Macroeconomics ECON 2301 Summer Session 1, 2008 Marilyn Spencer, Ph.D. Professor of Economics June 19, 2008

Chapter 7 Learning Objectives: After studying Chapter 7, you should be able to… 1.Explain how total production is measured. 2.Discuss whether GDP is a good measure of economic well-being. 3.Discuss the difference between real variables and nominal variables. 4.Become familiar with other measures of total production and total income.

Chapter 8: Unemployment & Inflation

Lucent Technologies Deals with Unemployment and Inflation The contract between Lucent and its union workers increased wages by less than the increase in prices expected by the firm and the workers.

After studying this chapter, you should be able to: 1.Define the unemployment rate and the labor force participation rate, and understand how they are computed. 2.Identify the FOUR types of unemployment. 3.Explain what factors determine the unemployment rate. 4.Define the price level and the inflation rate, and understand how they are computed. 5.Use price indexes to adjust for the effects of inflation. 6.Distinguish between the nominal interest rate and the real interest rate. 7.Discuss the problems caused by inflation. LEARNING OBJECTIVES

LEARNING OBJECTIVE 1 The Household Survey 4 Labor force The sum of employed and unemployed workers in the economy. 4 Unemployment rate The percentage of the labor force that is unemployed. 4 Discouraged workers People who are available for work, but who have not looked for a job during the previous four weeks because they believe no jobs are available for them. Measuring the Unemployment Rate and the Labor Force Participation Rate Go to: and click on the table for discouraged workers.

Which of the following groups is included in the labor force? a.The unemployed. b.Retirees, homemakers, and full-time students. c.People who could have a civilian job but are on active military service, in prison, or in mental hospitals. d.None of the above.

Which of the following groups is included in the labor force? a.The unemployed. b.Retirees, homemakers, and full-time students. c.People who could have a civilian job but are on active military service, in prison, or in mental hospitals. d.None of the above.

Measuring the Unemployment Rate and the Labor Force Participation Rate: The Household Survey The Employment Status of the Civilian Working-Age Population, June 2005

 The unemployment rate measures the percentage of the labor force that is unemployed:  The labor force participation rate measures the percentage of the working-age population that is in the labor force: Measuring the Unemployment Rate and the Labor Force Participation Rate: The Household Survey

What Happens If You Include the Military? LEARNING OBJECTIVE 1 People on active military service are not included in the employment, labor force, or working-age population totals compiled in the BLS household survey. Suppose people in the military were included in these statistics.

How would employment statistics be affected if we were to include people in the military? a.The unemployment rate would decrease. b.The working-age population would remain the same. c.The labor force participation rate would remain the same. d.All of the above.

How would employment statistics be affected if we were to include people in the military? a.The unemployment rate would decrease. b.The working-age population would remain the same. c.The labor force participation rate would remain the same. d.All of the above.

Measuring the Unemployment Rate and the Labor Force Participation Rate: Problems with Measuring the Unemployment Rate Trends in Labor Force Participation Trends in the Labor Force Participation Rates of Adult Men and Women Since 1948

Unemployment Data from the Bureau of Labor Statistics Go to: and click on the table(s) of interest.

Measuring the Unemployment Rate and the Labor Force Participation Rate: Unemployment Rates for Demographic Groups Unemployment Rates in the United States by Demographic Group, June 2005

Unemployment Data from the Bureau of Labor Statistics Go to: and click on the tables for different demographic groups.

In June 2005, which of the following demographic groups had a higher rate of unemployment than the unemployment rate for the total population? a.White adults. b.Black adults. c.Hispanic adults. d.None of the above. The unemployment rates for these groups were all lower than the overall unemployment rate.

In June 2005, which of the following demographic groups had a higher rate of unemployment than the unemployment rate for the total population? a.White adults. b.Black adults. c.Hispanic adults. d.None of the above. The unemployment rates for these groups were all lower than the overall unemployment rate.

Measuring the Unemployment Rate and the Labor Force Participation Rate: How Long Are People Usually Unemployed? LENGTH OF TIME UNEMPLOYED PERCENTAGE OF TOTAL UNEMPLOYED Less than 5 weeks36.2% 5 to 14 weeks to 26 weeks weeks or more17.8 Duration of Unemployment 8 – 1 Go to: and click on the tables for “Average Weeks Unemployed”.

Measuring the Unemployment Rate and the Labor Force Participation Rate: The Establishment Survey: Another Measure of Employment HOUSEHOLD SURVEY ESTABLISHMENT SURVEY MAYJUNE CHANGE MAYJUNE CHANGE Employed 141,475141, ,391133, Unemployed 7,6477,486–161 Labor Force 149,122149,123+1 Unemployment Rate 5.1%5.0% Household and Establishment Survey Data for May and June – 2 (In thousands)

Measuring the Unemployment Rate and the Labor Force Participation Rate: Job Creation and Job Destruction Over Time Establishments Creating and Eliminating Jobs, September-December – 3 NUMBER OF ESTABLISH- MENTS NUMBER OF JOBS ESTABLISHMENTS CREATING JOBS Existing establishments1,5306,365 New establishments3791,716 ESTABLISHMENTS ELIMINATING JOBS Continuing establishments1,4675,727 Closing establishments3201,485 (In thousands)

Types of Unemployment LEARNING OBJECTIVE The Annual Unemployment Rate in the United States,

From 1950 until 2004, the behavior of the annual unemployment rate in the United States demonstrated that: a.The unemployment rate rises during both recessions and expansions. b.The unemployment rate falls during both recessions and expansions. c.The unemployment rate falls during recessions and rises during expansions. d.The unemployment rate rises during recessions and falls during expansions.

From 1950 until 2004, the behavior of the annual unemployment rate in the United States demonstrated that: a.The unemployment rate rises during both recessions and expansions. b.The unemployment rate falls during both recessions and expansions. c.The unemployment rate falls during recessions and rises during expansions. d.The unemployment rate rises during recessions and falls during expansions.

Types of Unemployment: Frictional Unemployment and Job Search 1. Frictional unemployment Short-term unemployment arising from the process of matching workers with jobs. 2. Structural unemployment Unemployment arising from a persistent mismatch between the skills and characteristics of workers and the requirements of jobs.

Types of Unemployment, cont. 3. Seasonal unemployment Unemployment caused by seasonal changes in demand. 4. Cyclical unemployment Unemployment caused by a business cycle recession. Full Employment Natural rate of unemployment The normal rate of unemployment, consisting of structural unemployment plus frictional unemployment.

When the economy is at full employment, which types of unemployment remain? a.Cyclical and structural. b.Frictional, seasonal and structural. c.Frictional and cyclical. d.None of the above. Full employment means that there is no unemployment, so the unemployment rate would be zero.

When the economy is at full employment, which types of unemployment remain? a.Cyclical and structural. b.Frictional, seasonal and structural. c.Frictional and cyclical. d.None of the above. Full employment means that there is no unemployment, so the unemployment rate would be zero.

How Should We Categorize the Unemployment at Lucent Technologies? How can we categorize the unemployment at Lucent?

Explaining Unemployment: LEARNING OBJECTIVE 3 Government Policies and the Unemployment Rate 4 INTERNATIONAL COMPARISONS Average Unemployment Rates in the United States, Canada, Japan, and Europe,

Explaining Unemployment: Government Policies and the Unemployment Rate 4 UNEMPLOYMENT INSURANCE AND OTHER PAYMENTS TO THE UNEMPLOYED 4 MINIMUM WAGE LAWS Labor Unions Efficiency Wages 4 Efficiency wage A higher-than-market wage paid by a firm to increase worker productivity.

Why Did Henry Ford Pay His Workers Twice As Much As Other Car Manufacturers? Henry Ford claimed that paying a wage twice as high as his competitors was the finest cost-cutting move he ever made.

Measuring Inflation LEARNING OBJECTIVE 4 4 Price level A measure of the average prices of goods and services in the economy. 4 Inflation rate The percentage increase in the price level from one year to the next.

Measuring Inflation: The Consumer Price Index 4 Consumer price index (CPI) An average of the prices of the goods and services purchased by the typical urban family of four The CPI Market Basket, December 2004 Go to ftp://ftp.bls.gov/pub /special.requests/cpi /cpiai.txt for historical data. ftp://ftp.bls.gov/pub /special.requests/cpi /cpiai.txt

Measuring Inflation BASE YEAR (1999) PRODUCTQUANTITYPRICEEXPENDITURESPRICEEXPENDITURESPRICEEXPENDITURES Eye examina- tions1$50 $100 $85 Pizzas Books Total FORMULAAPPLIED TO 2006APPLIED TO 2007 CPI = Don’t Miscalculate the Inflation Rate

Measuring Inflation: Is the CPI Accurate?  Substitution bias.  Increase in quality bias.  New product bias.  Outlet bias.

Measuring Inflation: The Producer Price Index 4 Producer price index (PPI) An average of the prices received by producers of goods and services at all stages of the production process.

Which market basket below specifically targets intermediate goods? a.The basket used by the Consumer Price Index. b.The basket used by the GDP deflator. c.The basket used by the Producer Price Index. d.All of the above.

Which market basket below specifically targets intermediate goods? a.The basket used by the Consumer Price Index. b.The basket used by the GDP deflator. c.The basket used by the Producer Price Index. d.All of the above.

Measuring Inflation: GDP Price Index/Deflator 4 GDP price index (GDPPI), or GDP deflator An average of the prices received by producers on all types of goods and services – for C, I G and NX - at the final stage of the production process.

Using Price Indexes to Adjust for the Effects of Inflation LEARNING OBJECTIVE 5 Value in 2004 dollars = Value in 1980 dollars Falling Real Wages at Lucent

Calculating Real Average Hourly Earnings YEARNOMINAL AVERAGE HOURLY EARNINGS CPI ( = 100) 2002$ LEARNING OBJECTIVE 4 YEAR NOMINAL AVERAGE HOURLY EARNINGS CPI ( = 100) REAL AVERAGE HOURLY EARNINGS ( DOLLARS) 2002$ $

Real versus Nominal Interest Rates LEARNING OBJECTIVE 6 4 Nominal interest rate The stated interest rate on a loan. 4 Real interest rate The nominal interest rate minus the inflation rate. 4 Deflation A decline in the price level.

If the inflation rate turns out to be higher than expected, then: a.Borrowers pay lenders a higher real interest rate than they expected. b.Borrowers pay lenders a lower real interest rate than they expected. c.Borrowers pay only a nominal interest rate but not a real interest rate. d.Borrowers pay only a real interest rate but not a nominal interest rate.

If the inflation rate turns out to be higher than expected, then: a.Borrowers pay lenders a higher real interest rate than they expected. b.Borrowers pay lenders a lower real interest rate than they expected. c.Borrowers pay only a nominal interest rate but not a real interest rate. d.Borrowers pay only a real interest rate but not a nominal interest rate.

Real versus Nominal Interest Rates Nominal and Real Interest Rates,

Does Inflation Impose Costs on the Economy? LEARNING OBJECTIVE 7 Inflation Affects the Distribution of Income The Problem with Anticipated Inflation 4 Menu costs The costs to firms of changing prices. The Problem with Unanticipated Inflation

Which of the following is a better measure of the average of the prices of all goods and services included in GDP? a.The Consumer Price Index. b.The Producer Price Index. c.The GDP deflator. d.The inflation rate.

Which of the following is a better measure of the average of the prices of all goods and services included in GDP? a.The Consumer Price Index. b.The Producer Price Index. c.The GDP deflator. d.The inflation rate.

4 Consumer price index (CPI) 4 Cyclical unemployment 4 Deflation 4 Discouraged workers 4 Efficiency wage 4 Frictional unemployment 4 Inflation rate 4 Labor force 4 Labor force participation rate 4 Natural rate of unemployment 4 Nominal interest rate 4 Price level 4 Producer price index (PPI) 4 Real interest rate 4 Seasonal unemployment 4 Structural unemployment 4 Unemployment rate

Assignments to be completed for Ch. 9: 4 Read Chapter 9 & also read Review Questions 1-11 on p. 435, and Problems and Applications 3, 4, 6, 7, 11, 12, 13 & 15 on pp