© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/eO’Sullivan/Sheffrin Prepared by: Fernando Quijano and Yvonn Quijano CHAPTERCHAPTER 21 Unemployment and Inflation

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin What Is Unemployment? During periods of poor economic performance, such as economic recessions when real GDP declines, unemployment rises sharply and becomes a cause of public concern.During periods of poor economic performance, such as economic recessions when real GDP declines, unemployment rises sharply and becomes a cause of public concern. Unemployment is reduced but does not disappear during times of good economic performance and rapid economic growth.Unemployment is reduced but does not disappear during times of good economic performance and rapid economic growth.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Definitions The unemployed are people who are actively looking for work but do not currently have jobs.The unemployed are people who are actively looking for work but do not currently have jobs. People who are employed currently have jobs.People who are employed currently have jobs. The employed plus the unemployed comprise the labor force.The employed plus the unemployed comprise the labor force.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Definitions The unemployment rate is the percentage of people in the labor force who are unemployed.The unemployment rate is the percentage of people in the labor force who are unemployed. The labor force participation rate is the fraction of the population that is over 16 years of age that is in the labor force.The labor force participation rate is the fraction of the population that is over 16 years of age that is in the labor force.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Unemployment Data, 2001 The total population 16 years and older is divided into two groups:The total population 16 years and older is divided into two groups: Those in the labor force, which constitutes employed and unemployed. Those in the labor force, which constitutes employed and unemployed. Those outside the labor force. Those outside the labor force.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Unemployment Data, 2001 The labor participation rate in 2001 was 67% and the unemployment rate was 4.4%.The labor participation rate in 2001 was 67% and the unemployment rate was 4.4%.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Unemployment Rates Around the World, 2001 Country Unemployment Rate (%) United States 4.4 Belgium10.0 Sweden3.5 France8.7 Italy9.9 Spain13.1 United Kingdom 5.0 Netherlands1.9 Japan4.8 Australia6.9

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Issues in Measuring Unemployment To determine who is employed is relatively straightforward: Count the people who are working.To determine who is employed is relatively straightforward: Count the people who are working. There is difficulty in distinguishing between who is unemployed and who is not in the labor force.There is difficulty in distinguishing between who is unemployed and who is not in the labor force. One must be actively looking for work to be considered unemployed and, therefore, a part of the labor force.One must be actively looking for work to be considered unemployed and, therefore, a part of the labor force.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Issues in Measuring Unemployment Discouraged workers are those people who left the labor force because they could not find jobs.Discouraged workers are those people who left the labor force because they could not find jobs. Discouraged workers are not included in the official count of the unemployed.Discouraged workers are not included in the official count of the unemployed.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Issues in Measuring Unemployment The underemployed are workers who hold a part-time job but prefer to work full time or hold jobs that are far below their capabilities.The underemployed are workers who hold a part-time job but prefer to work full time or hold jobs that are far below their capabilities. It is difficult for the government to distinguish between those employed and those underemployed.It is difficult for the government to distinguish between those employed and those underemployed.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Issues in Measuring Unemployment Other factors to consider in measuring unemployment include the following:Other factors to consider in measuring unemployment include the following: Different groups of people suffer more unemployment than other groups.Different groups of people suffer more unemployment than other groups. Unemployment rates vary somewhat as GDP rises and falls.Unemployment rates vary somewhat as GDP rises and falls. Most of the employment and unemployment statistics reported in the newspapers are seasonally adjusted.Most of the employment and unemployment statistics reported in the newspapers are seasonally adjusted.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Selected U.S. Unemployment Statistics Unemployment Rates for May 2001 (in percent) Total4.4 Males 20 years and older 3.9 Females 20 years and older 3.8 Both sexes, years 13.6 White3.8 African American 8.0 White, years 11.8 African American, years 25.1 Married men 2.6 Married women 2.9 Women maintaining families 6.2

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Types of Unemployment There are three basic types of unemployment.There are three basic types of unemployment. Cyclical unemployment is the component of unemployment that accompanies fluctuations in real GDP.Cyclical unemployment is the component of unemployment that accompanies fluctuations in real GDP. Frictional unemployment is the unemployment associated with the normal workings of the economy.Frictional unemployment is the unemployment associated with the normal workings of the economy. Structural unemployment that results from the mismatch of skills and jobs.Structural unemployment that results from the mismatch of skills and jobs.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Suspicious Unemployment Statistics The natural rate of unemployment is the level of unemployment at which there is no cyclical unemployment.The natural rate of unemployment is the level of unemployment at which there is no cyclical unemployment. In the United States, economists estimate that the natural rate of unemployment is between 4.0% and 5.5%.In the United States, economists estimate that the natural rate of unemployment is between 4.0% and 5.5%. The natural rate of unemployment consists of only frictional and structural unemployment.The natural rate of unemployment consists of only frictional and structural unemployment.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Suspicious Unemployment Statistics Full employment is the level of employment that occurs when the unemployment rate is at the natural rate.Full employment is the level of employment that occurs when the unemployment rate is at the natural rate. Economists consider the economy to be at full employment when there is no cyclical unemployment.Economists consider the economy to be at full employment when there is no cyclical unemployment. Some frictional unemployment is needed for the economy to operate efficiently: it is the unemployment that exists so that workers and firms find the right matches.Some frictional unemployment is needed for the economy to operate efficiently: it is the unemployment that exists so that workers and firms find the right matches.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Consumer Price Index and the Cost of Living The Consumer Price Index (CPI) measures the cost of a fixed basket of goods chosen to represent the consumption pattern of individuals.The Consumer Price Index (CPI) measures the cost of a fixed basket of goods chosen to represent the consumption pattern of individuals. The CPI is a measure of the value of money over time.The CPI is a measure of the value of money over time.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Consumer Price Index and the Cost of Living The CPI index for a given year, say year K, is defined as:The CPI index for a given year, say year K, is defined as: Reality PRINCIPLE What matters to people is the real value of money or income–its purchasing power–not the face value of money or income.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Components of the CPI

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The CPI Versus the Chain Index for GDP Both the CPI and the chain index are measures of the average prices for the economy, yet they differ in several ways:Both the CPI and the chain index are measures of the average prices for the economy, yet they differ in several ways: The CPI includes goods produced in prior years, as well as imported goods, while the chain price index does not.The CPI includes goods produced in prior years, as well as imported goods, while the chain price index does not. Unlike the chain price index for GDP, the CPI asks how much a fixed basket of goods costs in the current year compared to the base year.Unlike the chain price index for GDP, the CPI asks how much a fixed basket of goods costs in the current year compared to the base year.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Problems in Measuring Changes in Prices In reality, all indexes tend to overstate actual price changes, primarily because we have a difficult time measuring quality improvements.In reality, all indexes tend to overstate actual price changes, primarily because we have a difficult time measuring quality improvements. Economists believe that the inflation rate is overstated by between 0.5% and 1.5% each year.Economists believe that the inflation rate is overstated by between 0.5% and 1.5% each year.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Problems in Measuring Changes in Prices Government programs, such as social security, automatically increase payments based on changes in the CPI and this increase tends to be larger than it should be.Government programs, such as social security, automatically increase payments based on changes in the CPI and this increase tends to be larger than it should be. Cost-of-living adjustments are automatic increases in wages or other payments that are tied to a price index.Cost-of-living adjustments are automatic increases in wages or other payments that are tied to a price index.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Inflation The percentage rate of change of the index can be calculated using the CPI or the chain price index.The percentage rate of change of the index can be calculated using the CPI or the chain price index. The percentage rate of change of the price level in the economy is known as the inflation rate.The percentage rate of change of the price level in the economy is known as the inflation rate.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Price Index of U.S. GDP,

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin U.S. Inflation Rate, , Based on Chain Price Index

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Looking Ahead Models and tools are developed in macroeconomics to help us analyze the economy as we try to understand it.Models and tools are developed in macroeconomics to help us analyze the economy as we try to understand it. As in all areas of economics, we can understand the issues more clearly if we focus on the essential aspects of a problem and not on all the details.As in all areas of economics, we can understand the issues more clearly if we focus on the essential aspects of a problem and not on all the details.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Looking Ahead Classical economics is a school of economic thought that provides insights into the economy when it operates at or near full employment.Classical economics is a school of economic thought that provides insights into the economy when it operates at or near full employment. Classical economists believe that economic fluctuations are short-lived and that the economy has a strong tendency to return to full employment.Classical economists believe that economic fluctuations are short-lived and that the economy has a strong tendency to return to full employment.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Looking Ahead Keynesian economics is the school of economic thought that provides insights into the economy when it operates away from full employment.Keynesian economics is the school of economic thought that provides insights into the economy when it operates away from full employment. Keynesian economists believe that the economy returns to full employment only slowly, if at all, and emphasize the role of economic fluctuations.Keynesian economists believe that the economy returns to full employment only slowly, if at all, and emphasize the role of economic fluctuations.