Unemployment and Inflation EVERYONES NIGHTMARE Chapter 6 Unemployment

Unemployment and Inflation EVERYONE’S NIGHTMARE Chapter 6

Unemployment and Inflation l The two key concepts of Macroeconomics – Either can destabilize the economy. – When BOTH happen together – REALLY, REALLY BAD. l STAGFLATION

Unemployment l People who are looking for work but have no jobs. – ACTIVELY LOOKING is critical to the definition.

Definitions for Unemployment l Labor Force = Employed + unemployed l Unemployment Rate = number of unemployed / total labor force l Labor Force Participation Rate = labor force / population 16 and over

Definitions of Unemployment Discouraged Workers – People who left the labor force because they could not find jobs. l Underemployed – Workers holding parttime work, but prefer full-time work OR hold jobs that are far below their capabilities. l

The reasons for unemployment Frictional Unemployment l Structural Unemployment l Seasonal Unemployment l Cyclical Unemployment l

Cyclical Unemployment l When GDP fluctuates demand in the economy is not sufficient to provide jobs for all those who seek work. – Recession – Depression

Frictional Unemployment People in between jobs. l Short period of time while changing jobs. l 3% - 4% frictional employment is considered normal. l

Structural Unemployment When changes in market supply or demand conditions affect major industries or regions. l The part of unemployment that results from the mismatch of skills and jobs. l

Causes of Structural Unemployment l l l Decline in demand for a product Increased foreign competition Automation of production Increased raw material costs Lack of labor mobility between occupations or regions.

Seasonal Unemployment Not included in your book – but in most other Econ texts l Most seasonal unemployment is tends to occur in certain industries. – – Hotel and catering Tourism Fruit picking Christmas

Suspicious Unemployment Statistics l Natural Rate of Unemployment – Level of unemployment at which there is no cyclical unemployment. l Full Employment – Level of employment that occurs when the unemployment rate is at the “natural rate. ”

QOD: l Why do we need unemployment to make the economy healthy?

The Natural Rate of Unemployment l Depending on whom you talk to … l 4% to 5% is considered the natural rate. – Consists of only structural and frictional unemployment.

Historic Unemployment Rates 1933 during the Great Depression – 25% l 1998 – Unemployment fell to 3. 9% l October 2009 – 10. 2% - highest in 26 years! l

3. 9% Unemployment l Why wouldn’t this be good for the economy? ? ?

Wage Inflation l How do employers attract or keep employees if there is not enough workers? – Higher Wages – More Benefits – 1999, Amigos was paying $9 per hour and Mc. Donalds offered $500 signing bonuses.

Why would that be bad? Costs go up (labor), so prices have to be upped to cover labor. l Higher prices make workers demand more money. l l Cost – Push Inflation

BTW: Current Data on Unemployment for the US l According to the Bureau of Labor Statistics (www. bls. gov) – Unemployment Rate in October – 10. 2% Average Hourly Earnings are up $. 01 in September.

Unemployment Data Previously: 303, 000 new jobless claims were filed in March 2009. l October 2009 claims dropped 3000 to 523700. l

How does the US compare? 07 -September 09

BRIC Country Unemployment Brazil – 9. 7% (est. ) l Russia – 6. 4% (est. ) l India – 6. 8% (DOWN) l China – 4. 0% (UNRELIABLE!) l

BTW: l Top 3 of unemployment: – Nauru – Liberia – Zimbabwe

Stuff I know Christa wants to know l Countries with the lowest unemployment – Andorra – Monaco – Qatar

Review l How do economists measure the unemployed? l Previously unemployed individuals who have stopped looking for work are called ____ workers. l What are the types of unemployment? l The natural rate of unemployment consists solely of _______ and ____ unemployment.

The Consumer Price Index and the Cost of Living The INFLATION Indicators

What do you think? 1976: Starting salary for an economics professor was $15, 000 l 2001: Starting salary for an econ prof was $55, 000. l Considering the REALITY PRICIPLE, who had a better life? l

Reality Principle l What matters to people is the real value of money – its PURCHASING POWER – not the nominal or face value of money.

CPI: Consumer Price Index l A price index that measures the cost of a fixed basket of goods chosen to represent the consumption pattern of individuals. l – Tracks the cost of living over time.

What is in the “market basket”? l l l l Food and Beverages Housing Apparel Transportation Medical Care Recreation Education Other goods and services

Food and Beverages l l l l Breakfast Cereal Milk Chicken Wine Coffee Service meals Snacks

Housing Rent for primary residences l Owners equivalent rent l Fuel Oil (home heating) l Bedroom furniture l

Apparel Men’s shirts and sweaters l Women’s dresses l Jewelry l

Transportation New cars l Airline fares l Gasoline l Car insurance l

Medical Care l l l Prescription drugs Medical supplies Doctor services Eyeglass services Hospital care

Recreation l l l Television Pets Pet products Sports equipment Admissions

Education and Communication l l l College Tuition Postage Telephone Services Computer Software Computer accessories

Other Goods and Services Tobacco and smoking products l Haircuts l Other personal services l Funeral Expenses l

BTW CPI - U for 2009: l UP. 1% so far for the year. l CPI – U for 2009 w/o fuel costs and food. – UP. 2% l How does that compare with our wages? l Statistics from bls. gov l

CPI l Used by both government and the private sector to measure changes in prices facing consumers. l SEE PAGE 122 to calculate CPI

CPI versus Chained GDP CPI measures goods produced in prior years (older cars) as well as imported goods. l Chained GDP does not measure either of these. ONLY new goods and those produced in the country. l

CPI v. Chained GDP l Because consumers will cut back on goods that cost more – the CPI will tend to overstate true changes in cost of living. – If chicken goes up in price, we switch to hamburger.

CPI Problems Does not “cut back” on higher priced goods like consumers do. l Would still count the same share of chicken as it did before the price index. l

What Economists THINK l CPI may be overestimated by. 5% to 1. 5% each year. l BIG argument among the econ community.

Cost of Living Adjustments Automatic increases in wages or other payments that are tied to a price index. For Future Reference on contract negotiations: Called COLA.

COLA and CPI l As CPI goes up, our wages or Social Security makes adjustments to keep up with the cost of living. – SEE PAGE 124 THE CPI AND SOCIAL SECURITY

INFLATION!!! l Inflation Rate: – The percentage rate of change of the price level of the economy.

Calculating Inflation Rates l Inflation Rate = percentage rate of change of a price index. l See page 124 for more on how to calculate!

Looking Ahead l Two “Schools” of Macroeconomics – Classical Economics – Keynsian Economics

Classical Economics l A school of economic thought that provides insights into the economy when it operates at or near full employment. – Popular thought so far in 2006. – Picture of David Ricardo (Travis’ favorite economist) l Darwin meets Economics

Keynsian Economics l A school of economic thought that provides insights into the economy when it operates away from full employment. – Economic fluctuations, business cycles, sharp changes in the economy.

THIS Concludes what the book has on unemployment and inflation I THINK you need and deserve more info on inflation!

So what is so wrong if everyone who wants a job has a job?

THE ANSWER? ? l. INFLATION – The trade-off with more employment.

What is the CPI pattern in 2009? l CPI measures the dollar’s worth. – Check out the website http: //minneapolisfed. org /Research/data/us/calc/ index. cfm TRY THE professor’s salary from the beginning with this site!

Types of Inflation l l l Demand-Pull Inflation Cost-Push Inflation Monetary Inflation Stagflation Hyperinflation

Demand-Pull Inflation l When the demand for goods and services exceeds the production capacity. – Prices rising because of shortages.

Cost-Push Inflation l Inflation can arise from changes in the costs of production of goods and services. – Increase in the price of raw materials – Increase in the price of labor – Increase in the cost of capital.

Cost-Push v. Demand Pull l They push and pull prices up. – Labor contracts containing COLA clauses. l Cost-Of-Living Adjustments.

Monetary Inflation l Inflation caused by excessive growth in the money supply. – Value of money decreases if it isn’t that “rare. ”

Rule for Monetary Inflation: VELOCITY l Quantity Equation – Mx. V=Tx. P – Money supply times the velocity at which it changes hands equals the number of transactions times the average level of prices.

Mx. V=Tx. P l Direct relationship between the money supply and the price level.

What happens when the quantity equation is “off”? Hyperinflation l Money supply increases much, much faster than an economy’s output of goods and services. l – THINK RUSSIA in 1990 s. – Zimbabwe in 2000 s – Germany post WWI

Phillips Curve: The relationship between unemployment and inflation. INVERSE relationship. Unemployment goes UP, then inflation goes DOWN.

Stagflation: When things REALLY go wrong on the Phillips Curve l Inflation and unemployment were at higher levels. – Combination of stagnation and inflation. – Both were increasing.

1970 s: What caused Stagflation? Spending on the Vietnam War PLUS spending on domestic social programs. l Inflationary expectations l Rise in energy costs caused by OPEC l Monopolistic pricing l

What is wrong with Inflation? Inflation reduces REAL INCOME of those whose incomes do not rise as fast as the price level. l Hurts: l – People holding assets in MONEY – Lenders

Special Note: Phillips Curve International – Europe 1970 s had higher inflation and unemployment. – Worse because: l l l Labor union practices Tax structures Government economic policies

Consequences of Unemployment l Real Output Effects – Each 1% of unemployment results in a reduction of $100 -billion in output. – Lower real investment means less growth and reduced future output. – OKUN’S LAW!

Consequences of Unemployment n Income Effects u Loss of income and benefits (Health insurance) u Loss of income to others because of reduced purchasing power u Reduced tax income and increased outlays of government.

Consequences of Unemployment l Social Effects – Health Problems – Increased suicides – Break up of families – Increased child abuse – Increased crime

Consequences of INFLATION l Income Effects: – Reduced purchasing power of the dollar – Reduced real income for fixed income receivers – Reduced real wealth of savings

Income Effects of Inflation (cont. ) Benefits those whose incomes rise faster than the inflation rate. l Benefits owners of real assets (real estate, precious metals (kinda!)) l Benefits debtors l

How Inflation effects Real Output Inflation initially stimulates output l Near full employment, there arise bottlenecks in supplies l Costs begin rising faster than prices l Interest rates accelerate, discouraging new investment. l