Unemployment and Inflation EVERYONE’S NIGHTMARE Chapter 6

Unemployment and Inflation The two key concepts of Macroeconomics – Either can destabilize the economy. – When BOTH happen together – REALLY, REALLY BAD. STAGFLATION

Unemployment People who are looking for work but have no jobs. – ACTIVELY LOOKING is critical to the definition.

Definitions for Unemployment Labor Force = Employed + unemployed Unemployment Rate = number of unemployed / total labor force Labor Force Participation Rate = labor force / population 16 and over

Definitions of Unemployment Discouraged Workers – People who left the labor force because they could not find jobs. Underemployed – Workers holding part- time work, but prefer full-time work OR hold jobs that are far below their capabilities.

The reasons for unemployment Frictional Unemployment Structural Unemployment Seasonal Unemployment Cyclical Unemployment

When GDP fluctuates demand in the economy is not sufficient to provide jobs for all those who seek work. – Recession – Depression

Frictional Unemployment People in between jobs. Short period of time while changing jobs. 3% - 4% frictional employment is considered normal.

Structural Unemployment When changes in market supply or demand conditions affect major industries or regions. The part of unemployment that results from the mismatch of skills and jobs.

Causes of Structural Unemployment Decline in demand for a product Increased foreign competition Automation of production Increased raw material costs Lack of labor mobility between occupations or regions.

Seasonal Unemployment Not included in your book – but in most other Econ texts Most seasonal unemployment is tends to occur in certain industries. – Hotel and catering – Tourism – Fruit picking – Christmas

Suspicious Unemployment Statistics Natural Rate of Unemployment – Level of unemployment at which there is no cyclical unemployment. Full Employment – Level of employment that occurs when the unemployment rate is at the “natural rate.”

QOD: Why do we need unemployment to make the economy healthy?

The Natural Rate of Unemployment Depending on whom you talk to … 4% to 5% is considered the natural rate. – Consists of only structural and frictional unemployment.

Historic Unemployment Rates 1933 during the Great Depression – 25% 1998 – Unemployment fell to 3.9%

3.9% Unemployment Why wouldn’t this be good for the economy???

Wage Inflation How do employers attract or keep employees if there is not enough workers? – Higher Wages – More Benefits – 1999, Amigos was paying $9 per hour and McDonalds offered $500 signing bonuses.

Why would that be bad? Costs go up (labor), so prices have to be upped to cover labor. Higher prices make workers demand more money. Cost – Push Inflation

BTW: Current Data on Unemployment for the US According to the Bureau of Labor Statistics ( – Unemployment Rate in February: 4.8% Average Hourly Earnings are up $.05 in February.

Unemployment Data Previously: 303,000 new jobless claims were filed. On March 16, new numbers will be posted. – See / money and click on economic calendar for the latest posting.

Review How do economists measure the unemployed? Previously unemployed individuals who have stopped looking for work are called ____ workers. What are the types of unemployment? The natural rate of unemployment consists solely of _______ and ____ unemployment.

The Consumer Price Index and the Cost of Living The INFLATION Indicators

What do you think? 1976: Starting salary for an economics professor was $15, : Starting salary for an econ prof was $55,000. Considering the REALITY PRICIPLE, who had a better life?

Reality Principle What matters to people is the real value of money – its PURCHASING POWER – not the nominal or face value of money.

CPI: Consumer Price Index A price index that measures the cost of a fixed basket of goods chosen to represent the consumption pattern of individuals. – Tracks the cost of living over time.

What is in the “ market basket ” ? Food and Beverages Housing Apparel Transportation Medical Care Recreation Education Other goods and services

Food and Beverages Breakfast Cereal Milk Chicken Wine Coffee Service meals Snacks

Housing Rent for primary residences Owners equivalent rent Fuel Oil (home heating) Bedroom furniture

Apparel Men’s shirts and sweaters Women’s dresses Jewelry

Transportation New cars Airline fares Gasoline Car insurance

Medical Care Prescription drugs Medical supplies Doctor services Eyeglasses Eyeglass services Hospital care

Recreation Television Pets Pet products Sports equipment Admissions

Education and Communication College Tuition Postage Telephone Services Computer Software Computer accessories

Other Goods and Services Tobacco and smoking products Haircuts Other personal services Funeral Expenses

BTW CPI for 2006: UP.7% so far for the year. How does that compare with our wages? Statistics from bls.gov

CPI Used by both government and the private sector to measure changes in prices facing consumers. SEE PAGE 122 to calculate CPI

CPI versus Chained GDP CPI measures goods produced in prior years (older cars) as well as imported goods. Chained GDP does not measure either of these. ONLY new goods and those produced in the country.

CPI v. Chained GDP Because consumers will cut back on goods that cost more – the CPI will tend to overstate true changes in cost of living. – If chicken goes up in price, we switch to hamburger.

CPI Problems Does not “cut back” on higher priced goods like consumers do. Would still count the same share of chicken as it did before the price index.

What Economists THINK CPI may be overestimated by.5% to 1.5% each year. BIG argument among the econ community.

Cost of Living Adjustments Automatic increases in wages or other payments that are tied to a price index. For Future Reference on contract negotiations: Called COLA.

COLA and CPI As CPI goes up, our wages or Social Security makes adjustments to keep up with the cost of living. – SEE PAGE 124 THE CPI AND SOCIAL SECURITY

INFLATION!!! Inflation Rate: – The percentage rate of change of the price level of the economy.

Calculating Inflation Rates Inflation Rate = percentage rate of change of a price index. See page 124 for more on how to calculate!

Looking Ahead Two “Schools” of Macroeconomics – Classical Economics – Keynsian Economics

Classical Economics A school of economic thought that provides insights into the economy when it operates at or near full employment. – Popular thought so far in – Picture of David Ricardo (Travis’ favorite economist) Darwin meets Economics

Keynsian Economics A school of economic thought that provides insights into the economy when it operates away from full employment. – Economic fluctuations, business cycles, sharp changes in the economy.

THIS Concludes what the book has on unemployment and inflation I THINK you need and deserve more info on inflation!

So what is so wrong if everyone who wants a job has a job?

THE ANSWER???? INFLATION – The trade-off with more employment.

What is the CPI pattern in 2005? CPI measures the dollar’s worth. – Check out the website Research/data/us/calc/i ndex.cfm TRY THE professor’s salary from the beginning with this site!

Types of Inflation Demand-Pull Inflation Cost-Push Inflation Monetary Inflation Stagflation Hyperinflation

Demand-Pull Inflation When the demand for goods and services exceeds the production capacity. – Prices rising because of shortages.

Cost-Push Inflation Inflation can arise from changes in the costs of production of goods and services. – Increase in the price of raw materials – Increase in the price of labor – Increase in the cost of capital.

Cost-Push v. Demand Pull They push and pull prices up. – Labor contracts containing COLA clauses. C ost- O f- L iving A djustments.

Monetary Inflation Inflation caused by excessive growth in the money supply. – Value of money decreases if it isn’t that “rare.”

Rule for Monetary Inflation: VELOCITY Quantity Equation – M x V = T x P – Money supply times the velocity at which it changes hands equals the number of transactions times the average level of prices.

M x V = T x P Direct relationship between the money supply and the price level.

What happens when the quantity equation is “ off ” ? Hyperinflation Money supply increases much, much faster than an economy’s output of goods and services. – THINK RUSSIA in 1990s.

Phillips Curve: The relationship between unemployment and inflation. INVERSE relationship. Unemployment goes UP, then inflation goes DOWN.

Stagflation: When things REALLY go wrong on the Phillips Curve Inflation and unemployment were at higher levels. – Combination of stagnation and inflation. – Both were increasing.

1970s: What caused Stagflation? Spending on the Vietnam War PLUS spending on domestic social programs. Inflationary expectations Rise in energy costs caused by OPEC Monopolistic pricing

What is wrong with Inflation? Inflation reduces REAL INCOME of those whose incomes do not rise as fast as the price level. Hurts: – People holding assets in MONEY – Lenders

Special Note: Phillips Curve International – Europe 1970s had higher inflation and unemployment. – Worse because: Labor union practices Tax structures Government economic policies

Consequences of Unemployment Real Output Effects – Each 1% of unemployment results in a reduction of $100-billion in output. – Lower real investment means less growth and reduced future output.

Consequences of Unemployment Income Effects Income Effects  Loss of income and benefits (Health insurance)  Loss of income to others because of reduced purchasing power  Reduced tax income and increased outlays of government.

Consequences of Unemployment Social Effects – Health Problems – Increased suicides – Break up of families – Increased child abuse – Increased crime

Consequences of INFLATION Income Effects: – Reduced purchasing power of the dollar – Reduced real income for fixed income receivers – Reduced real wealth of savings

Income Effects of Inflation (cont.) Benefits those whose incomes rise faster than the inflation rate. Benefits owners of real assets (real estate, precious metals (kinda!)) Benefits debtors

How Inflation effects Real Output Inflation initially stimulates output Near full employment, there arise bottlenecks in supplies Costs begin rising faster than prices Interest rates accelerate, discouraging new investment.