Chapter 13 Unemployment and Inflation: Can We Find a Balance? Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

13-2 What Is Unemployment? Not in the Labor Force Labor Force Unemployed Potential Labor Force Population LFPR = # people in labor force # in potential labor force population UR = # people unemployed # people in labor force

13-3 Unemployment in a Market Economy Employment per unit of time Wage rates D DS S e0e0 ee1e1 w w1w1

13-4 Types of Unemployment Frictional Unemployment Structural Unemployment Cyclical Unemployment Full Employment Unemployment Rate

13-5 Annual Unemployment Rate

13-6 What Is Inflation? Inflation – a continuing rise in the general level of prices Dynamic, self-sustaining Suppressed inflation

How Is Inflation Measured? The inflation rate between year 0 and year 1 is calculated as follows: If CPI in year 0 = 100 and CPI in Year 1 = 108, then: Inflation Rate in Year 1 = 108 – 100 * 100 = 8% 100 Inflation rate in year 1 = CPI in Year 1 – CPI in Year 0 * 100 CPI in Year

13-8 Price Indexes Consumer Price Index (CPI) = cost-of- living index Implicit price deflator

13-9 Year 01 PCostP 40 lbs grapes $2.00$80.00$2.10$ Knitting Needles $1.00$120.00$1.10$ Cost of Market Basket $200.00$ Constructing the Consumer Price Index

How the Consumer Price Index Is Calculated Choose a Base Year Index = Cost of Market Basket year i * 100 Cost of Market Basket in base year Index(Year 0) = ($200/$200) * 100 = 100 Index(Year 1) = ($216/$200) * 100 =

Problems in Measuring the Cost of Living Typical household Substitution bias Introduction of new goods Unmeasured quality changes 13-11

13-12 The Rate of Inflation Over Time

13-13 Equity Effects People on relatively fixed incomes Creditors and Debtors InflationLoan TermsNominal ValueReal Value 0% 5%$1,050 10% 5%$1,050$950 10% inflation 15%$1,150$1,050

13-14 Efficiency Effects Impact on resource allocation Costs of adjusting to inflation

13-15 Output Effects Positive effect of mild inflation Negative effect of runaway or hyperinflation Pure inflation

13-16 Circular Flow of Economic Activity ProducersHouseholds Flow of final goods and services Flow of money payments(consumption) Demand for goods Supply of goods Flow of productive services Flow of money payments Supply of resources Demand for resources Product Market Resource Market

13-17 Aggregate Demand AD = C + I + G + (X – M) Consumer Spending  MPC  MPS  Psychological law of consumption Investment Spending Government Purchases Exports and Imports  Trade deficit  Trade surplus The Spending Multiplier Price level (p) D D p p1p Output demanded per year (q)

13-18 Short-Run Aggregate Supply Determinants of AS  Resource prices  Techniques of production Price level (p) p0p0 qq1q1 qfqf Output supplied per year (q) p2p2 p1p1 S S

13-19 Long-Run Aggregate Supply Price level (p) p0p0 q0q0 Output supplied per year (q) p1p1 S S 0 Full Employment Output

13-20 The Short-Run and Long-Run Aggregate Supply Curves Price level (p) p0p0 q0q0 Output supplied per year (q) p1p1 S1S1 S1S1 0 q1q1 S0S0 S0S0

13-21 Aggregate Demand and Aggregate Supply Price level (p) p0p0 q0q0 Output supplied per year (q) p2p2 S1S1 S1S1 0 q1q1 S0S0 q2q2 S0S0 D0D0 D0D0 D1D1 D1D1 D2D2 D2D2 p1p1 p3p3

13-22 Reasons for Deficient Aggregate Demand Consumption Investment Government Purchases Exports and Imports

13-23 Circular Flow of Economic Activity ProducersHouseholds Flow of final goods Consumer spending Flow of productive services Flow of money payments Investment Government Spending Exports Savings Taxes Imports Leakages Injections

13-24 Weakness in Aggregate Supply Price level (p) p0p0 q0q0 Output supplied per year (q) p1p1 0 q1q1 S0S0 S0S0 D0D0 D0D0 S1S1 S1S1

Possible Trade-offs and Policy Options The Phillips Curve  Expansionary policies  Contractionary policies Policy Problems Unemployment rate Inflation Rate ac b