Chapter 22

Unemployment and Inflation

© 2009 South-Western/ Cengage Learning

Unemployment

• Unemployment– Personal cost

– Cost on the economy

• Measuring unemployment– Civilian non-institutional adult population

– Labor force• Employed + Unemployed

– Unemployment rate• Percentage of unemployed in the labor force

2

Unemployment

• Adult population– Employed

• Working full time or part time

– Not working• Unemployed (looking for work)• Not in labor force

– Retired; Students; Don’t want to work– Discouraged workers

3

Exhibit 1The adult population sums: employed, unemployed, and those not in labor force, June 2007 (in millions)

4

LABOR FORCE

(153.1)

Employed

(146.2)

NOT WORKING

(85.5)

Not in labor force

(78.6)

Unemployed

(6.9)

Labor force= employed + unemployed

Not working = not in the labor force + unemployed

Adult population = employed + unemployed + not in the labor force

Unemployment

• Labor force participation rate– Number in labor force / Adult population

• Unemployment over time– Rise during contractions

– Fall during expansions

– Overall downward trend (1980s to 2000)• Growing economy• Fewer teenagers in workforce

5

Exhibit 2The US unemployment rate since 1900

6

Unemployment

• Unemployment in various groups– Age

• Higher unemployment among teenagers

– Race

– Gender

– Geography

– Occupation

7

Exhibit 3 (a)Unemployment rates for 20 years of age and older

8

Exhibit 3 (b)Unemployment rates for 16 to 19 years of age

9

High school dropouts, labor market dropouts

• High unemployment rates – Poorly educated young black males

• 2000, 65% of high-school dropouts– Not working

» Unemployed» Not looking for jobs» In prison

• 2004, 72% of high-school dropouts– Not working

10

High school dropouts, labor market dropouts

• Possible causes– Failing schools

– Absent parents

– Racial discrimination

– Fewer blue collar jobs

– Growing competition

– Stricter child-support enforcement

– Rising incarceration rate

– Subculture: downplay the value of work 11

Unemployment

• Varies by occupation– Blue-collar workers

• Higher unemployment

• Varies across regions– Certain occupations

• Dominate certain regions

12

Exhibit 4Unemployment rates differ: US metropolitan areas

13

Sources of Unemployment

• Frictional unemployment– Bring together employers and job

seekers

– Doesn’t last long

– Better match workers and jobs

• Seasonal unemployment– Seasonal changes

14

Sources of Unemployment

• Structural unemployment– Mismatch of skills or geographic location

– Problem

• Cyclical unemployment– Increases during recessions

– Decreases during expansions

15

Full Employment

• Full employment– No cyclical unemployment

– Some unemployment• Frictional• Structural• Seasonal

– Estimates: 4-6%

16

Unemployment Compensation

• Unemployment benefits– Half of the unemployed

– Criteria• Lost job• Looking for work

– Time limit: 6 months

– 40% of wages

– May reduce the incentive to find work

17

International Comparisons

• Unemployment trends– US: down

– Japan: up• Low unemployment : Job security• Bankruptcy

– Western Europe: remained high• Higher unemployment benefits• Last longer• Government regulations

18

Exhibit 5Since 1980, the US unemployment rate fell, Europe’s remained high, and Japan’s rose

19

Europe

U.S.

Japan

Problems with Unemployment Figures

• Understate unemployment• Discouraged workers

– Not counted

• Underemployed – Only part-time (want full-time)– Overqualified

• Overstate unemployment• Looking for work

– Qualify for unemployment benefits

• Only full-time (want part-time)• Underground economy 20

Inflation

• Inflation• Sustained increase in price level

• Annual inflation rate• Percentage increase in price level

• Hyperinflation• Extremely high inflation

• Deflation• Sustained decrease in price level

• Disinflation• Decrease in inflation 21

Hyperinflation in Brazil

• Price level in 1994• 3.6 million times higher than in 1988• People – don’t want to hold cruzeiro

• Workers• Paid daily; purchases• Exchanges for a stable currency

• Real Cruzeiro: larger denominations• Facilitate purchase• Reduce productivity

• Dropped since 1994 22

Two Sources of Inflation

• Increase in AD– Demand-pull inflation

– Increased government spending

– Social programs

• Decrease in AS– Cost-push inflation

– Increase cost of production• Push up the price level

– Stagflation 23

Exhibit 6Inflation caused by shifts of AD and AS curves

24

Aggregate output0

Price

level

P’

P

AS

AD’

AD

(a) Demand-pull inflation: inflation caused by an increase of aggregate demand

An outward shift of the aggregate demand to AD’ “pulls” the price level up from P to P’.

Aggregate output0

Price

level

P’

P

AS

AD

(b) Cost-push inflation: inflation caused by a decrease of aggregate supply

A decrease of aggregate supply to AS’ “pushes” the price level up from P to P’.

AS’

A Historical Look: Inflation; Price Level

• Price level, US, since 1913– Steady increase

• Inflation or deflation, US, since 1913– Before 1950s

• High inflation – war related– Followed by deflation

– Since 1950s• Inflation: 3.8% per year

25

Exhibit 7 (a)Consumer price index since 1913

26

Exhibit 7 (b)Inflation since 1913

27

Anticipated vs. Unanticipated Inflation

• Anticipated inflation– Expected inflation

• If inflation > expected– Sellers lose

– Buyers gain

• If inflation < expected– Sellers gain

– Buyers lose

28

Inflation

• Unpopular• Imposes transaction costs• Obscures relative price changes• Differ across metropolitan areas

– Housing prices

29

Exhibit 8Average annual inflation between 2002 and 2006 differed across US metropolitan areas

30

International Comparisons of Inflation

• First half of 1980s– Declining inflation

• Mid-1980s to early 1990s– Rising inflation

• Mid-1990s– Lower trend

• Similar trend– Overall: lower inflation

31

Exhibit 9Inflation rates in major economies have trended lower over the last quarter century

32

Europe

U.S.

Japan

Inflation and Interest Rates

• Interest– Dollar amount

• Paid by borrowers to lenders

• Interest rate• As percentage

• Supply of loanable funds– Upward sloping

• Demand of loanable funds – Downward sloping

33

Inflation and Interest Rates

• Nominal interest rate– Current dollars

• Real interest rate • =Nominal interest rate – Inflation rate

• Expected real interest rate

34

Exhibit 10The market for loanable funds

35

Loanable funds per period0

Nom

inal

inte

rest

rat

e

i

D

S The upward sloping supply curve, S, shows that more loanable funds are supplied at higher interest rates.

The downward-sloping demand curve, D, shows that the quantity of loanable funds demanded is greater at lower interest rates.

The two curves intersect to determine the market interest rate, i.

Why is Inflation Unpopular?

• Pay higher prices– Inflation = Penalty

• Receive higher receipts– Higher income

• ‘well-deserved’ reward

• Fixed nominal income– Unadjusted for inflation

• Social Security– Adjusted for inflation (COLA) 36