Unemploymentand Inflation F ERNANDO Q UIJANO, Y VONN Q UIJANO, K YLE T HIEL & A PARNA S UBRAMANIAN PREPARED BY: © 2007 Pearson/Prentice Hall Economics:

Unemployment and Inflation

FERNANDO QUIJANO, YVONN QUIJANO,

KYLE THIEL & APARNA SUBRAMANIAN

PREPARED BY:

© 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan • Sheffrin • Perez

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2 of 27© 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan • Sheffrin • Perez

1 What do the recent data show about trends in the percentage of women who are

working?

After Growing Sharply, Women’s Labor Force Participation Has Leveled Off

2 Who are the new discouraged workers in Japan?

NEETs Are the New Discouraged Workers in Japan

3 What are the costs of either too high or too low levels of unemployment insurance?

Finding the Optimal Level of Unemployment Insurance

4 Are Social Security payments properly adjusted for changes in the cost of living?

Using the CPI to Adjust Social Security Benefits

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EXAMINING UNEMPLOYMENT

How Is Unemployment Defined and Measured?

6.1

• labor forceThe total number of workers, both the employed and the unemployed.

• unemployment rateThe percentage of the labor force that is unemployed.

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6.1

• labor force participation rateThe percentage of the population over 16 years of age that is in the labor force.

FIGURE 6.1Unemployment Data, February 2006

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AFTER GROWING SHARPLY, WOMEN’S LABOR FORCE PARTICIPATION HAS LEVELED OFF

APPLYING THE CONCEPTS #1: What do the recent data show about trends in the percentage of women who are working?

In 1948, the labor force participation rate for women 20 years and older was 32 percent. By 1970, it had grown to 43 percent, and by 1997 it had reached 60 percent. Since 1997, the figure has remained virtually constant at 60 percent. Explanations:

• Women may simply have run out of available time.

• Even with new technology, housework and childcare do take time.

Conclusion: Because women provide more household services than men, it is understandable why their labor force participation may have reached a peak.

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LAZY DAYS FOR JOB GROWTH

• Wages are also expected to increase as the job market continues to tighten and inflation puts continued pressure on wage demands.

• While nominal wages are up, real wages appear to be relatively constant as the high cost of petroleum erodes the bulk of the higher wages.

Most analysts expect job growth to remain stable for August. Employers are forecast to add jobs slowly but also increase hours worked and wages. The moderate job growth is consistent with other economic data. For example, construction payrolls are abating as the housing market cools down with the industry only adding an average of 12,000 jobs per month over the past several months. Retail trade is moving the opposite direction with this industry segment down about 85,000 jobs over the previous four months.

While wages appear to be increasing, workers do not feel wealthier. The high cost of petroleum is pushing all prices higher as transportation costs increase. Real wage (which is the nominal wage adjusted for changes in the cost of living) increases would be a better indicator of a healthier (and wealthier) economy. Note that nominal wages are pushed higher in the graph as the demand for labor increases.

Extra Application 5

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6.1

FIGURE 6.2Unemployment Rates in Developed Countries

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FRENCH UNEMPLOYMENT FALLS

• Critics maintain that the 74 year old Chirac is positioning himself for another election.

• Trade unions and opposing politicians accused Chirac of “statistical clearing out” of unemployment rosters in order to make the figure appear lower than it actually was.

• Civil unrest related to the unemployed French youth is still extremely high and that some demographics face unemployment levels that are more than double the average.

• In contrast to France, the United Kingdom posted unemployment numbers of 5.4 percent for the same time period.

French president Chirac identified the country’s recent unemployment rate decline as proof that his policies were working. However, the 8.8 percent unemployment rate for September 2006 is still much higher than other countries in the region. Chirac went on to acknowledge that while the current level of social unrest was still unacceptable he did believe “that things are advancing” and that unemployment would further decline.

Note the connection between civil unrest and unemployment. One of the primary reasons countries are concerned with unemployment is that there is a correlation between high unemployment numbers and social unrest.

Extra Application 6

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Alternative Measures of Unemployment and Why They’re Important

6.1

• discouraged workersWorkers who left the labor force because they could not find jobs.

FIGURE 6.3Alternative Measures of Unemployment, February 2006

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NEETS ARE THE NEW DISCOURAGED WORKERS IN JAPAN

APPLYING THE CONCEPTS #2: Who are the new discouraged workers in Japan?

In Japan, there is growing concern about young people who are not joining the labor force.

What are NEETs?

Young workers who have given up looking for work and oftenreceive support from their parents are known as NEETs—“not in education, employment, or training.”

Why the concern?

• Japan has an aging population and does not encourage immigration.

• It is concerned about labor shortages.

• It potentially signals a change in the strong Japanese work ethic.

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Who Are the Unemployed?

6.1

• seasonal unemploymentThe component of unemployment attributed to seasonal factors.

FIGURE 6.4Selected U.S. Unemployment Statistics, Unemployment Rates for February 2006

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CATEGORIES OF UNEMPLOYMENT

Types of Unemployment: Cyclical, Frictional, and Structural

6.2

• cyclical unemploymentUnemployment that occurs during fluctuations in real GDP.

• frictional unemploymentUnemployment that occurs with the normal workings of the economy, such as workers taking time to search for suitable jobs and firms taking time to search for qualified employees.

• structural unemploymentUnemployment that occurs when there is a mismatch of skills and jobs.

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CATEGORIES OF UNEMPLOYMENT

The Natural Rate of Unemployment

6.2

• natural rate of unemploymentThe level of unemployment at which there is no cyclical unemployment. It consists of only frictional and structural unemployment.

• full employmentThe level of unemployment that occurs when the unemployment rate is at the natural rate.

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THE COSTS OF UNEMPLOYMENT6.3

• unemployment insurancePayments unemployed people receive from the government.

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FINDING THE OPTIMAL LEVEL OF UNEMPLOYMENT INSURANCE

APPLYING THE CONCEPTS #3: What are the costs of either too high or too low levels of unemployment insurance?

How do we balance the benefits and costs of unemployment insurance?

Suppose that the government provided all unemployed workers a payment that was equal to their previous salary as long as they remained unemployed:

• This would prevent unemployed workers from suffering any financial hardship.

• Very few workers would return to work if the government were paying them their full salaries.

• Result: excessive unemployment.

States recognize this and replace only a fraction of a worker’s prior salary—typically about 40 percent.

Economist Jonathan Gruber of MIT attempted to calculate the optimal amount of unemployment insurance.

• Result: Looking at both the costs and the benefits of unemployment insurance, Gruber found that the optimal level of insurance was probably somewhat lower (closer to 30 percent) than the current 40 percent provided by the states.

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THE CONSUMER PRICE INDEX AND THECOST OF LIVING6.4

• Consumer Price IndexA price index that measures the cost of a fixed basket of goods chosen to represent the consumption pattern of a typical consumer.

The CPI index for a given year, say year K, is defined as

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FIGURE 6.5Components of the Consumer Price Index (CPI)

THE CONSUMER PRICE INDEX AND THECOST OF LIVING6.4

The CPI Versus the Chain Index for GDP

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THE CONSUMER PRICE INDEX AND THECOST OF LIVING

Problems in Measuring Changes in Prices

6.4

• cost-of-living adjustments (COLAs)Automatic increases in wages or other payments that are tied to the CPI.

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INFLATION6.5

• inflation rateThe percentage rate of change in the price level.

inflation rate = percentage rate of change of a price index

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FIGURE 6.6Price Index for U.S. GDP, 1875–2005

6.5 INFLATION

Historical U.S. Inflation Rates

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6.5 INFLATION


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6.5 INFLATION


FIGURE 6.7U.S. Inflation Rate, 1950–2005, Based on Chain-Weighted Price Index

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USING THE CPI TO ADJUST SOCIAL SECURITY BENEFITS

APPLYING THE CONCEPTS #4: Are Social Security payments properly adjusted for changes in the cost of living?

Each year, the federal government increases Social Security paymentsto the elderly by the rate of increase of prices as measured by the Consumer Price Index.

Reason for this adjustment: to make sure that the elderly, whose other income tends to be fixed, do not suffer from cost-of-living increases.

Problem: we actually overcompensate the elderly for price changes and thus increase their benefits in real terms.

• Economists believe that the CPI overstates actual price increases by between 0.5 and 1.5 percent a year.

• If we reduced this adjustment for Social Security by 1 percent, it would save $42 billion over a five-year period!

Defenders of the elderly claim that this is a misleading argument. Why?

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6.5 INFLATION

The Perils of Deflation

• deflationNegative inflation or falling prices of goods and services.

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THE COSTS OF INFLATION6.6

• anticipated inflationInflation that is expected.

• unanticipated inflationInflation that is not expected.

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THE COSTS OF INFLATION6.6

• menu costsThe costs associated with changing prices and printing new price lists when there is inflation.

• shoe-leather costsCosts of inflation that arise from trying to reduce holdings of cash.

Anticipated Inflation

Unanticipated Inflation

• hyperinflationAn inflation rate exceeding 50 percent per month.

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anticipated inflation

Consumer Price Index (CPI)

cost-of-living adjustments (COLAs)

cyclical unemployment

deflation

discouraged workers

frictional unemployment

full employment

hyperinflation

inflation rate

labor force

labor force participation rate

menu costs

natural rate of unemployment

seasonal unemployment

shoe-leather costs

structural unemployment

unanticipated inflation

unemployment insurance

unemployment rate

Documents

Unemploymentand Inflation F ERNANDO Q UIJANO, Y VONN Q UIJANO, K YLE T HIEL & A PARNA S UBRAMANIAN PREPARED BY: © 2007 Pearson/Prentice Hall Economics: