of Economic Research.
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DEFINING UNEMPLOYMENT
Unemployment rate: the percent of the
total number of people in the labor force
who are unemployed.
Labor force: all workers, employed or
unemployed.
Labor force participation rate: the
percentage of adults (people 16 and over)
in the labor force.
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DEFINING UNEMPLOYMENT
Measuring the labor force participation rate: The %
of the adult (16+) noninstitutionalized civilian population
who are working or actively looking for work.
#Unemployed + #Employed
´100
Adult population
Labor force
=
´100
Adult population
Labor Force Participation rate =
Measuring unemployment: The unemployment rate is
the % of the labor force without a job
#Unemployed
Unemployment rate (%) =
´100
#Unemployed + #Employed
#Unemployed
=
´100
Labor force
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LEARN BY DOING: PRACTICE QUESTION
In your country, there are 24 million
people in the labor force. 21.5 million
people are employed. What is the
unemployment rate in your country?
a)
b)
c)
d)
10.4%
2.5%
89.6%
21.5%
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THE SIGNIFICANCE OF THE
UNEMPLOYMENT RATE
The unemployment rate is a good indicator of
how easy or difficult it is to find a job given the
current state of the economy.
It can overstate the true level of unemployment.
Even if the labor market is healthy, it takes time to
find the right job. (Meanwhile, you’re
“unemployed.”)
It can understate the true level of
unemployment.
You are not “unemployed” if you have given up
looking for a job because there are no jobs
available.
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PROBLEMS WITH UNEMPLOYMENT
STATISTICS
Discouraged workers: nonworking people who
have given up looking for work for the time being.
Not considered unemployed.
The deeper the recession, the more discouraged workers
there are.
Marginally attached workers: those who were
available and actively looked for work recently but
are not currently looking (in the past 12 months but
NOT in the past 4 weeks)
Underemployed workers: people who work part
time because they cannot find full-time jobs.
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ALTERNATIVE MEASURES OF
UNEMPLOYMENT, 1994–2014
Source: Bureau of Labor Statistics
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LEARN BY DOING: PRACTICE QUESTION
Adult population
200 million
Labor force
150 million
Employed persons
138.75 million
Discouraged workers
10.5 million
According to the table, the unemployment
rate is _________ and the labor force
participation rate is __________.
a) 7%; 60.4%
b) 0.7%; 99.3%
c) 5.6%; 69.4%
d) 7.5%; 75%
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LEARN BY DOING: PRACTICE QUESTION
Which of the following individuals can be
counted as unemployed?
a) Darren, a 10-year-old child
b) Nazma, a stay-at-home mom
c) Moesha, a full-time college student
d) Carl, who works part time at the Olive
Garden but would prefer more hours
e) None of the answers is correct.
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DEFINING UNEMPLOYMENT
So how good an indicator is the
unemployment rate?
It isn’t perfect.
It doesn’t measure the quality of jobs or how well
people are matched to their jobs.
Economists also look at other indicators:
• Labor force participation rate
• Number of full-time jobs
• Average wages
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UNEMPLOYMENT RATES AND
DEMOGRAPHICS
Data show that unemployment rates vary greatly
between groups.
Source: Bureau of Labor Statistics
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GROWTH AND UNEMPLOYMENT
Unemployment and Recessions,
1978–2014 (Shaded areas are recessions.)
Sources: Bureau of Labor Statistics; National Bureau of Economic Research.
A jobless recovery is a period in which the real GDP growth
rate is positive but the unemployment rate is still rising.
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GROWTH AND CHANGES IN
UNEMPLOYMENT, 1949–2013
Generally there is a negative relationship between
economic growth and the unemployment rate.
Sources: Bureau of Labor Statistics; Bureau of
C O P Y R I G H T
2 0 1 5
Economic Analysis.
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ECONOMICS
IN ACTION
FAILURE TO LAUNCH
Times of high unemployment are especially
hard on new graduates.
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THE NATURAL RATE OF
UNEMPLOYMENT
Some unemployment is natural.
Over the past 50 years, the national
unemployment rate has never dropped
below 2.9%.
There are three types of unemployment:
1. frictional
2. structural
3. cyclical
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LABOR MARKET FLOWS IN AN
AVERAGE MONTH IN 2007
In a healthy year (like 2007) many workers move
into and out of both employment and
unemployment each month.
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FRICTIONAL UNEMPLOYMENT
Frictional unemployment: unemployment due to
the time workers spend in job search.
Scarcity of information creates frictional
unemployment.
Matching people to jobs takes time.
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DURATION OF UNEMPLOYMENT,
2007
The short duration of unemployment for most workers
suggests that most unemployment in 2007 was frictional.
Source: Bureau of Labor Statistics.
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STRUCTURAL UNEMPLOYMENT
Structural unemployment: more people are
seeking jobs in a particular labor market than there
are jobs available at the current wage rate, even
when the economy is at the peak of the business
cycle.
Some causes:
Labor unions
Efficiency wages
Efficiency wages: wages that employers set above
the equilibrium rate as an incentive for better
employee performance.
Side effects of government policies
Mismatches between employees and employers
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STRUCTURAL UNEMPLOYMENT
Union: an association of workers that
bargains collectively with employers over
wages, benefits, and working conditions.
Unions take many forms: some act to increase
wages simply by restricting entry into a
profession with licensing requirements.
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STRUCTURAL UNEMPLOYMENT
The traditional argument: minimum wage creates lowskilled unemployment: the higher the wage, the more
structural unemployment.
Wage rate
Structural
unemployment
Labor supply
Minimum
wage
Minimu
m
wage
Equilibrium
wage
Labor demand
QE
QD
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Quantity of
labor
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MINIMUM WAGE AND
UNEMPLOYMENT
Other research suggests the opposite effect… at
any rate, minimum wage in the U.S. is relatively
low.
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NATURAL UNEMPLOYMENT AROUND
THE OECD
Are persistently high European unemployment rates the
result of government policies like high minimum wages
and generous unemployment benefits?
Source: OECD.
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LEARN BY DOING: PRACTICE QUESTION
Jasmine has recently moved to Florida
because she loves the warm climate there.
Being new to the area, she will need to
spend a few weeks looking for a new job.
This is an example of:
a)
b)
c)
d)
frictional unemployment.
cyclical unemployment.
structural unemployment.
underemployment.
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LEARN BY DOING: APPLICATION VIDEO
Even after an extension of unemployment benefits to
99 weeks, many of those about to go off the program
are in a quandary. 60 Minutes talks to some of them
in Silicon Valley in this clip. (13:05 minutes)
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THE NATURAL RATE OF
UNEMPLOYMENT
Frictional and structural unemployment are
always present; they are “natural.”
Natural unemployment = frictional
unemployment + structural unemployment.
Actual unemployment = natural
unemployment + cyclical unemployment.
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CYCLICAL UNEMPLOYMENT
Cyclical unemployment:
unemployment correlated with
the business cycle—the
deviation from the natural rate.
Lower growth is usually correlated
with higher unemployment for two
reasons:
1. When GDP falls, firms lay off
workers.
2. Idle labor and capital →
economic growth not being
maximized → ↓ ability of the
economy to create more jobs.
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Fighting for jobs in the Great Depression
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CHANGES IN THE NATURAL RATE OF
UNEMPLOYMENT
We need estimates of the natural rate of
unemployment both to make forecasts and to
conduct policy analyses.
What causes it to change?
Changes in characteristics of the labor force
Changing demographics
Changes in labor market institutions
Unions, temp agencies, and new technology
Changes in government policies
Job training programs
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THE CHANGING MAKEUP OF THE U.S.
LABOR FORCE, 1948–2014
1970s: Women and baby boomers join the labor
force in droves.
Source: Bureau of Labor Statistics
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LEARN BY DOING: PRACTICE QUESTION
Which of the following statements is true?
a) The natural rate of unemployment
equals a country’s unemployment rate
during a recession.
b) The natural rate of unemployment
equals a country’s unemployment rate
during an expansion.
c) The natural rate of unemployment is the
sum of frictional and structural
unemployment.
d) The natural rate of unemployment is the
sum of frictional and cyclical
unemployment.
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ECONOMICS
IN ACTION
STRUCTURAL UNEMPLOYMENT IN EAST GERMANY
Since reunification in 1989, East Germany’s
economy has remained depressed, with
productivity low and structural unemployment high.
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INFLATION AND DEFLATION
Inflation hurts the economy, but most people
misunderstand how.
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THE LEVEL OF PRICES DOESN’T
MATTER
Inflation does not make everyone poorer
because incomes often rise with prices.
A better measure? Real wages.
Real wage is the wage rate divided by
the price level.
Real income is income divided by the
price level.
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THE RATE OF CHANGE DOES MATTER
It’s crucial to distinguish between the level of prices
and the inflation rate
Inflation rate = Price level in year 2 – Price level in year 1 X 100
Price level in year 1
Example: if the CPI increases from 120 to 135 over a
year, what is the inflation rate?
Answer: inflation rate = 135-120 x 100 = 12.5%
120
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THE PRICE LEVEL VS. THE INFLATION
RATE, 1960–2014
The consumer price index has continuously increased,
but the inflation rate fluctuates.
Source: Bureau of Labor Statistics.
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WHAT HIGH INFLATION COSTS
Shoe-leather costs: the increased costs of
transactions caused by inflation.
Since cash loses its value quickly
during high inflation, people
waste more time running around
to spend it as fast as they can
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ECONOMICS
IN ACTION
ISRAEL’S EXPERIENCE WITH INFLATION
The shoe-leather
costs of inflation in
Israel: When the
inflation rate hit
500% in 1985,
people spent a lot
of time in line at
banks.
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WHAT INFLATION COSTS
Menu cost: the real cost of changing a
listed price.
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WHAT INFLATION COSTS
Unit-of-account costs: costs arising from the
way inflation makes money a less reliable
unit of measurement.
Calculations are hard when inflation is high.
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WINNERS AND LOSERS FROM
INFLATION
If inflation is different from predictions, some
will lose and some will benefit.
Interest rate: the price (calculated as a percentage
of the amount borrowed) that a lender charges for
the use of his or her savings for one year.
Nominal interest rate: the interest rate expressed in
dollar terms.
Real interest rate: the nominal interest rate minus
the rate of inflation.
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LEARN BY DOING: PRACTICE QUESTION
Mary expects the inflation rate to be 5%, and she is
willing to pay a real interest rate of 3%. Joe expects the
inflation rate to be 5%, and he is willing to lend money
if he receives a real interest rate of 3%. If the actual
inflation rate is 6% and the loan contract specifies a
nominal interest rate of 8%, then:
a) Joe is glad he lent out funds even though his real
interest rate has fallen.
b) Joe is sorry he lent out funds, since his real interest
rate is now 9%.
c) Mary is glad she borrowed the funds because her
real interest rate has fallen.
d) Mary is sorry she borrowed funds, since her real
interest rate is now 9%.
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LEARN BY DOING: DISCUSS
Sarah works for a firm that automatically adjusts her wages
to the annual rate of inflation.
Bob works for a firm that grants its employees a 5% annual
income increase.
Milt is retired and receives two payments: a pension
payment that is fixed at $2,000 per month and a Social
Security payment of $1,000 per month. The Social Security
payment is indexed to the inflation rate in the community.
a) Suppose the rate of inflation is 8% this year. Describe the
effect of this inflation rate on Sarah, Bob, and Milt. Who is
left in worse shape with this inflation? Does anyone end
up better off despite this inflation rate? Explain your
answer.
b) Suppose the rate of inflation is 20% this year. Describe
the effect of this inflation rate on Sarah, Bob, and Milt.
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Explanation here
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LEARN BY DOING: DISCUSS
(Answers to previous question) With an inflation rate of 8% for the year,
Sarah finds that her income is automatically adjusted upward by that
8%: Sarah’s real income has not changed, since prices rose by 8%, as
did her income. Bob’s income will rise by 5% even though the inflation
rate was 8%: Bob is worse off, since his nominal income rose by an
amount smaller than he needed to stay even with the inflation rate.
Bob has less purchasing power than he did initially. Milt’s situation is
complicated: his pension from his former employer does not adjust with
the inflation rate: this implies that Milt will now have less purchasing
power from his fixed pension of $2,000 per month than he did initially.
Milt’s government-provided retirement payment maintains its real
value, since it is adjusted with changes in the rate of inflation. Overall,
Milt has less purchasing power than he did initially. No one in this
example ends up better off despite this inflation rate.
Again, Sarah’s purchasing power is not affected, since her nominal
income is adjusted each year based upon the rate of inflation. Bob is
much worse off this year, since the overall price level rose 20% while his
nominal income only rose 5%. Milt’s fixed pension sees an even bigger
erosion in its purchasing power than in part (a), while his governmentprovided
retirement payment maintains its real value.
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WINNERS AND LOSERS FROM
INFLATION
Americans who took out mortgages in
the early 1970s quickly found their real
payments reduced by higher-thanexpected inflation.
(By 1983, the purchasing power of a dollar
was only 45% of what it had been in 1973.)
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INFLATION IS EASY; DISINFLATION IS
HARD
The policies needed to slow prices usually cause
unemployment.
Disinflation is the process of bringing the inflation
rate down.
In the 1970s and
early 1980s,
bringing inflation
down required a
temporary but
very large
increase in the
unemployment
rate.
Source: B …
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