1. Unemploymentand Inflation F ERNANDO Q UIJANO, Y VONN Q UIJANO, K YLE T HIEL & A PARNA S UBRAMANIAN PREPARED BY: © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez

2. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 2 of 27 1 What do the recent data show about trends in the percentage of women who are working? After Growing Sharply, Women’s Labor Force Participation Has Leveled Off 2 Who are the new discouraged workers in Japan? NEETs Are the New Discouraged Workers in Japan 3 What are the costs of either too high or too low levels of unemployment insurance? Finding the Optimal Level of Unemployment Insurance 4 Are Social Security payments properly adjusted for changes in the cost of living? Using the CPI to Adjust Social Security Benefits

3. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 3 of 27 EXAMINING UNEMPLOYMENT How Is Unemployment Defined and Measured? 6.1 labor force The total number of workers, both the employed and the unemployed. unemployment rate The percentage of the labor force that is unemployed.

4. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 4 of 27 EXAMINING UNEMPLOYMENT How Is Unemployment Defined and Measured? 6.1 labor force participation rate The percentage of the population over 16 years of age that is in the labor force.  FIGURE 6.1 Unemployment Data, February 2006

5. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 5 of 27 AFTER GROWING SHARPLY, WOMEN’S LABOR FORCE PARTICIPATION HAS LEVELED OFF APPLYING THE CONCEPTS #1: What do the recent data show about trends in the percentage of women who are working? In 1948, the labor force participation rate for women 20 years and older was 32 percent. By 1970, it had grown to 43 percent, and by 1997 it had reached 60 percent. Since 1997, the figure has remained virtually constant at 60 percent. Explanations: Women may simply have run out of available time. Even with new technology, housework and childcare do take time. Conclusion: Because women provide more household services than men, it is understandable why their labor force participation may have reached a peak.

6. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 6 of 27 LAZY DAYS FOR JOB GROWTH Wages are also expected to increase as the job market continues to tighten and inflation puts continued pressure on wage demands. While nominal wages are up, real wages appear to be relatively constant as the high cost of petroleum erodes the bulk of the higher wages. Most analysts expect job growth to remain stable for August. Employers are forecast to add jobs slowly but also increase hours worked and wages. The moderate job growth is consistent with other economic data. For example, construction payrolls are abating as the housing market cools down with the industry only adding an average of 12,000 jobs per month over the past several months. Retail trade is moving the opposite direction with this industry segment down about 85,000 jobs over the previous four months. While wages appear to be increasing, workers do not feel wealthier. The high cost of petroleum is pushing all prices higher as transportation costs increase. Real wage (which is the nominal wage adjusted for changes in the cost of living) increases would be a better indicator of a healthier (and wealthier) economy. Note that nominal wages are pushed higher in the graph as the demand for labor increases. Extra Application 5

7. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 7 of 27 EXAMINING UNEMPLOYMENT How Is Unemployment Defined and Measured? 6.1  FIGURE 6.2 Unemployment Rates in Developed Countries

8. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 8 of 27 FRENCH UNEMPLOYMENT FALLS Critics maintain that the 74 year old Chirac is positioning himself for another election. Trade unions and opposing politicians accused Chirac of “statistical clearing out” of unemployment rosters in order to make the figure appear lower than it actually was. Civil unrest related to the unemployed French youth is still extremely high and that some demographics face unemployment levels that are more than double the average. In contrast to France, the United Kingdom posted unemployment numbers of 5.4 percent for the same time period. French president Chirac identified the country’s recent unemployment rate decline as proof that his policies were working. However, the 8.8 percent unemployment rate for September 2006 is still much higher than other countries in the region. Chirac went on to acknowledge that while the current level of social unrest was still unacceptable he did believe “that things are advancing” and that unemployment would further decline. Note the connection between civil unrest and unemployment. One of the primary reasons countries are concerned with unemployment is that there is a correlation between high unemployment numbers and social unrest. Extra Application 6

9. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 9 of 27 EXAMINING UNEMPLOYMENT Alternative Measures of Unemployment and Why They’re Important 6.1 discouraged workers Workers who left the labor force because they could not find jobs.  FIGURE 6.3 Alternative Measures of Unemployment, February 2006

10. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 10 of 27 NEETS ARE THE NEW DISCOURAGED WORKERS IN JAPAN APPLYING THE CONCEPTS #2: Who are the new discouraged workers in Japan? In Japan, there is growing concern about young people who are not joining the labor force. What are NEETs? Young workers who have given up looking for work and often receive support from their parents are known as NEETs— “not in education, employment, or training.” Why the concern? Japan has an aging population and does not encourage immigration. It is concerned about labor shortages. It potentially signals a change in the strong Japanese work ethic.

11. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 11 of 27 EXAMINING UNEMPLOYMENT Who Are the Unemployed? 6.1 seasonal unemployment The component of unemployment attributed to seasonal factors.  FIGURE 6.4 Selected U.S. Unemployment Statistics, Unemployment Rates for February 2006

12. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 12 of 27 CATEGORIES OF UNEMPLOYMENT Types of Unemployment: Cyclical, Frictional, and Structural 6.2 cyclical unemployment Unemployment that occurs during fluctuations in real GDP. frictional unemployment Unemployment that occurs with the normal workings of the economy, such as workers taking time to search for suitable jobs and firms taking time to search for qualified employees. structural unemployment Unemployment that occurs when there is a mismatch of skills and jobs.

13. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 13 of 27 CATEGORIES OF UNEMPLOYMENT The Natural Rate of Unemployment 6.2 natural rate of unemployment The level of unemployment at which there is no cyclical unemployment. It consists of only frictional and structural unemployment. full employment The level of unemployment that occurs when the unemployment rate is at the natural rate.

14. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 14 of 27 THE COSTS OF UNEMPLOYMENT 6.3 unemployment insurance Payments unemployed people receive from the government.

15. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 15 of 27 FINDING THE OPTIMAL LEVEL OF UNEMPLOYMENT INSURANCE APPLYING THE CONCEPTS #3: What are the costs of either too high or too low levels of unemployment insurance? How do we balance the benefits and costs of unemployment insurance? Suppose that the government provided all unemployed workers a payment that was equal to their previous salary as long as they remained unemployed: This would prevent unemployed workers from suffering any financial hardship. Very few workers would return to work if the government were paying them their full salaries. Result: excessive unemployment. States recognize this and replace only a fraction of a worker’s prior salary—typically about 40 percent. Economist Jonathan Gruber of MIT attempted to calculate the optimal amount of unemployment insurance. Result: Looking at both the costs and the benefits of unemployment insurance, Gruber found that the optimal level of insurance was probably somewhat lower (closer to 30 percent) than the current 40 percent provided by the states.

16. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 16 of 27 THE CONSUMER PRICE INDEX AND THE COST OF LIVING 6.4 Consumer Price Index A price index that measures the cost of a fixed basket of goods chosen to represent the consumption pattern of a typical consumer. The CPI index for a given year, say year K, is defined as

17. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 17 of 27  FIGURE 6.5 Components of the Consumer Price Index (CPI) THE CONSUMER PRICE INDEX AND THE COST OF LIVING 6.4 The CPI Versus the Chain Index for GDP

18. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 18 of 27 THE CONSUMER PRICE INDEX AND THE COST OF LIVING Problems in Measuring Changes in Prices 6.4 cost-of-living adjustments (COLAs) Automatic increases in wages or other payments that are tied to the CPI.

19. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 19 of 27 INFLATION 6.5 inflation rate The percentage rate of change in the price level. inflation rate = percentage rate of change of a price index

20. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 20 of 27  FIGURE 6.6 Price Index for U.S. GDP, 1875–2005 6.5 INFLATION Historical U.S. Inflation Rates

21. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 21 of 27 6.5 INFLATION Historical U.S. Inflation Rates

22. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 22 of 27 6.5 INFLATION Historical U.S. Inflation Rates  FIGURE 6.7 U.S. Inflation Rate, 1950–2005, Based on Chain-Weighted Price Index

23. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 23 of 27 USING THE CPI TO ADJUST SOCIAL SECURITY BENEFITS APPLYING THE CONCEPTS #4: Are Social Security payments properly adjusted for changes in the cost of living? Each year, the federal government increases Social Security payments to the elderly by the rate of increase of prices as measured by the Consumer Price Index. Reason for this adjustment: to make sure that the elderly, whose other income tends to be fixed, do not suffer from cost-of-living increases. Problem: we actually overcompensate the elderly for price changes and thus increase their benefits in real terms. Economists believe that the CPI overstates actual price increases by between 0.5 and 1.5 percent a year. If we reduced this adjustment for Social Security by 1 percent, it would save $42 billion over a five-year period! Defenders of the elderly claim that this is a misleading argument. Why?

24. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 24 of 27 6.5 INFLATION The Perils of Deflation deflation Negative inflation or falling prices of goods and services.

25. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 25 of 27 THE COSTS OF INFLATION 6.6 anticipated inflation Inflation that is expected. unanticipated inflation Inflation that is not expected.

26. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 26 of 27 THE COSTS OF INFLATION 6.6 menu costs The costs associated with changing prices and printing new price lists when there is inflation. shoe-leather costs Costs of inflation that arise from trying to reduce holdings of cash. Anticipated Inflation Unanticipated Inflation hyperinflation An inflation rate exceeding 50 percent per month.

27. chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 27 of 27 anticipated inflation Consumer Price Index (CPI) cost-of-living adjustments (COLAs) cyclical unemployment deflation discouraged workers frictional unemployment full employment hyperinflation inflation rate labor force labor force participation rate menu costs natural rate of unemployment seasonal unemployment shoe-leather costs structural unemployment unanticipated inflation unemployment insurance unemployment rate