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Unemployment and Inflation

CHAPTER

8

© 2003 South-Western/Thomson Learning

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Measuring Unemployment

Civilian Noninstitutional Adult Population

All civilians 16 years of age and olderExcludes institutionalized in prisons or mental hospitalsExcludes those in military

Labor forceThose in the adult population who are either working or looking for work

UnemployedThose with no job who are looking for work

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Measuring Unemployment

Civilian Noninstitutional Adult Population

Labor Force Not In Labor Force

Employed Unemployed

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Measuring Unemployment

Unemployment rateMeasures the percentage of those in the labor force who are unemployedEquals the number unemployed divided by the number in the labor forceDoes not include discouraged workers

Discouraged workersThose who are no longer looking for work but are unemployed

Labor Force Participation RateThe number in the labor force divided by the adult population

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Trend of Unemployment RateDecline in the unemployment rate over last 20 years

Overall growth in the economyRelatively fewer teenagers in the work force

Unemployment rate says nothing about who is unemployed or for how long

Unemployment rates differ across• Race• Gender• Age• Geographical area• Occupational group

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Types of Unemployment

Four sources of unemployment

Frictional unemployment

Structural unemployment

Seasonal unemployment

Cyclical unemployment

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Frictional Unemployment

Time required to bring together labor suppliers and labor demanders

Employers need time to learn about the talent availableJob seekers need time to learn about employment opportunities

Generally short-term and voluntary

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Structural Unemployment

Exists because unemployed workers often

do not have the skills demanded by employers, ordo not live where their skills are in demand

• That is, there is a mismatch of skills or geographic location

• More of a problem than is frictional unemployment

Occurs because changes in tastes, technology, taxes, or competition reduce the demand for certain skills and increase the demand for other skills

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Seasonal UnemploymentUnemployment caused by seasonal changes in labor demand during the year

For example, during the winter months the demand for farm hands declines while during the Christmas season demand for retail employees increases

To eliminate the impact of such changes, monthly unemployment statistics are seasonally adjusted which smoothes out these factors

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Cyclical Unemployment

Occurs because of business cycle fluctuations in output that occur during recessions

Government policies to stimulate aggregate demand are aimed at reducing this type of unemployment

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Full Employment

Changes in product demand and technology continually alter the supply and demand for particular types of labor even in a healthy economy there will be some frictional, structural, and seasonal unemployment

Full employment Occurs when the only unemployment is frictional, structural, or seasonalDoes not mean zero unemployment

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Unemployment Compensation

Applies to unemployed workers who meet certain qualifications

Last for up to six months – longer in certain cases - provided the individual looks for workFewer than half of all unemployed workers receive these benefitsReplaces on average about 40% of a person’s take home pay

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Unemployment Compensation

Problems with unemployment compensation

Evidence suggests that unemployed workers who receive benefits tend to search less actively than those who don’tMay reduce the urgency of finding work thereby increasing the average duration of unemployment and unemployment rate

On the plus side, it allows for a higher-quality job search

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0

2

4

6

8

10

12

1983 1985 1987 1989 1991 1993 1995 1997 1999 2001

Per

cent

Une

mpl

oyed

Exhibit 4: Unemployment Rates

Japan

Europe

United States

In the last two decades, the unemployment rate:

Remained high in Europe Fell in the U.S. Rose in Japan

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Problems with Unemployment Figures

Unemployment figures understate the actual amount of unemployment because of discouraged workers and underemployment

Discouraged workers are those who have stopped looking for workUnderemployment occurs when

• People are counted as employed even if they can find only part-time jobs or

• Are vastly overqualified for their job

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Problems with Unemployment Figures

Official figures tend to overstate unemployment because

Some people may act as if they are looking for work just to qualify for welfare and unemployment insuranceSome who would prefer to work part time can find only full time workSome are forced to work overtime and weekends but would prefer to work fewer hoursPeople in the underground economy may not readily acknowledge such jobs since their intent is to evade taxes

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Inflation

Inflation is a sustained increase in the average price level

Hyperinflation: Extremely high inflation

A sustained decline in the average price level is called deflation

A reduction in the rate of inflation is called disinflation

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Inflation

Typically measure inflation on an annual basis

Annual inflation rate is the percentage increase in the average price level from one year to the next

Two sources of inflationDemand-pull inflationCost-push inflation

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Exhibit 5a: Sources of Inflation

PriceLevel

P

Aggregate output

AS

AD

A) Demand-pull inflation: inflation induced by an increase in aggregate demand

0

The increase in the aggregate demand curve pulls up the price level. To generate continuousdemand-pull inflation, the aggregate demand curve would have to keep shifting outward along a given aggregate supply curve

AD'

P'

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Exhibit 5b: Sources of Inflation

PriceLevel

P

Aggregate output

AS

AD

0

AS'

P'

The increase in costs of

productionpush up the price

level. To generate

continuouscost-push

inflation, the aggregate

supply curve would have to

keepshifting to the left

along a givenaggregate

demand curve.

B) Cost-push inflation:Inflation induced by a decrease in aggregate supply

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Exhibit 6a: Consumer Price Index CPI, consumer price index, measures the cost of a “marketbasket” of consumer goods and services over time.

0

20

40

60

80

100

120

140

160

180

200

Con

sum

er p

rice

inde

x (1

982-

1984

= 1

00)

Source: The CPI Home page of the U.S. Bureau of Labor Statistics at http:\\ftp.bls.gov\pub\special requests.cpi\cpia.html

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Exhibit 6b: Consumer Price Index Shows the annual rate of change in the CPI, or the annual rate of inflation or deflation

-15

-10

-5

0

5

10

15

20

25

Ann

ual p

erce

nt c

hang

e

1913

194 0

195 0

196 0

197 0

198 0

199 0

200 0

193 0

Source: The CPI Home page of the U.S. Bureau of Labor Statistics at http:\\ftp.bls.gov\pub\special requests.cpi\cpia.html

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Anticipated versus Unanticipated Inflation

Unanticipated inflation creates more problems for the economy than does anticipated inflation

To the extent that inflation is higher or lower than anticipated, it arbitrarily creates winners and losers

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Transaction Costs of Inflation

When prices are stable, people correctly believe that they can predict future prices and can therefore plan accordingly

But, if inflation changes unexpectedly, planning gets harder which undermines the ability of money to serve as a link between the present and the future

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Obscures Relative Price Changes

Relative Prices

The workings of supply and demand mean that the prices of some goods increase while some decrease, e.g., the relative prices of goods and services change

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Obscures Relative Price Changes

Inflation does not necessarily cause the change in relative prices, but it can obscure them

Since prices usually do not move in unison, tying a particular product’s price to the overall inflation rate may result in a price that is too high or too low based on market conditions

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Exhibit 7: Inflation Rates in Major Economies Have Trended Lower in Last Two Decades

-1

1

3

5

7

9

11

13

15

19811985

19901995

2000

Ann

ual P

erce

nt I

nfla

tion

Japan

Europe

United States

Developed from annual CPI inflation reported in OECD Economic Outlook, 69 (June 2001). Annex Table 16. Europe averages France, Germany, Italy, and U.K. For latest data go to www.oecd.org/eco/.

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Inflation and Interest Rates

Nominal interest rateMeasures interest in terms of the current dollars paidAppears on the borrowing agreementThe rate quoted in the news media

Real interest rateEquals the nominal rate of interest minus the inflation rate

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Why is Inflation Unpopular?

Problems with unanticipated inflationIt hits those whose incomes are fixed in nominal termsArbitrarily redistributes income and wealth from one group to anotherReduces the ability to make long-term plans

• The more variable and unpredictable inflation is, the greater the difficulty of negotiating long-term contracts

Forces buyers and sellers to pay more attention to prices

• Because people must spend more time coping with uncertainty created by inflation, they have less time for production overall productivity of economy falls