Chapter 5: Monitoring Jobs and Inflation

• Measures of activity in the labor market– Unemployment– labor force participation– employment-population ratio.– Shortcomings of unemployment rate as measure of labor

market performance– Statistics describing U.S. labor market

• Prices– Measuring the price level: the consumer price index– Why inflation is a problem

• Winners and losers

– Shortcomings of CPI as measure of price level

Unemployment

• Why is unemployment a problem?– 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

Labor Force Measures: December, 2011

U.S. population: 312.9 million

Civilian Non-institutionalized Working age (16+) population: 240.6 m.

In Labor Force153.9 m.

Employed140.8

Unemployed13.1

Out of labor force

86.7 m.

Not in Civilian Non-Institutionalized Population

72.3.m.

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

Labor market statistics

forcelabor civilian

unemployed ratent unemployme

population age workingtionalizednoninstitucivilian

forcelabor civilian rateion participat forcelabor

population age workingtionalizednoninstitucivilian

employed ratio population-employment

Employment ratio is more cyclical than labor force participation rate.

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.

Sources of Unemployment

People become unemployed if they1. Lose their jobs and search for another job.2. Leave their jobs and search for another job.3. Enter or reenter the labor force to search for a

job.People end a spell of unemployment if they4. Are hired or recalled.5. Withdraw from the labor force.

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

Types of Unemployment

• Frictional– 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

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.

The natural unemployment rate changes over time and is influenced by many factors.

• Key factors areThe age distribution of the populationThe scale of structural changeThe real wage rateUnemployment benefits

Unemployment and Full Employment

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

When real GDP is ________ potential GDP, the unemployment rate is ________ the natural unemployment rate.

A. B. C. D.

0% 0%0%0%

A. greater than; less than

B. less than; equal to

C. equal to; greater than

D. greater than; greater than

10

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

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)

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 1982-84 as the base year, • the CPI in December 2009 was 216• prices in December 2009 were 116 percent higher than

in 1982-84.

Constructing the CPI

• Selecting the basket– Based on

Consumer Expenditure Survey of 2001-02

– Basket contains 80,000 goods

• The monthly price survey– Every month, BLS employees check the prices of

80,000 goods in 30 metropolitan areas• Calculating the CPI

1. Find the cost of the CPI basket at base-period prices.2. Find the cost of the CPI basket at current-period

prices.3. CPI in t = Cost of bundle at current prices in t X 100

Cost of bundle at base year prices

Constructing the CPI

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•(140-100)/100 = 40%

The Price Level: 1982-84=100

The Inflation Rate

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

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

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.

Adjusting for Inflation: Nominal vs. Real Variables

Real Variable in t = Nominal Variable in t X 100 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 ($20*100/200=$10)

Real variable –Adjusts nominal values to reflect prices in base year.