Chapter 8

 Relate fluctuations in GDP to employment and the demand for labor.  Classify unemployment into three categories.  Distinguish the difference between full employment and the natural rate of unemployment and correlate both to potential GDP.  Determine inflation’s effect on the economy.

 The maximum sustainable level of output  About 3% annual growth  Actual GDP can be greater or less than potential GDP

 The “normal” rate of unemployment, the amount due to job shopping and imperfect information  The sustainable employment level  About 95%  Actual employment level can be higher or lower than full employment

 “Operating at potential GDP” has the same meaning as “operating at full employment” ◦ The economy is neither in a boom or a bust ◦ There is no cyclical unemployment present ◦ However, some unemployment (about 5%) will always be present in a dynamic economy ◦ This is the natural rate of unemployment

Time Real GDP Business peak Recessionary trough Contraction Expansion Business peak Recessionary trough Trend line

Although real GDP in the United States has grown at an average rate of approximately 3%, the growth has been characterized by economic ups-and- downs. Note: periods of recession are indicated with shading. Annual Rate of Growth in Real GDP (long-run growth rate approximately 3%) Source: Economic Report of the President, various issues % -2% 0% 2% 4% 6% 8%

 During a recession ◦ Unemployment is higher than the natural rate ◦ Actual GDP is below potential GDP ◦ Demand for resources is weak  During a boom ◦ Unemployment is below the natural rate ◦ Actual GDP is above potential GDP ◦ Demand for resources is strong

 Employed (in the labor force)  Unemployed (in the labor force)  Not in the Labor Force  A person cannot be in more than one of these categories at a time

 Labor Force – The number of people 16+ who are employed or unemployed ◦ Employed – got a job ◦ Unemployed – ◦ (1) actively seeking employment or ◦ (2) waiting to begin or return to a job

 Not in the labor force ◦ Neither employed nor unemployed ◦ NO JOB AND NOT LOOKING FOR WORK  Possible examples: full time student, homemaker, retiree

 Labor force participation rate – fraction of adult population that is in the labor force Labor Force Participation Rate of Men and Women Source: % 70 % 33 % 38 % 46 % 57.5 % ––––––– Men ––––––– –––––– Women –––––– % 76 % 57.7 % 87 %

 Unemployment rate – percentage of the labor force that is unemployed Source: Both –– Men aged –– All men All women –– Women aged –– % 26.2% 22.1% 14.0% 6.3% 7.7% 7.3% 12.3% 5.9% Civilian Rates of Unemployment (April 2013)

Job leavers 7.4% 10.9% 26.9% 10% 44.8% New entrants Reentrants On Layoff Dismissed from Previous Job Breakdown of Unemployed 2013 (April)

Civilian pop. (age 16 and over) Employed Unemployed14.5 a) Calculate the unemployment rate (9.3%) b) Calculate the labor force participation rate (65.9%) c) Calculate the employment / population ratio (59.7%)

 Frictional  Structural  Cyclical

 Frictional Unemployment – caused by constant changes in the labor market. ◦ Imperfect information ◦ Search activities ◦ Workers have the skills to fill job openings

 Structural Unemployment – caused by changes in basic characteristics of the economy ◦ Some jobs become obsolete ◦ New jobs are created ◦ Workers do not have the skills to fill openings

 Institutional and policy factors ◦ Changes in public sector spending ◦ Minimum wage laws ◦ Unemployment benefits  Options of structurally unemployed: Career change, prolonged unemployment, exit labor market

 Cyclical Unemployment – due to recessions and inadequate labor demand ◦ Overall unemployment rate rises during recessions ◦ Unemployment inversely related to output

 Natural rate of unemployment ◦ the “normal” unemployment rate due to frictional and structural unemployment ◦ in the U.S. about 5% ◦ Structural + frictional = natural

 Potential output – maximum sustainable level of output, given ◦ Resources ◦ Labor force quantity and quality ◦ Natural rate of unemployment (full employment)

 Inflation – decline in the purchasing power of money ◦ Rising prices ◦ Rising (nominal) wages  Low rates of inflation accompany low variation in the inflation rate  High rates of inflation tend to be quite variable

 Unanticipated Inflation – surprise to most ◦ When inflation is high and variable, impossible to predict accurately ◦ Unpredictable inflation can lead to recession  Anticipated Inflation – expected by most ◦ When inflation is low and stable, many can predict it accurately ◦ Stable prices enhances economic growth

 Reduces investment ◦ If can’t predict the future, won’t make long term goals ◦ Change in inflation changes result of long-term projects  Distorts information and relative prices ◦ Some prices change quickly, others slowly ◦ Less efficient allocation of resources  Less productive use of resources ◦ People spend time and money to predict and respond to inflation rates ◦ Menu and shoeleather costs

 Some unemployment is inevitable and not due to recessions  High, unanticipated inflation causes ◦ Lower investment ◦ Associated with more frequent recessions  Low, stable, predictable inflation ◦ Not so horrible

 Relate fluctuations in GDP to employment and the demand for labor.  Classify unemployment into three categories.  Distinguish the difference between full employment and the natural rate of unemployment and correlate both to potential GDP.  Determine inflation’s effect on the economy.