1. In This Lecture….. Phases of the Business Cycle
Calculating Official Unemployment Rate
Problems with Measuring the Unemployment Rate
Four Types of Unemployment
Full Employment (Natural Rate of Unemployment)
Potential Real GDP
Recessionary Gap / Inflationary Gap

2. Business Cycle Phases Expansion: when Real GDP is rising.
Peak: when Real GDP stops rising, it has hit the peak.
Recession: when Real GDP is actually declining.
Two consecutive quarters of decline
Depression: if decline is very large
Trough: when Real GDP stops falling, it has hit the trough
Recovery: period while Real GDP is making up for the production that was lost during a recession.

3. Business Cycles
Recurrent swings (up and down) in Real GDP; alternating periods of expansions and recessions. 3

4. Determining Labor Participation & Unemployment Rate
Current Population Survey / Household Survey
Conducted every month
U.S. Bureau of the Census
Sample of 60,000 households
16 years of age and older
Labor Participation: Employed / Unemployed
BLS: calculates monthly unemployment rate

5. Understanding the Unemployment Rate and the Labor Force Participation Rate

6. Labor Force & Labor Force Participation Rate
Labor force – The labor force is the sum of those people who are officially employed and unemployed.
Labor force participation rate - The percentage of the working-age population that is in the civilian labor force:
Labor force
LFPR = x 100
Working-Age Population

7. Calculating the Official Unemployment Rate
Unemployment Rate-The percentage of the civilian force that is unemployed:
Number of unemployed persons
U = X 100
Labor force 7

8. Problems with Measuring the Unemployment Rate
Distinguishing between the unemployed and those not in labor force.
Discouraged Workers
Part-time vs. Full-time jobs
Inaccurate responses to survey
Beware of Liars
Working in the Underground Economy

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

10. Types of Unemployment
Cyclical Unemployment
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.

11. EXAMINING UNEMPLOYMENT
How Is Unemployment Defined and Measured?
FIGURE 6.2 Unemployment Rates in Developed Countries

12. Government Policies & the Unemployment Rate
Unemployment Insurance & Other Payments
Legislation against firing workers
Minimum Wage Laws
Labor Unions
Efficiency Wages
12 - 5
Average Unemployment Rates in the United States, Canada, Japan, and Europe,

13. Self Test
What is the major difference between a person who is frictionally unemployed and one who is structurally unemployed?
The frictionally unemployed person has readily transferable skills, and the structurally unemployed person does not.

14. Self Test
If the cyclical unemployment rate is positive, what does this imply?
It implies that the (actual, measured) unemployment rate in the economy is greater than the natural unemployment rate. For example, if the unemployment rate is 8 percent and the natural unemployment rate is 6 percent, the cyclical unemployment rate is 2 percent.

15. Understanding Potential Real GDP
Potential Real GDP – The amount of production we need to have in order to have full employment. Potential GDP is a goal – the amount an economy would like to produce in order to have full employment.
Real GDP: Remember………..Real GDP is the amount we actually produce
GDP Gap: The difference between the actual Real GDP and the Potential Real GDP

16. Understanding GDP Gaps
Recessionary Gap – occurs when Real GDP falls below Potential Real GDP. Therefore, in this case, the unemployment rate is above the natural rate of unemployment. That is, the economy is not exhibiting full employment.
Inflationary Gap – occurs when Real GDP falls above Potential Real GDP. Therefore, in this case, the unemployment rate is below the natural rate of unemployment. That is, the economy can provide jobs to whomever wants one and inflation is on the rise.

17. In This Lecture….. Defining Price Level and Inflation
Calculating the Consumer Price Index (CPI)
COLA
Calculating Percentage Changes in the CPI
Overstating the CPI
GDP Deflator
Nominal Interest Rate vs. Real Interest Rate
The Effects of Inflation 17

18. Defining Price Level & Inflation
Price Level - A weighted average of the prices of all good and services.
Inflation – an increase in the price level
Deflation – a decrease of the price level
Price Index – A measure of the price level 18

19. The Consumer Price Index (CPI)
Consumer price index (CPI): An average of the prices of the goods and services purchased by the typical urban family of four.
12 - 6
The CPI Market Basket, December 2004

20. The Consumer Price Index (CPI)
COLA – Cost of living adjustment…….income is adjusted automatically to reflect the increases in prices, as measured by the increase in the CPI.
Base Year - The year chosen as a point of reference or basis of comparison for prices in other years; a benchmark year. 20

21. Shortcomings of the CPI
Substitution Bias
Outlet Bias
Increase in Quality Bias
Overstated by 1%? 21

22. Computing the Consumer Price Index22

23. Changes in Prices
In 2005 the CPI was 195.3; in 2006 the index was What was the percentage change in prices from ?
Click below for answer.
3.23 % 23

24. Consumer Price Index 1983-2007 Year Annual 1983 99.6 1984 103.9 1985
107.6
1986
109.6
1987
113.6
1988
118.3
1989
124.0
1990
130.7
1991
136.2
1992
140.3
1993
144.5
1994
148.2
1995
152.4
Year
Annual
1996
156.9
1997
160.5
1998
163.0
1999
166.6
2000
172.2
2001
177.1
2002
179.9
2003
184.0
2004
188.9
2005
195.3
2006
201.6
2007
207.3
2008 24

25. Self-Test
1. What is a base year? It is a year that is used for comparison purposes with other years. 25

26. Self Test 2. Explain how the CPI is calculated.
The CPI is calculated as follows:
(1) define a market basket,
(2) determine how much it would cost to purchase the market basket in the current year and in the base year
(3) divide the dollar cost of purchasing the market basket in the current year by the dollar cost of purchasing the market basket in the base year, and
(4) multiply the quotient by 100. 26

27. The GDP Deflator
GDP Deflator: another measure of the price level . Evaluates changes in the prices of ALL products…….calculated as nominal GDP divided by Real GDP x 100.
Real GDP = Nominal GDP x 100
Real GDP 27

28. The GDP Deflator: Better Measure of Inflation?
No fixed Market Basket
Base Year is different from CPI
GDP Deflator measures changes in the prices of all goods and services, whereas the CPI measures only a basket of goods. 28

29. Self-Test
4. Assume there are three goods in the economy: Quantity 2000 Quantity 2008 Price 2000 Price 2008 A $1 $3 B 5 10 $2 $6 C $5 $15 Using this data, calculate the GDP Deflator for 2008. 29

30. Effects of Inflation: Winners & Losers
Debtors
Nominal interest rate: interest rate quoted
Real interest rate: nominal interest rate minus the rate of inflation
Homeowners
Wage earners
Government
Losers
Creditors
Savers
Wage Earners 30