1. Chapter 5: Monitoring Jobs and Inflation
The labor market
Measurement of unemployment, labor force participation, employment-population ratio.
Shortcomings of unemployment rate as measure of labor market performance
Statistics describing U.S. labor market
Prices
Why inflation is a problem
Measuring the price level: the consumer price index
Shortcomings of CPI

2. Unemployment Why is unemployment a problem? Measuring unemployment
Lost production and income
Lost human capital
Measuring unemployment
The Current Population Survey
Monthly survey
Approximately 60,000 households
Used to monitor employment, hours wages
Primary source of data for unemployment rates

3. Labor Force Measures: 4th quarter, 2009
U.S. population: million
Civilian Non-institutionalized Working age (16+) population: m.
In Labor Force
153.5 m.
Employed
138.1
Unemployed
15.4
Out of labor force
83.2 m.
Not in Civilian Non-Institutionalized Population
71.8 m.

4. Labor market definitions
Civilian Non-institutionalized Working Age Population
Excludes military and institutionalized
Working age is 16+
Unemployed
Without work but has made specific efforts to find a job within the previous four weeks
Waiting to be called back to a job from which he or she has been laid off
Waiting to start a new job within 30 days

5. Labor market statistics

9. Which is more cyclical – participation rate or employment ratio? Why?

10. Unemployment as a measure of labor utilization.
Imperfect measure because
Excludes some underutilized
Underemployed
e.g. part-time workers who want full-time work
Discouraged workers
People who want jobs but quit searching due to lack of job opportunities
Some unemployment is “natural”
Even when economy is operating at capacity, there are new entrants who must search for jobs
In 2008, more than 3 million new workers entered the labor force and more than 2.5 million workers retired in U.S. economy.

11. Sources of Unemployment
People become unemployed if they
Lose their jobs and search for another job.
Leave their jobs and search for another job.
Enter or reenter the labor force to search for a job.
People end a spell of unemployment if they
Are hired or recalled.
Withdraw from the labor force.

12. All are counter-cyclical, but job losers is most sensitive to business cycle.

13. Types of Unemployment Frictional Structural Cyclical
unemployment that arises from normal labor market turnover (entry, re-entry, etc.)
Affected by UI generosity, demographics
Structural
unemployment created by changes in technology and foreign competition that change the skills needed to perform jobs or the locations of jobs
Cyclical
Fluctuating unemployment over the business cycle
Temporary loss of jobs associated with a recession

14. Natural Rate of Unemployment
The unemployment rate when the economy
is at “full employment”
has only frictional and structural unemployment, no cyclical unemployment
Natural unemployment rate in 1980s was thought to be around 6%; thought to be around 5% in 1990s and 2000s.
Decline in natural rate due to changing demographics
Baby boom
Entry of women into labor market

15. Real GDP and Unemployment
Potential GDP is the quantity of real GDP produced
when the economy is at full employment
When the unemployment rate equals the natural rate
Output Gap = Real GDP – Potential GDP

17. Inflation
Price level
average of the prices that people pay for all the goods and services that they buy.
Inflation rate
percentage change in the price level between time periods.
Inflation
occurs when the price level is rising persistently.
Deflation
occurs when inflation is negative and prices are falling persistently

18. Why inflation is a problem
Redistributes income and wealth
Borrowers and lenders
Employers and workers
Taxes that are not indexed for inflation
Diverts resources from production
Inflation forecasting becomes more important
Negotiate shorter contracts more frequently
May lead to “barter” if inflation rises to sufficiently high levels (hyperinflation)

19. Measuring the price level and inflation
Consumer Price Index (CPI)
measures the average of the prices paid by urban consumers for a “fixed” basket of consumer goods and services.
defined to equal 100 for the reference or base period.
Using as the base year,
the CPI in December 2009 was 216
prices in December 2009 were 116 percent higher than in

20. Constructing the CPI Selecting the basket
Based on Consumer Expenditure Survey of
Basket contains 80,000 goods

21. Constructing the CPI The monthly price survey Calculating the CPI
Every month, BLS employees check the prices of 80,000 goods in 30 metropolitan areas
Calculating the CPI
Find the cost of the CPI basket at base-period prices.
Find the cost of the CPI basket at current-period prices.
CPI in t = Cost of bundle at current prices in t X Cost of bundle at base year prices

22. Base year = 2008
CPI in 2008 = (70/70)*100
=100
(CPI in base year always equals 100
CPI in 2009 = (70/50)*100
=140
Inflation rate between 2008 & 09
percentage change in CPI
( )/100 = 40%

23. The Price Level: =100

24. The Inflation Rate

25. Biases in CPI
The CPI might overstate the true inflation for four reasons:
New goods bias
Quality change bias
Commodity substitution bias
Outlet substitution bias

26. Consequences of bias in CPI
Increases government spending too quickly
Social Security, Disability, etc.
Approximately 1/3 of federal spending tied to CPI
Causes tax revenue to rise too slowly
Income tax code is tied to CPI
Creates downward bias in estimate of real earnings growth
Distorts private contracts tied to CPI
Union COLA’s

27. Other price indexes CPI for different types of consumers
Urban consumers
Urban workers
Different regions, states, metro areas
CPI for specific commodity groups
Core CPI
Excludes food and energy
GDP deflator (covered earlier)
Covers prices of all goods & services produced, not just what consumers purchase.

28. Adjusting for Inflation: Nominal vs. Real Variables
Real Variable in t = Nominal Variable in t X Price Index in t
Price index could be CPI or GDP deflator
e.g. If Nominal Wage in 2010 is $20 and CPI is 200, Real Wage in 2010 is
Real variable
Adjusts nominal values to reflect prices in base year.