Chapter 22 Monitoring Jobs and Inflation

I. Employment and Unemployment

A. Current Population Survey
1. The U.S. Census Bureau measures the population, labor force, and amount of
employment. The working-age population is the total number of people aged
16 years and over who are not in jail, a hospital, or some other form of
institutional care. The labor force is the sum of the employed and the
unemployed.
2. Unemployment occurs when someone who wants a job cannot find one. To be
counted as unemployed, a person must be available for work and must be in
one of three categories:
a). Without work but has made specific efforts to find a job within the
previous four weeks
b). Waiting to be called back to a job from which he or she has been laid off
c). Waiting to start a new job within 30 days.
3. Figure 22.1 shows the population labor force categories in May 2021.

Figure 22.1 Population Labor Force Categories

B. Three Labor Market Indicators

1. The unemployment rate is the percentage of the people in the labor force who
are unemployed. It equals

Number of people unemployed

100
Labor force

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 and Labor force = Number of people employed + Number of people
unemployed. Between 1980 and 2017 the unemployment rate averaged 6.4
percent (Figure 22.2).

Figure 22.2 The Unemployment Rate: 1980–2021

2. The employment-to-population ratio is the percentage of people of working

age who have jobs. It equals

Number of people employed

 100.
Working - age population

In recent years the employment-to-population ratio has been about 62 percent.

It fell during the recession and in June 2010 was 58.5 percent.
3. The labor force participation rate is the percentage of working-age population
who are members of the labor force. It equals

Labor force
 100.
Working - age population

The labor force participation rate has been declining since it reached about 67
percent in 2000 and in June 2017 was 62.7 percent (Figure 22.3).

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 Figure 22.3 Labor Force Participation and Employment: 1980–2021

4. Marginally attached workers are people who are available and willing to
work but currently are neither working nor looking for work. These workers
often temporarily leave the labor force during a recession and decrease the
labor force participation rate. Because they are no longer counted as
unemployed, marginally attached workers lower the unemployment rate. A
discouraged worker is a marginally attached worker who has stopped looking
for work because of repeated failures to find a job.
5. Economic part-time workers are people who are working part-time but would
like to find full time work. These workers are not unemployed by the U-3
standard but are considered “part-unemployed.”
6. Marginally attached workers (and discouraged workers) as well as economic
part-time workers who want a full-time job are not counted as unemployed in
the official unemployment rate.

II. Unemployment and Full Employment

A. Types of Unemployment
1. Frictional unemployment is the unemployment that arises from normal labor
turnover. These workers are searching for jobs. The unemployment related to
this search process is a permanent phenomenon in a dynamic, growing
economy. Frictional unemployment increases when more people enter the labor
market or when unemployment compensation payments increase.
2. Structural unemployment is the unemployment that arises when changes in
technology or international competition change the skills needed to perform
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 jobs or change the locations of jobs. Sometimes there is a mismatch between
skills demanded by firms and skills provided by workers, especially when there
are great technological changes in an industry. Structural unemployment
generally lasts longer than frictional unemployment.
3. Cyclical unemployment is the fluctuating unemployment over the business
cycle. Cyclical unemployment increases during a recession and decreases
during an expansion.

B. “Natural” Unemployment
1. Natural unemployment is the unemployment that arises from frictions and
structural change when there is no cyclical unemployment—when all the
unemployment is frictional and structural. Natural unemployment as a
percentage of the labor force is called the natural unemployment rate.
2. Full employment is defined as a situation in which the unemployment rate
equals the natural unemployment rate.

C. What Determines the Natural Unemployment Rate?

1. The Age Distribution of the Population: An economy with a young population
has a large number of new job seekers every year and has a high level of
frictional unemployment.
2. The Scale of Structural Change: The scale of structural change is sometimes
small but sometimes there is a technological upheaval. When the pace and
volume of technological change and when the change driven by international
competition increase, natural unemployment rises.
3. The Real Wage Rate: The natural unemployment rate increases if minimum
wage is raised to exceed the equilibrium wage rate.

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 4. Unemployment Benefits: Unemployment benefits increase the natural
unemployment rate by lowering the opportunity cost of job search.

D. Real GDP and Unemployment Over the Business Cycle

When the economy is at full employment, the unemployment rate equals the
natural unemployment rate and real GDP equals potential GDP. When the
unemployment rate is greater than the natural unemployment rate, real GDP is less
than potential GDP. And when the unemployment rate is less than the natural
unemployment rate, real GDP is greater than potential GDP. The gap between real
GDP and potential GDP is called the output gap (Figure 22.5).

Figure 22.5 The Output Gap and the Unemployment Rate

III. The Price Level, Inflation, and Deflation

The price level is the average level of prices. The average level of prices can be
rising, falling, or stable. Inflation occurs when the price level persistently rises;
deflation occurs when the price level persistently falls. The inflation rate is the
percentage change in the price level.

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A. Why Inflation and Deflation are Problems
1. Unexpected inflation or deflation is a problem for society because they
redistribute income and wealth. Unexpected inflation benefits employers and
borrowers; unexpected deflation benefits workers and lenders. They motivate
people to divert resources from producing goods and services to forecasting
and protecting themselves from the inflation or deflation.
2. Unexpected deflation hurts businesses and households that are in debt
(borrowers) who in turn cut their spending. A fall in total spending brings a
recession and rising unemployment.
3. Hyperinflation is an inflation rate of 50 percent a month or higher

B. The Consumer Price Index

1. The Consumer Price Index (CPI) is a measure of the average of the prices
paid by urban consumer for a fixed “basket” of consumer goods and services.
The CPI is calculated monthly by the Bureau of Labor Statistics.
2. The CPI is defined to equal 100 for a period called the reference base period.
The current reference base period is 1982-1984, so the average CPI during that
period was 100.
3. In June 2010, the CPI was 218.0. In June 2009, the CPI was 215.7. Thus, since
1982-84, prices increased by 115.7 percent to 2009 and by 118.0 percent to
2010.
C. Constructing the CPI
1. The BLS conducts an infrequent survey of consumers to determine the average
“basket” of goods and services purchased by urban household (Figure 22.6).
Then each month the BLS records the prices of goods and services in the
basket, keeping the representative items as similar as possible in consecutive
months. The BLS uses the fixed basket quantities and the recorded prices to
determine the cost of the basket each month. The CPI for the month equals 100
multiplied by the ratio of the cost in the current month to the cost in the base
period.

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 Figure 22.6 The CPI Basket

2. For example, suppose the initial survey shows that the CPI basket is 2 books
and 20 coffees. The initial base period prices and quantities are in the table to
the right. In this base period, say 2005, the cost of the CPI basket is $80.

Item Quantity Price Cost

(dollars)
Books 2 $30 $60
Coffee 20 $1 $20
Basket $80

3. Next suppose that the BLS survey taken one month in 2011 reveals that the
price of a book is $35 and the price of a coffee is $3. These 2011 prices and the
initial base period quantities are in the table to the right. In this period the cost
of the CPI basket is $130.

Item Quantity Price Cost

(dollars)
Books 2 $35 $70
Coffee 20 $3 $60
Basket $130

Using these data, the problem is like the CPI of the 2005 $80 basket is 100,
what is the CPI of the 2011 when the basket is $130. This can be solved easily
by
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 $80 :100 = $130: CPI in 2011.

Therefore, CPI in 2011 is 162.5. So between the base period and the current
period, the CPI has risen by 62.5 percent.

D. Measuring the Inflation Rate

1. The inflation rate is the percentage change in the price level from one year to
the next. In a formula,

 CPI this year - CPI last year 

Inflation rate =    100 .
 CPI last year 

2. In June 2010, the CPI was 218.0. In June 2009, the CPI was 215.7. Between
 218.0 - 215.7 
2009 and 2010, the inflation rate was   100 or 1.1%.
 215.7 
3. Figure 22.7 shows the CPI and the inflation rate from 1970–2021.

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 Figure 22.7 The CPI and the Inflation Rate

E. The Biased CPI

The CPI has four biases that lead it to overstate the inflation rate. The biases are:
a). New Goods Bias: New goods are often more expensive than the goods
they replace.
b). Quality Change Bias: Sometimes price increases reflect quality
improvements (safer cars, improved health care) and should not be counted
as part of inflation.
c). Commodity Substitution Bias: Consumers substitute away from goods
and services with large relative price increases.
d). Outlet Substitution Bias: When prices rise, people use discount stores
more frequently and convenience stores less frequently.

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F. The Magnitude and Consequences of the Bias
1. The Boskin Commission in 1996 estimated the bias overstates the inflation rate
by about 1.1 percentage points a year.
2. Any bias in the CPI matters because many contracts and payments are indexed
to the CPI, including Social Security. Close to 1/3 of government outlays are
linked to the CPI.

G. Alternative Price Indexes

Three alternative to the CPI are:
a). Chained CPI: The chained CPI is calculated similarly to chained GDP.
The chained CPI incorporates both new goods and the substitution of one
good for another and so overcomes these sources of bias. But the difference
between the chained CPI and regular CPI is small: on average, since 2000 the
chained CPI is 0.3 percentage points lower per year.
b). Personal Consumption Expenditure Deflator (PCE deflator): The
deflator from nominal and real consumption expenditure. The PCE deflator
equals
Nominal consumption expenditure
× 100
Real consumption expenditure

The basket of goods in the PCE deflator is broader than the basket in the CPI
because it includes all consumption expenditure.
c). GDP Deflator: Similar to the PCE deflator, the GDP deflator is from
nominal and real GDP. The GDP deflator equals

Nominal GDP
100.
Real GDP

The difference between the GDP deflator and regular CPI is small: on
average, since 2000 the GDP deflator is 0.2 percentage points lower per year.

H. Core CPI Inflation

The inflation rate is often volatile. To strip out the volatile elements and focus on
the underlying trend inflation, the core inflation rate is used. The core inflation
rate is the CPI inflation rate excluding volatile elements. The core CPI inflation
rate equals the percentage change in the CPI excluding food and fuel prices
(Figure 22.8).

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 Figure 22.8 Core Inflation

I. Real Variables in Macroeconomics

Real variables are measured in constant prices and can be considered to be
measured in units of “goods and services.” In general nominal variables, such as
the nominal wage rate and nominal GDP, are deflated to become real variables
using the formula
Nominal variable
real variable = 100 .
Price level
The exception to this rule is the nominal interest rate. (In two chapters, we see that
the real interest rate = nominal interest rate − inflation rate.)

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