LECTURE 6

22
MONITORING JOBS
AND INFLATION
AFTER STUDYING THIS CHAPTER, YOU WILL BE ABLE TO:

Explain why unemployment is a problem and how we

measure the unemployment rate and other labor market
indicators

Explain why unemployment occurs and why it is present even

at full employment

Explain why inflation is a problem and how we measure the

inflation rate
EMPLOYMENT AND UNEMPLOYMENT
• What kind of job market will you enter when you graduate?
• The class of 2017 had a better time in the job market when 7 million
Americans (down from 10 million in 2015) who wanted a job but couldn’t
find one.
• Also in 2015, 8 million people had given up looking for a full-time job and
taken a part-time job.
• The U.S. economy creates lots of jobs: during the recession of 2009, 139
million people had jobs—22 million more than in 1989.
• In recent years, the population has grown faster than the number of jobs, so
unemployment is a serious problem.
EMPLOYMENT AND UNEMPLOYMENT

• Why Unemployment Is a Problem

–Unemployment results in
Lost incomes and production
Lost human capital
–The loss of income is devastating for those who bear it. Employment benefits create a safety net but don’t
fully replace lost wages, and not everyone receives benefits.
–Prolonged unemployment permanently damages a person’s job prospects by destroying human capital.
EMPLOYMENT AND UNEMPLOYMENT

• Current Population Survey

– The U.S. Census Bureau conducts a monthly population survey to determine the status of the U.S.
labor force.
– The population is divided into two groups:
– 1. The working-age population—the number of people aged 16 years and older who are not in jail,
hospital, or some other institution
– 2. People too young to work (under 16 years of age) or in institutional care
EMPLOYMENT AND UNEMPLOYMENT

– The working-age population is divided into two groups:

– 1. People in the labor force
– 2. People not in the labor force
– The labor force is the sum of employed and unemployed workers.
EMPLOYMENT AND UNEMPLOYMENT

– To be counted as unemployed, a person must be in one of the following three categories:

– 1. Without work but has made specific efforts to find a job within the previous four weeks
– 2. Waiting to be called back to a job from which he or she has been laid off
– 3. Waiting to start a new job within 30 days
 EMPLOYMENT AND
UNEMPLOYMENT
–Figure 22.1 shows the labor force
categories.

In June 2017:
–Population: 325 million
–Working-age population: 255 million
–Labor force: 160 million
–Employed: 153 million
–Unemployed: 7 million
EMPLOYMENT AND UNEMPLOYMENT

• Three Labor Market Indicators

The unemployment rate
The employment-to-population ratio
The labor force participation rate
EMPLOYMENT AND UNEMPLOYMENT

• The Unemployment Rate

–The unemployment rate is the percentage of the labor force that is unemployed.
–The unemployment rate is
(Number of people unemployed ÷ labor force)  100.
–In June 2017, the labor force was 160 million and
7 million were unemployed, so the unemployment rate was 4.4 percent.
–The unemployment rate increases in a recession and reaches its peak value after the recession ends.
 EMPLOYMENT AND
UNEMPLOYMENT
–Figure 22.2 shows the unemployment rate: 1980–2017.
–The unemployment rate increases in a recession.
 EMPLOYMENT AND
UNEMPLOYMENT

• The Employment-to-Population Ratio

–The employment-to-population ratio is the percentage of the working-age population who have jobs.
–The employment-to-population ratio is
(Employment ÷ Working-age population)  100.
–In June 2017, the employment was 153 million and the working-age population was 255 million.
–The employment-to-population ratio was 60 percent.
 EMPLOYMENT AND
UNEMPLOYMENT
• The Labor Force Participation Rate
–The labor force participation rate is the percentage of the working-age population
who are members of the labor force.
–The labor force participation rate is
(Labor force ÷ Working-age population)  100.
–In June 2017, the labor force was 160 million and the working-age population was
255 million.
–The labor force participation rate was 62.7 percent.
 EMPLOYMENT AND
UNEMPLOYMENT
• Figure 22.3 shows that the labor force participation rate and the employment-
to-population ratio both trended upward before 2000 and downward after
2000.
 EMPLOYMENT AND
UNEMPLOYMENT

–Other Definitions of Unemployment

–The purpose of the unemployment rate is to measure the underutilization of labor resources.
–The BLS believes that the unemployment rate gives a correct measure.
–But the official measure is an imperfect measure because it excludes
Marginally attached workers
Part-time workers who want full-time jobs
EMPLOYMENT AND UNEMPLOYMENT

–Marginally Attached Workers

–A marginally attached worker is a person who currently is neither working nor looking for work but has
indicated that he or she wants and is available for a job and has looked for work sometime in the recent
past.
–A discouraged worker is a marginally attached worker who has stopped looking for a job because of
repeated failure to find one.
EMPLOYMENT AND UNEMPLOYMENT

– Part-Time Workers Who Want Full-Time Jobs

– Many part-time workers want to work part time, but some part-time workers would like full-time
jobs and can’t find them.
– In the official statistics, these workers are called economic part-time workers and they are partly
unemployed.
– Most Costly Unemployment
– All unemployment is costly, but the most costly is long-term unemployment that results from job
loss.
EMPLOYMENT AND UNEMPLOYMENT

–Alternative Measures of Unemployment

• The BLS reports six alternative measures of the unemployment rate: two narrower than the
official measure and three broader ones.
• The narrower measures, U-1 and U-2, focus on the personal cost of unemployment.
• The broader measures, U-4, U-5, and U-6, focus on assessing the full amount of unused labor
resources.
 EMPLOYMENT AND
UNEMPLOYMENT
– Figure 22.4 shows six
alternative measures.
– U-1: Those unemployed
for 15 weeks or longer
– U-2: Unemployed job
losers
– U-3: The official
unemployment rate
EMPLOYMENT AND UNEMPLOYMENT
– Broader measures are
– U-4: U-3 + Discouraged
workers
– U-5: U-4 + Other
marginally attached
workers
– U-6: U-4 + Part-time
workers who want full-time
jobs
– All measures increase
together in recession.
 UNEMPLOYMENT AND FULL
EMPLOYMENT

–Unemployment can be classified into three types:

Frictional unemployment
Structural unemployment
Cyclical unemployment
 UNEMPLOYMENT AND FULL
EMPLOYMENT

–Frictional Unemployment
–Frictional unemployment is unemployment that arises from normal labor market turnover.
–The creation and destruction of jobs requires that unemployed workers search for new jobs.
–Increases in the number of people entering and reentering the labor force and increases in unemployment
benefits raise frictional unemployment.
–Frictional unemployment is a permanent and healthy phenomenon of a growing economy.
 UNEMPLOYMENT AND FULL
EMPLOYMENT

–Structural Unemployment
–Structural unemployment is unemployment created by changes in technology and foreign competition
that change the skills needed to perform jobs or the locations of jobs.
–Structural unemployment lasts longer than frictional unemployment.
 UNEMPLOYMENT AND FULL
EMPLOYMENT

–Cyclical Unemployment
–Cyclical unemployment is the higher than normal unemployment at a business cycle trough and lower
than normal unemployment at a business cycle peak.
–A worker who is laid off because the economy is in a recession and is then rehired when the expansion
begins experiences cyclical unemployment.
 UNEMPLOYMENT AND FULL
EMPLOYMENT

• “Natural” Unemployment
• Natural unemployment is the unemployment that arises from frictions and structural change
when there is no cyclical unemployment.
• Natural unemployment is all frictional and structural unemployment.
–The natural unemployment rate is natural unemployment as a percentage of the labor force.
 UNEMPLOYMENT AND FULL
EMPLOYMENT

–Full employment is defined as the situation in which the unemployment rate equals the natural
unemployment rate.
–When the economy is at full employment, there is no cyclical unemployment or, equivalently, all
unemployment is frictional and structural.
 UNEMPLOYMENT AND FULL
EMPLOYMENT

–The natural unemployment rate changes over time and is influenced by many factors.
• Key factors are
The age distribution of the population
The scale of structural change
The real wage rate
Unemployment benefits
 UNEMPLOYMENT AND FULL
EMPLOYMENT

• Real GDP and Unemployment Over the Cycle

–Potential GDP is the quantity of real GDP produced at full employment.
–Potential GDP corresponds to the capacity of the economy to produce output on a sustained basis.
–Real GDP minus potential GDP is the output gap.
–Over the business cycle, the output gap fluctuates and the unemployment rate fluctuates around the natural
unemployment rate.
 UNEMPLOYMENT AND FULL
EMPLOYMENT
–Figure 22.5 shows the output gap and …
–the fluctuations of unemployment around the
natural rate.
–When the output gap is negative, ...
–the unemployment rate exceeds the natural
unemployment rate.
PRICE LEVEL, INFLATION, AND
DEFLATION
– The price level is the average level of prices and the value of money.
– A persistently rising price level is called inflation.
– A persistently falling price level is called deflation.
– We are interested in the price level because we want to
– 1. Measure the inflation rate or the deflation rate
– 2. Distinguish between money values and real values of economic
variables.
PRICE LEVEL, INFLATION, AND
DEFLATION
–Why Inflation and Deflation Are Problems
–Low, steady, and anticipated inflation or deflation is not a problem.
–Unpredictable inflation or deflation is a problem because it
Redistributes income
Redistributes wealth
Lowers real GDP and employment
Diverts resources from production
PRICE LEVEL, INFLATION, AND
DEFLATION
–Unpredictable changes in the inflation rate redistribute income in arbitrary ways between employers and
workers and between borrowers and lenders.
–A high inflation rate is a problem because it diverts resources from productive activities to inflation
forecasting.
–From a social perspective, this waste of resources is a cost of inflation.
–At its worst, inflation becomes hyperinflation—an inflation rate that is so rapid that workers are paid
twice a day because money loses its value so quickly.
PRICE LEVEL, INFLATION, AND
DEFLATION
–The Consumer Price Index
–The Consumer Price Index, or CPI, measures the average of the prices paid by urban consumers for a
“fixed” basket of consumer goods and services.
– Capmas.gov.eg
PRICE LEVEL, INFLATION, AND
DEFLATION
• Reading the CPI Numbers
–The CPI is defined to equal 100 for the reference base period.
–Currently, the reference base period is 19821984.
–That is, for the average of the 36 months from January 1982 through December 1984,
the CPI equals 100.
–In June 2017, the CPI was 245.
–This number tells us that the average of the prices paid by urban consumers for a
fixed basket of goods was 145 percent higher in June 2017 than it was during
19821984.
PRICE LEVEL, INFLATION, AND
DEFLATION
• Constructing the CPI
–Constructing the CPI involves three stages:
Selecting the CPI basket
Conducting a monthly price survey
Calculating the CPI
PRICE LEVEL, INFLATION, AND
DEFLATION
–The CPI Basket
–The CPI basket is based on a Consumer Expenditure Survey, which is undertaken infrequently.
–The CPI basket today is based on data collected in the Consumer Expenditure Survey of 2016.
 PRICE LEVEL, INFLATION, AND
DEFLATION
–Figure 22.6 illustrates the CPI basket.
–Housing is the largest component.
–Transportation and food and beverages
are the next largest components.
–All other components account for 27.4
percent of the basket.
PRICE LEVEL, INFLATION, AND
DEFLATION
–The Monthly Price Survey
–Every month, BLS employees check the prices of the 80,000 goods in the CPI basket in 30 metropolitan
areas.
–Calculating the CPI
–1. Find the cost of the CPI basket at base-period prices.
–2. Find the cost of the CPI basket at current-period prices.
–3. Calculate the CPI for the current period.
 PRICE LEVEL, INFLATION, AND
DEFLATION
–Let’s work an example of the CPI
calculation.
–In a simple economy, people consume
only oranges and haircuts.
–The CPI basket is
10 oranges and 5 haircuts.
–The table also shows the prices in the
base period.
–The cost of the CPI basket in the base
period was $50.
 PRICE LEVEL, INFLATION, AND DEFLATION

–Table 22.1(b) shows the fixed CPI basket of

goods.
–It also shows the prices in the current period.
–The cost of the CPI basket at current-period prices
is $70.
PRICE LEVEL, INFLATION, AND
DEFLATION
–The CPI is calculated using the formula:
–CPI = (Cost of basket at current-period prices ÷ Cost of basket at base-period prices) x 100.
–Using the numbers for the simple example,
– CPI = ($70 ÷ $50) x 100 = 140.
–The CPI is 40 percent higher in the current period than it was in the base period.
PRICE LEVEL, INFLATION, AND
DEFLATION
• Measuring the Inflation Rate
–The major purpose of the CPI is to measure inflation.
–The inflation rate is the percentage change in the price level from one year to the next.
–The inflation formula is:
–Inflation rate = [(CPI this year – CPI last year) ÷ CPI last year]  100.
 PRICE LEVEL, INFLATION, AND
DEFLATION
– Figure 22.7 shows the relationship
between the price level and the
inflation rate.
– The inflation rate is
 High when the price level is rising
rapidly.
 Low when the price level is rising slowly.
 Negative when the price level is falling.
PRICE LEVEL, INFLATION, AND
DEFLATION
• The Biased CPI
–The CPI might overstate the true inflation rate for four reasons:
New goods bias
Quality change bias
Commodity substitution bias
Outlet substitution bias
PRICE LEVEL, INFLATION, AND
DEFLATION
–New Goods Bias
–New goods that were not available in the base year appear and, if they are more expensive than the goods
they replace, they put an upward bias into the CPI.
–Quality Change Bias
–Quality improvements occur every year. Part of the rise in the price is payment for improved quality and is
not inflation.
–The CPI counts all the price rise as inflation.
PRICE LEVEL, INFLATION, AND
DEFLATION
–Commodity Substitution Bias
–The market basket of goods used in calculating the CPI is fixed and does not take into account consumers’
substitutions away from goods whose relative prices increase.
–Outlet Substitution Bias
–As the structure of retailing changes, people switch to buying from cheaper sources, but the CPI, as
measured, does not take account of this outlet substitution.
PRICE LEVEL, INFLATION, AND
DEFLATION
• The Magnitude of the Bias
• An estimate made in 1996 says that the CPI overstates inflation by 1.1 percentage points a year.
• Some Consequences of the Bias
 Distorts private contracts.
 Increases government outlays (close to a third of federal government outlays are linked to the CPI).
– The BLS has now corrected much of the bias, but some still remains.
PRICE LEVEL, INFLATION, AND
DEFLATION
• Alternative Price Indexes
–Alternative measures of the price level are
Personal consumption expenditure deflator
GDP deflator
PRICE LEVEL, INFLATION, AND
DEFLATION
• Personal Consumption Expenditure Deflator
• The PCE deflator equals
• (Nominal consumption expenditure ÷ Real consumption expenditure) x 100
• PCE deflator is a broader measure of the price level than the CPI because it
includes all consumption expenditure.
• GDP Deflator
• GDP deflator is like the PCE deflator except it includes the prices of all goods
and services that are counted in GDP.
• (NGDP/RGDP )*100
 PRICE LEVEL, INFLATION, AND
DEFLATION
• Core and Sticky-Price Inflation
• The core inflation rate attempts to reveal the underlying inflation trend.
• The core inflation rate is calculated as the percentage change in the PCE
index excluding the prices of food and fuel, the two most volatile prices.
• But if the relative prices of the excluded items are changing, the percentage
change in the core PCE index will give a biased measure of the inflation rate.
• A new method of revealing the inflation trend is to calculate the sticky-price
inflation rate, which is the rate at which infrequently adjusted prices are
changing.
 PRICE LEVEL, INFLATION, AND
DEFLATION
• Figure 22.8 graphs the core,
sticky-price, and CPI inflation
rates.
• The core inflation rate is below
the CPI inflation.
• The sticky-price inflation rate
fluctuated less than the CPI
inflation rate, but they have a
similar average.
PRICE LEVEL, INFLATION, AND
DEFLATION
• The Real Variables in Macroeconomics
–We can use the GDP deflator to deflate nominal variables
to find their real values.
–For example,
–Real wage rate = (Nominal wage rate ÷ GDP deflator) x 100
–But not the real interest rate! It is different.