1. © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Fernando & Yvonn Quijano Prepared by: Chapter 8 Unemployment and Inflation

2. © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 2 of 36 Alcatel-Lucent Contributes to Unemployment 8.1Define unemployment rate and labor force participation rate and understand how they are computed. 8.2Identify the three types of unemployment. 8.3Explain what factors determine the unemployment rate. 8.4Define price level and inflation rate and understand how they are computed. 8.5Use price indexes to adjust for the effects of inflation. 8.6Distinguish between the nominal interest rate and the real interest rate. 8.7Discuss the problems that inflation causes. Learning Objectives When total employment in the United States declined during 2001, Lucent contributed to the decline.

3. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 3 of 36 Labor force The sum of employed and unemployed workers in the economy. Unemployment rate The percentage of the labor force that is unemployed. Measuring the Unemployment Rate and the Labor Force Participation Rate Learning Objective 8.1 The Household Survey Discouraged workers People who are available for work but have not looked for a job during the previous four weeks because they believe no jobs are available for them.

4. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 4 of 36 Learning Objective 8.1 FIGURE 8-1 The Employment Status of the Civilian Working-Age Population, April 2007 Measuring the Unemployment Rate and the Labor Force Participation Rate The Household Survey

5. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 5 of 36 Learning Objective 8.1 The unemployment rate measures the percentage of the labor force that is unemployed. Measuring the Unemployment Rate and the Labor Force Participation Rate The Household Survey The labor force participation rate measures the percentage of the working-age population in the labor force.

6. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 6 of 36 Solved Problem 8-1 What Happens if You Include the Military? Learning Objective 8.1 In the BLS household survey, people on active military service are not included in the totals for employment, the labor force, or the working-age population. Suppose people in the military were included in these categories.

7. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 7 of 36 Learning Objective 8.1 Measuring the Unemployment Rate and the Labor Force Participation Rate Problems with Measuring the Unemployment Rate Although the BLS reports the unemployment rate measured to the tenth of a percentage point, it is not a perfect measure of the current state of joblessness in the economy. The unemployment rate provides some useful information about the employment situation in the country, but it is far from an exact measure of joblessness in the economy.

8. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 8 of 36 Learning Objective 8.1 FIGURE 8-2 Trends in the Labor Force Participation Rates of Adult Men and Women Since 1948 Measuring the Unemployment Rate and the Labor Force Participation Rate Trends in Labor Force Participation

9. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 9 of 36 Learning Objective 8.1 What Explains the Increase in “Kramers”? Making the Connection Why do more men seem to be adopting Kramer’s lifestyle?

10. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 10 of 36 Learning Objective 8.1 FIGURE 8-3 Unemployment Rates in the United States by Demographic Group, April 2007 Measuring the Unemployment Rate and the Labor Force Participation Rate Unemployment Rates for Demographic Groups

11. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 11 of 36 Learning Objective 8.1 Table 8-1 Duration of Unemployment LENGTH OF TIME UNEMPLOYEDPERCENTAGE OF TOTAL UNEMPLOYED Less than 5 weeks35.6% 5 to 14 weeks31.3 15 to 26 weeks15.7 27 weeks or more17.5 Measuring the Unemployment Rate and the Labor Force Participation Rate How Long Are People Usually Unemployed?

12. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 12 of 36 Learning Objective 8.1 Table 8-2 Household and Establishment Survey Data for March and April 2007 HOUSEHOLD SURVEYESTABLISHMENT SURVEY MARCHAPRILCHANGE MARCHAPRILCHANGE EMPLOYED 146,254,000145,786,000−468,000137,596,000137,684,000+88,000 UNEMPLOYED 6,724,0006,801,000+77,000 LABOR FORCE 152,979,000152,587,000−392,000 UNEMPLOYMENT RATE 4.4%4.5%+0.1% Measuring the Unemployment Rate and the Labor Force Participation Rate The Establishment Survey: Another Measure of Employment

13. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 13 of 36 Learning Objective 8.1 Table 8-3 Establishments Creating and Eliminating Jobs, April–June 2006 NUMBER OF ESTABLISHMENTS NUMBER OF JOBS ESTABLISHMENTS CREATING JOBS Existing establishments1,558,0006,286,000 New establishments360,0001,475,000 ESTABLISHMENTS ELIMINATING JOBS Existing establishments1,543,0005,937,000 Closing establishments341,0001,358,000 Measuring the Unemployment Rate and the Labor Force Participation Rate Job Creation and Job Destruction Over Time

14. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 14 of 36 Types of Unemployment Learning Objective 8.2 FIGURE 8-4 The Annual Unemployment Rate in the United States, 1950–2006

15. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 15 of 36 Learning Objective 8.2 Frictional Unemployment and Job Search Frictional unemployment Short-term unemployment that arises from the process of matching workers with jobs. Types of Unemployment Structural unemployment Unemployment arising from a persistent mismatch between the skills and characteristics of workers and the requirements of jobs. Cyclical unemployment Unemployment caused by a business cycle recession. Cyclical Unemployment Structural Unemployment

16. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 16 of 36 Learning Objective 8.2 Natural rate of unemployment The normal rate of unemployment, consisting of frictional unemployment plus structural unemployment. Full Employment Types of Unemployment

17. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 17 of 36 Learning Objective 8.2 How Should We Categorize the Unemployment at Alcatel-Lucent? Making the Connection The people who lost their jobs at Alcatel-Lucent fit into more than one category of unemployment.

18. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 18 of 36 Learning Objective 8.3 Unemployment Insurance and Other Payments to the Unemployed Government Policies and the Unemployment Rate Explaining Unemployment In the United States and most other industrial countries, the unemployed are eligible for unemployment insurance payments from the government. In the United States, these payments are equal to about half the average wage. Unemployment insurance helps the unemployed maintain their income and spending, which lessens the personal hardship of being unemployed and also helps reduce the severity of recessions.

19. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 19 of 36 Learning Objective 8.3 FIGURE 8-5 Average Unemployment Rates in the United States, Canada, Japan, and Europe, 1997–2006 International Comparisons Government Policies and the Unemployment Rate Explaining Unemployment

20. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 20 of 36 Learning Objective 8.3 Minimum Wage Laws Government Policies and the Unemployment Rate Explaining Unemployment In 1938, the federal government enacted a national minimum wage law. If the minimum wage is set above the market wage determined by the demand and supply of labor, the quantity of labor supplied will be greater than the quantity of labor demanded. Economists agree that the current minimum wage is above the market wage for some workers, but they disagree on the amount of unemployment that has resulted.

21. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 21 of 36 Learning Objective 8.3 Efficiency Wages Efficiency wage A higher-than- market wage that a firm pays to increase worker productivity. Labor Unions Explaining Unemployment Labor unions are organizations of workers that bargain with employers for higher wages and better working conditions for their members.

22. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 22 of 36 Learning Objective 8.3 Why Does Costco Pay Its Workers So Much More Than Wal-Mart Does? Making the Connection Costco’s relatively high wages and health benefits reduce employee turnover and raise morale and productivity.

23. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 23 of 36 Measuring Inflation Learning Objective 8.4 Price level A measure of the average prices of goods and services in the economy. Inflation rate The percentage increase in the price level from one year to the next.

24. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 24 of 36 Measuring Inflation Learning Objective 8.4 The Consumer Price Index FIGURE 8-6 The CPI Market Basket, December 2006

25. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 25 of 36 Measuring Inflation Learning Objective 8.4 Consumer price index (CPI) An average of the prices of the goods and services purchased by the typical urban family of four. The Consumer Price Index BASE YEAR (1999)20082009 PRODUCT QUANTIT YPRICEEXPENDITURESPRICE EXPENDITURES (ON BASE-YEAR QUANTITIES)PRICE EXPENDITURE S (ON BASE- YEAR QUANTITIES) Eye examinations 1$50.00 $100.00 $85.00 Pizzas2010.00200.0015.00300.0014.00280.00 Books2025.00500.0025.00500.0027.50550.00 Total$750.00$900.00$915.00

26. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 26 of 36 Measuring Inflation Learning Objective 8.4 The Consumer Price Index FORMULAAPPLIED TO 2008APPLIED TO 2009 CPI = Don’t Let This Happen to YOU! Don’t Miscalculate the Inflation Rate

27. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 27 of 36 Measuring Inflation Learning Objective 8.4 Is the CPI Accurate? Substitution bias. Increase in quality bias. Outlet bias. New product bias. It is important that the CPI be as accurate as possible, but there are four biases that make changes in the CPI overstate the true inflation rate:

28. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 28 of 36 Measuring Inflation Learning Objective 8.4 The Producer Price Index Producer price index (PPI) An average of the prices received by producers of goods and services at all stages of the production process.

29. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 29 of 36 Using Price Indexes to Adjust for the Effects of Inflation Learning Objective 8.5 Falling Real Wages at Alcatel-Lucent For some purposes, we are interested in tracking changes in an economic variable over time rather than in seeing what its value would be in today’s dollars. In that case, to correct for the effects of inflation, we can divide the nominal variable by a price index and multiply by 100 to obtain a real variable. Nominal average hourly earnings are often referred to as the nominal wage, and real average hourly earnings are often referred to as the real wage.

30. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 30 of 36 Solved Problem 8-5 Calculating Real Average Hourly Earnings Learning Objective 8.5 YEAR NOMINAL AVERAGE HOURLY EARNINGS CPI (1982-1984 = 100) 2004$15.69188.9 200516.13195.3 200616.76201.6 YEAR NOMINAL AVERAGE HOURLY EARNINGS CPI (1982-1984 = 100) REAL AVERAGE HOURLY EARNINGS (1982-1984 DOLLARS) 2004$15.69188.9$8.31 2005 16.13195.3 8.26 2006 16.76201.6 8.31

31. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 31 of 36 Real versus Nominal Interest Rates Learning Objective 8.6 Nominal interest rate The stated interest rate on a loan. Real interest rate The nominal interest rate minus the inflation rate. Real interest rate = Nominal interest rate − Inflation rate Deflation A decline in the price level.

32. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 32 of 36 Real versus Nominal Interest Rates Learning Objective 8.6 FIGURE 8-7 Nominal and Real Interest Rates, 1970–2006

33. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 33 of 36 Does Inflation Impose Costs on the Economy? Learning Objective 8.7 Inflation Affects the Distribution of Income The Problem with Anticipated Inflation Menu costs The costs to firms of changing prices. The Problem with Unanticipated Inflation The extent to which inflation redistributes income depends in part on whether the inflation is anticipated—in which case consumers, workers, and firms can see it coming and can prepare for it— or unanticipated—in which case they do not see it coming and do not prepare for it. Like many of life’s other problems, inflation is easier to manage if you see it coming. Even when inflation is perfectly anticipated, however, some individuals will experience a cost.

34. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 34 of 36 Learning Objective 8.7 Why a Lower Inflation Rate Is Like a Tax Cut for Alcatel-Lucent’s Bondholders Making the Connection PRINCIPAL REAL INTEREST RATE INFLATION RATE NOMINAL INTEREST RATE $1,0004%6%10% $1,0004%2%6% INFLATION RATE NOMINAL INTEREST PAYMENT TAX PAYMENT AFTER-TAX INTEREST PAYMENT ADJUSTMENT FOR INFLATION REAL AFTER-TAX INTEREST PAYMENT 6%$100– $25= $75– $60= $15 2%$60– $15= $45– $20= $25

35. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 35 of 36 An Inside LOOK Making Sense of Employment Data Jobs Data Signal Growth Is Easing but Still Solid

36. Chapter 8: Unemployment and Inflation © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 36 of 36 Consumer price index (CPI) Cyclical unemployment Deflation Discouraged workers Efficiency wage Frictional unemployment Inflation rate Labor force Labor force participation rate Menu costs Natural rate of unemployment Nominal interest rate Price level Producer price index (PPI) Real interest rate Structural unemployment Unemployment rate K e y T e r m s