Eco 1: Principles of Economics

Eco 1
Chapter
Chapter 3 Where Prices
19: Unemployment Come
and From:
inflation
The Interaction of Demand and Supply
 Employment and Unemployment
Employment: based on a survey of establishment.
Monthly survey about 145,000 businesses and government agencies, representing
about 557,000 individual worksites.

Unemployment: based on Current Population Survey.

Monthly survey of about 68,000 households.
So, we use two different surveys to get the statistics about employment and
unemployment!
 Current Population Survey
Each month, interviewers working on a joint project of BLS and the U.S. Bureau of the
Census conducts the Current Population Survey (a.k.a. the household survey) survey
68,000 households to establish the age and job market status of each member of the
household.

Working-age population is the total number of people aged 16 years and

older, who are not in U.S. Armed Forces, in jail, hospital, or some other
form of institutional care.
The Employment Status of the Civilian Working-Age Population, August 2015
 Different labor groups
The working age population is divided into those in labor force and those who are not.
Labor force: The sum of employed and unemployed workers in the economy.
Not in labor force:
1. Not available for work
– homemakers, retirees, full-time students, etc.)
2. Available for work but not currently working
➢ Discouraged workers: people who are available for work but have not
looked for a job during previous four weeks because they believe no jobs are
available for them
➢ Not currently looking because of child care responsibilities or transportation
or other problems.
 Let’s say in current economy, the there are 157.07 million people in labor force, 8.03 million are
unemployed, 149.04 million are employed and 251.1 million people are in working-are population,
calculate the unemployment rate, labor force participation rate and employment-population ratio

Number of unemployed 8.03 million

100 = Unemployme nt rate 100 = 5.1%
Labor force 157.07 million

Labor force 157.07 million

100 = Labor force participat ion rate 100 = 62.6%
Working - age population 251.1 million

Employment
100 = Employment - population ratio 149.04 million 100 = 59.3%
Working - age population 251.1million
 Problems with Measuring the Unemployment Rate

The unemployment rate measured by the BLS is not a perfect measure of joblessness. Why?
➢ It may understate unemployment:
Distinguishing between people who are unemployed and not in the labor force requires
judgment (should we exclude “discouraged workers”?)
Only measures employment, not intensity of employment (full-time vs. part-time; some
people are underemployed)
➢ It may overstate unemployment:
People might claim falsely to be actively looking for work
May claim not to be working to evade taxes or keep criminal activity unnoticed
 Trends in Labor Force Participation

The labor force participation rate of adult men has declined gradually since 1948, but it has
increased significantly for adult women, making the overall rate higher today than it was
then.
 Trends in Labor Force Participation

While the unemployment rate returned to “normal” after the 2007-2009 recession, the employment-
population ratio did not. Why?
• Aging population (baby boomers reaching retirement)
• Long-term unemployment leading to skill deterioration
• Affordable Care Act making access to health care easier
 Unemployment Rates for Different Groups

Unemployment rates vary by ethnic group and by education level.

These two observations are statistically related.
The unemployment rate of African Americans is the highest of the four ethnic groups shown, while the unemployment
rate of Asians is the lowest. High school dropouts have an unemployment rate that is triple the unemployment rate for
college graduates.
 U.S. Annual Unemployment Rate over Time

Unemployment rates follow business cycle. It falls during expansion; rises during recessions

But they never fall to zero. To understand why, we will examine the types of unemployment.
 Types of Unemployment

Frictional unemployment: Short-term unemployment that arises from the process of

matching workers with jobs.
Frictional unemployment occurs mostly because of job search: entering or re-entering the labor force, or being between
jobs.
It also occurs because of seasonal unemployment: some jobs fluctuate in availability due to seasonal demand, like ski-
instructor or farm-work.
Some frictional unemployment actually increases economic efficiency by allowing for better job matches.

Structural unemployment: Unemployment that arises from a persistent mismatch between the skills and attributes of
workers and the requirements of jobs.
- Longer unemployment spells.
- May require retraining in order to obtain “modern” jobs.
Cyclical unemployment: Unemployment causes by a business cycle recession.
- During an economic recession, firms find that sales are declining, so they cut production, which induces them to lay off workers.
When cyclical unemployment is zero, the economy said to be at full employment. Usually between 4 - 6% unemployment.

Natural rate of unemployment = structural +frictional unemployment. Also called the full-employment rate of unemployment
 Inflation
Price level: a measure of the average prices of goods and services in the
economy.
Inflation: rising general level of prices:
- Always reduces the purchasing power of money. In 1981 $1 to got you a loaf of
bread. Now you need $2.5 to get a loaf of bread.

We refer to the percentage increase in the price level from one year to the
next as the inflation rate. When the prices fall, we have deflation.
In chapter 19, we used GDP deflator to measure price level. However, there is a more
accurate way to calculate price level.

The consumer price index is a measure of the average change over time in the prices a
typical urban family of four pays for the goods and services they purchase.

To calculate the CPI in a given year, we need:

✓ A basket of goods
✓ The cost to purchase the basket of goods in a base year
✓ The prices in the current year
The CPI in the current year is the cost to purchase the basket of goods this year, divided by
the cost in the base year. By convention, we multiply this by 100, so that the CPI in the
base year is 100.
 A Simple CPI Calculation

The table above gives the information we need to create the CPI in 2016 and 2017, using
the basket of goods from 1999.
Formula Applied to 2016 Applied to 2017

Expenditures in the current year  $900   $915 

CPI= 100    100 = 120    100 = 122
Expenditures in the base year  $750   $750 
 A Simple CPI Calculation—continued
Formula Applied to 2016 Applied to 2017

Expenditures in the current year  $900   $915 

CPI= 100
Expenditures in the base year    100 = 120  $750   100 = 122
 $750   

Based on these data, the inflation rate from 2016 to 2017 is the percentage change in the CPI:

 122 − 120 
   100 = 1.7%
 120 
Since the CPI measures consumer prices, it is often referred to as the
cost-of-living index. CPI-inflation is sometimes used to generate “fair”
increases in wages for workers, and government benefits.

General formula: Inflation rate in 2010=(𝐶𝑃𝐼 2010 −𝐶𝑃𝐼 2009)

𝐶𝑃𝐼 2009
x 100%
 Is the CPI an Accurate Measure of Inflation?
Some potential problems with the CPI include:
Substitution bias: Consumers may change their purchasing habits away from goods that
have increased in price.
Increase in quality bias: Products like cars and computers have become more durable and
better quality over time. It is hard to isolate the pure-inflation part of price increases.
New product bias: The basket of goods changes only every 10 years. There is a delay to
including new goods like cell phones.
Outlet bias: Increases in purchases from discount stores like Sam’s Club and Costco or
the internet are not incorporated into the CPI; it still uses full-retail price.
For these reasons, economists believe the CPI overstates true inflation by 0.5 to 1
percentage point.
 Adjusting for the effects of inflation
We can compare dollar values across different time periods (real vs. nominal)
If you earned $25,000 in 1990, how much is it worth today? Let CPI for 1990 102 and
CPI for 2015 be 120, then

𝐶𝑃𝐼 𝑖𝑛 2015
Value in 2015 = Value in 1990 dollars x
𝐶𝑃𝐼 𝑖𝑛 1990
= $25,000 x (120/102) = $29411.76
 Real vs. Nominal Interest Rate
What is your true return when borrowing and lending money?
Nominal interest rate: the stated interest rate on a loan
Real interest rate: adjusted nominal rate for inflation, that is,
real interest rate = nominal interest rate – inflation rate

Holding the interest rate constant, the higher the inflation, the lower real interest
rate.
You should consider the real interest rate when borrowing, it is a better indicator
for the true cost of borrowing.
 Is inflation good or bad?
Unanticipated Inflation Anticipated Inflation
• People and firms have increased real costs of
holding cash.
Unpredictable inflation makes
borrowing and lending risky • Firms have menu costs: the cost to firms of
changing prices. Frequently changing prices are
inconvenient for firms (and consumers too!) to deal
with.
• Investors are taxed on nominal returns, rather than
real returns; so this can increase the tax due.

Hurt by inflation Helped by inflation

Lenders – people who lend money (at fixed interest rates) Borrowers – people who borrow money
People with fixed income A business where the price of the product increases faster that
the price of the resources
Savers