1. The Macroeconomy: Unemployment, Inflation, and Deflation
Chapter 7
The Macroeconomy: Unemployment, Inflation, and Deflation

2. Introduction
How does the U.S. government measure the overall level of prices?
Why doesn’t the U.S. government use Wal-Mart prices in calculating inflation?
This chapter will help you answer these questions.
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3. Learning Objectives
Explain how the U.S. government calculates the official unemployment rate
Discuss the types of unemployment
Describe how price indexes are calculated and define the key types of price indexes
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4. Learning Objectives (cont'd)
Distinguish between nominal and real interest rates
Evaluate who looses and who gains from inflation
Understand key features of business fluctuations
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5. Chapter Outline Unemployment The Major Types of Unemployment
Full Employment and the Natural Rate of Unemployment
Inflation and Deflation
Anticipated versus Unanticipated Inflation
Changing Inflation and Unemployment: Business Fluctuations
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6. Did You Know That...
Trying to understand and better forecast labor employment and the overall performance of the national economy is a central objective of macroeconomics?
This branch of economics seeks to explain and predict movements in unemployment, the average level of prices, and the total production of goods and services?
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7. Unemployment Unemployment
Total number of adults (aged 16 years or older) willing and able to work and who are actively looking for work and have not found a job
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8. Unemployment (cont'd) Labor Force
Individuals aged 16 years or older who either have jobs or who are looking and available for jobs; the number of employed plus the number of unemployed
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9. Unemployment (cont'd) Question What are the costs of unemployment?
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10. Unemployment (cont'd) Answers Lost output
During early 2000s, unemployment rate rose by 2 percentage points
Factory output was 80% of potential
Lost output was $200 billion of goods and services that could have been produced
Personal psychological impact
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11. Figure 7-1 More Than a Century of Unemployment
Source: U.S. Department of Labor, Bureau of Labor Statistics
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12. Figure 7-2 Adult Population
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13. Unemployment (cont'd)
The unemployment rate is the percentage of the measured labor force that is unemployed.
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14. Unemployment (cont'd) Labor force = The employed + The unemployed
152.7* =
Unemployed
Labor force
Unemployment rate =
x 100 =
x 100 = 4.8%
7.3
152.7
*U.S., millions of people; as of 2007
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15. Unemployment (cont'd) Stock Flow
The quantity of something, measured at a given point in time—for example, an inventory of goods
Flow
A quantity measured over time, such as the income you make per year, or the number of individuals fired every month
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16. Unemployment (cont'd) Categories of individuals without work Job loser
Reentrant
Job leaver
New entrant
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17. Unemployment (cont'd) Job Loser
An individual whose employment was involuntarily terminated or who was laid off
40–60% of the unemployed
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18. Unemployment (cont'd) Reentrant
An individual who has worked a full-time job before but left the labor force and has now reentered it looking for a job
20–30% of the unemployed
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19. Unemployment (cont'd) Job Leaver An individual who voluntarily quit
10 to 15% of the unemployed
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20. Unemployment (cont'd) New Entrant
An individual who has never worked a full- time job for two weeks or longer
10 to 15% of the unemployed
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21. Unemployment (cont'd) Duration of unemployment
More than a third of job seekers find work within one month.
Approximately another third find employment within a second month.
About a sixth are still unemployed after six months.
Average duration is just over 15 weeks throughout the last 15 years.
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22. Figure 7-3 The Logic of the Unemployment Rate
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23. Unemployment (cont'd) Question
What is likely to happen to the duration of unemployment during a downturn in the economy?
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24. Unemployment (cont'd) Discouraged Workers Question
Individuals who have stopped looking for a job because they are convinced they will not find a suitable one
Question
How does the existence of discouraged workers bias the unemployment rate?
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25. Unemployment (cont'd) Labor Force Participation Rate
The proportion of noninstitutionalized working-age individuals who are employed or seeking employment
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26. The Major Types of Unemployment
Frictional
Structural
Cyclical
Seasonal
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27. The Major Types of Unemployment (cont'd)
Frictional Unemployment
Results from the fact that workers must search for appropriate job offers
This takes time, so they remain temporarily unemployed
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28. The Major Types of Unemployment (cont'd)
Structural Unemployment
Results from a poor match of workers’ abilities and skills with current requirements of employers
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29. The Major Types of Unemployment (cont'd)
Cyclical Unemployment
Results from business recessions that occur when aggregate (total) demand is insufficient to create full employment
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30. The Major Types of Unemployment (cont'd)
Seasonal Unemployment
Results from the seasonal pattern of work in specific industries
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31. International Example: Challenges of Measuring the Unemployment Rate in China
Measurement of China’s labor force and unemployment rate fails to encompass all of the roughly 115 million people who migrate from rural areas.
In addition, China’s government has not yet developed a way to determine how many millions of people laid off from state- owned firms have obtained positions with private firms.
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32. Full Employment and the Natural Rate of Unemployment
Question
Does full employment mean that everybody has a job?
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33. Full Employment and the Natural Rate of Unemployment (cont'd)
An arbitrary level of unemployment that corresponds to “normal” friction in the labor market
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34. Full Employment and the Natural Rate of Unemployment (cont'd)
The unemployment rate that is estimated to prevail in the long-run macroeconomic equilibrium
Should not reflect cyclical unemployment
When seasonally adjusted, the natural rate should include only frictional and structural unemployment.
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35. Inflation and Deflation
A sustained increase in the average of all prices of goods and services in an economy
Deflation
A sustained decrease in the average of all prices of goods and services in an economy
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36. Inflation and Deflation (cont'd)
Purchasing Power
The value of money for buying goods and services
Varies with prices and income
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37. Inflation and Deflation (cont'd)
Nominal value
Price expressed in today’s dollars
Real value
Value expressed in purchasing power, adjusted for inflation
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38. Inflation and Deflation (cont'd)
Measuring the rate of inflation
Price Index
The cost of today’s market basket of goods expressed as a percentage of the cost of the same market basket during a base year
Price index =
 100
Cost today of market basket
Cost of market basket in base year
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39. Inflation and Deflation (cont'd)
Market Basket
Representative bundle of goods and services
Base Year
The point of reference for comparison of prices in other years
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40. Table 7-1 Calculating a Price Index for a Two-Good Market Basket
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41. Inflation and Deflation (cont'd)
Real-world price indexes
Consumer Price Index (CPI)
Producer Price Index (PPI)
GDP deflator
Personal Consumption Expenditure (PCE)
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42. Inflation and Deflation (cont'd)
Consumer Price Index (CPI)
A statistical measure of a weighted average of prices of a specified set of goods and services purchased by wage earners in urban areas
Market basket of goods and services of typical consumer
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43. Inflation and Deflation (cont'd)
Producer Price Index (PPI)
A statistical measure of a weighted average of prices of goods and services that firms produce and sell
Used as a short-run leading indicator (before CPI)
PPIs for
Foodstuffs
Intermediate goods
Finished goods
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44. Inflation and Deflation (cont'd)
GDP Deflator
A price index measuring the changes in prices of all new goods and services produced in the economy
Broadest measure of prices; reflects both price changes and the public’s market responses to those price changes
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45. Inflation and Deflation (cont'd)
Personal Consumption Expenditure (PCE) Index
A statistical measure of average price using annually updated weights based on consumer spending
Primary inflation index used by the Federal Reserve
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46. Figure 7-4 Inflation and Deflation in U.S. History
Source: U.S. Department of Labor, Bureau of Labor Statistics
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47. Anticipated versus Unanticipated Inflation
To determine who is hurt by inflation we distinguish between the two types.
The effects of inflation on individuals depend upon which type of inflation exists.
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48. Anticipated versus Unanticipated Inflation (cont'd)
The inflation rate that we believe will occur
Unanticipated Inflation
Inflation at a rate that comes as a surprise
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49. Anticipated versus Unanticipated Inflation (cont'd)
Inflation and interest rates
Nominal Rate of Interest
The market rate of interest expressed in today’s dollars
Real Rate of Interest
The nominal rate of interest minus the anticipated rate of inflation
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50. Anticipated versus Unanticipated Inflation (cont'd)
Real interest rate
Nominal interest rate = 10%
Expected inflation rate = 6%
Real rate = 10% – 6% = 4%
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51. Anticipated versus Unanticipated Inflation (cont'd)
Does inflation necessarily hurt everyone?
Inflation affects people differently
Unanticipated inflation
Creditors lose
Debtors gain
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52. Anticipated versus Unanticipated Inflation (cont'd)
Protecting against inflation
Cost-Of-Living Adjustments (COLAs)
Clauses in contracts that allow for increases in specified nominal values to take account of changes in the cost of living
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53. Anticipated versus Unanticipated Inflation (cont'd)
The resource cost of inflation
Repricing or Menu Cost of Inflation
The cost associated with recalculating prices and printing new price lists when there is inflation
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54. Inequality based on consumption of fuel, education, and health care
Policy Example: How Pervasive Is “Inflation Inequality” in the United States?
Inequality based on consumption of fuel, education, and health care
Households facing higher inflation do so for a short period of time.
To the extent inflation inequality exits, it is neither pervasive nor persistent.
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55. Changing Inflation and Unemployment: Business Fluctuations
The ups and downs in business activity throughout the economy
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56. Changing Inflation and Unemployment: Business Fluctuations (cont'd)
Expansion
A business fluctuation in which the pace of national economic activity is speeding up
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57. Changing Inflation and Unemployment: Business Fluctuations (cont'd)
Contraction
A business fluctuation during which the pace of national economic activity is slowing down
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58. Changing Inflation and Unemployment: Business Fluctuations (cont'd)
Recession
A period of time during which the rate of growth of business activity is consistently less than its long-term trend or is negative
Depression
An extremely severe recession
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59. Figure 7-5 The Idealized Course of Business Fluctuations
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60. Figure 7-6 National Business Activity, 1880 to the Present
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61. Changing Inflation and Unemployment: Business Fluctuations (cont'd)
Leading Indicators
Events that have been found to occur before changes in business activity
Economic downturns often follow
Reduction in the average workweek
Rise in unemployment insurance claims
Decrease in prices of raw materials
Drop in the quantity of money circulating
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62. Issues and Applications: Wal-Mart, Product Quality, and the CPI
Wal-Mart offers lower prices on most food items.
The Bureau of Labor Statistics (BLS) uses prices charged at a nearby Kroger.
As far as the BLS is concerned, lower Wal- Mart prices must reflect lower quality.
BLS quality adjustments may result in an upward bias in the rate of CPI inflation.
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63. Summary Discussion of Learning Objectives
How the U.S. government calculates the official unemployment rate
Percentage of the total number of adults willing and able to work who are actively looking for work but have not found a job
The major types of unemployment
Frictional
Structural
Cyclical
Seasonal
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64. Summary Discussion of Learning Objectives (cont'd)
Full employment
Arbitrary level of unemployment
Corresponds to “normal” friction in labor market
Natural rate of unemployment
Estimated to prevail in the long-run macroeconomic equilibrium
All workers and employers adjust to any changes in economy
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65. Summary Discussion of Learning Objectives (cont'd)
How price indexes are calculated and key price indexes
Multiply 100 times the ratio of the cost of a market basket of goods in the current year to the cost of the same basket in a base year
Key price indexes
CPI
PPI
GDP deflator
PCE
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66. Summary Discussion of Learning Objectives (cont'd)
Nominal versus real interest rates
Nominal rate is the market rate expressed in current dollars.
Real rate is net of inflation.
Hence the real interest rate equals the nominal interest rate minus the expected inflation rate.
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67. Summary Discussion of Learning Objectives (cont'd)
Losers and gainers from inflation
Creditors lose as a result of unanticipated inflation.
Borrowers gain.
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68. Summary Discussion of Learning Objectives (cont'd)
Key features of business fluctuations
Increases and decreases in business activity
Expansion from previous trough to new peak
Contraction from previous peak to new trough
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69. The Macroeconomy: Unemployment, Inflation, and Deflation
End of Chapter 7
The Macroeconomy: Unemployment, Inflation, and Deflation