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Ch 5: Macroeconomic Ch 5: Macroeconomic Measurements, Part IMeasurements, Part IPrices & Prices & UnemploymentUnemployment

James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts UniversityUniversity©2005 Thomson Business & Professional Publishing, A Division of Thomson ©2005 Thomson Business & Professional Publishing, A Division of Thomson LearningLearning

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Measuring Measuring PricesPrices

Price LevelPrice Level: A weighted average of : A weighted average of the prices of all goods and services.the prices of all goods and services.

Price IndexPrice Index: A measure of the price : A measure of the price level.level.

Consumer Price Index (CPI)Consumer Price Index (CPI): A : A widely cited index for the price level; widely cited index for the price level; the weighted average of prices of a the weighted average of prices of a specific set of goods and services specific set of goods and services purchased by a typical household.purchased by a typical household.

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Consumer Price IndexConsumer Price Index

We use a base year to calculate the We use a base year to calculate the CPI.CPI.

The CPI is equal to the total dollar The CPI is equal to the total dollar expenditure in the current year for expenditure in the current year for the market basket divided by the the market basket divided by the total dollar expenditure in the base total dollar expenditure in the base year for the market basket.year for the market basket.

This result is then multiplied by 100.This result is then multiplied by 100.

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Exhibit 1: Computing the Consumer Price Index

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Exhibit 2: CPI, 1959-2003

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Calculating the Percentage Calculating the Percentage Change in Prices (as measured Change in Prices (as measured by the CPI) Over One Year or by the CPI) Over One Year or Several YearsSeveral Years

Percentage difference in the CPI Percentage difference in the CPI from one year to any other year = from one year to any other year =

(CPI (CPI later year later year – CPI – CPI earlier yearearlier year) X 100) X 100____________________________________________________________________________________________________________________________________________________________________

CPI CPI earlier year earlier year

InflationInflation: an increase in the : an increase in the price level.price level.

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Are You Beating (CPI) Are You Beating (CPI) Inflation or is Inflation Inflation or is Inflation Beating You?Beating You?

Nominal IncomeNominal Income: the current-dollar : the current-dollar amount of a person’s income.amount of a person’s income.

Real IncomeReal Income: nominal income : nominal income adjusted for price changes. adjusted for price changes.

Real Income (in base year prices)Real Income (in base year prices) = [(Nominal Income)/CPI]x100= [(Nominal Income)/CPI]x100

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How Is The CPI Used?How Is The CPI Used?

The CPI is used as:The CPI is used as: An economic indicatorAn economic indicator To find the real value of an To find the real value of an

economic variableeconomic variable To adjust certain income To adjust certain income

paymentspayments

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Substitute Bias in Substitute Bias in Fixed Weight Fixed Weight MeasuresMeasures

A A fixed weightfixed weight price assumes the price assumes the same items are boughtsame items are bought

A A substitute biassubstitute bias is introduced is introduced when one good is substituted for when one good is substituted for another.another.

As a result of the substitution bias, As a result of the substitution bias, fixed weight measures can overstate fixed weight measures can overstate the “cost of living”the “cost of living”

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Other MeasuresOther Measures

The The Chain-Weighted Chain-Weighted Price IndexPrice Index corrects corrects for the substitution for the substitution bias found in fixed bias found in fixed weight measures.weight measures.

The The GDP Deflator GDP Deflator oror GDP Implicit Price GDP Implicit Price DeflatorDeflator is based on is based on all goods and services all goods and services within an economy.within an economy.

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Converting Dollars Converting Dollars from One Year to from One Year to AnotherAnother

Take your price, income, or salary Take your price, income, or salary that you want to compare. Choose that you want to compare. Choose the current year and the year to the current year and the year to compare to. compare to.

Complete this formula:Complete this formula:Salary Salary current yearcurrent year = (CPI = (CPI current yearcurrent year / CPI / CPI earlier yearearlier year) )

x Income x Income earlierearlier yearyear

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Self-TestSelf-Test

Explain how the CPI is calculated.Explain how the CPI is calculated. If the CPI in one year is 132.5, and is If the CPI in one year is 132.5, and is

143.6 the following year, what is the 143.6 the following year, what is the inflation rate?inflation rate?

In year 1, your annual income is $45,000 In year 1, your annual income is $45,000 and the CPI is 143.6; in year 2, your and the CPI is 143.6; in year 2, your annual income is $51,232 and the CPI is annual income is $51,232 and the CPI is 150.7. Has your real income risen, 150.7. Has your real income risen, fallen, or remained constant? Explain fallen, or remained constant? Explain your answer.your answer.

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UNEMPLOYMENTUNEMPLOYMENT

Civilian Non-Institutional PopulationCivilian Non-Institutional Population (Potentially Employed)(Potentially Employed)– 16 years of age or older16 years of age or older– not in the armed servicesnot in the armed services– not institutionalized. not institutionalized.

A person is considered A person is considered EmployedEmployed if if– did any work for pay or profit during the survey did any work for pay or profit during the survey

reference weekreference week– worked at least 15 hours per week as an unpaid worked at least 15 hours per week as an unpaid

worker in a family-operated enterpriseworker in a family-operated enterprise– was temporarily absent from work due to illness, was temporarily absent from work due to illness,

vacation, strike, bad weather, industrial dispute, vacation, strike, bad weather, industrial dispute, or various personal reasons.or various personal reasons.

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Exhibit 3: Breakdown of Exhibit 3: Breakdown of the U.S. Population and the U.S. Population and the Labor Forcethe Labor Force

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UnemploymentUnemployment

A person is A person is UnemployedUnemployed if: if: They do not have a job, have made They do not have a job, have made

specific active efforts to find a job specific active efforts to find a job during the prior 4 weeks, and were during the prior 4 weeks, and were available for work.available for work.

They were not working and were They were not working and were waiting to be called back to a job waiting to be called back to a job from which they had been from which they had been temporarily laid off.temporarily laid off.

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The Unemployment and The Unemployment and Employment RatesEmployment Rates

Unemployment RateUnemployment Rate: Number of : Number of Unemployed Persons divided by the Civilian Unemployed Persons divided by the Civilian Labor ForceLabor Force

Employment RateEmployment Rate: Number of Employed : Number of Employed Persons divided by the Civilian Non-Persons divided by the Civilian Non-institutionalized Population.institutionalized Population.

Labor Force Participation RateLabor Force Participation Rate: Civilian : Civilian Labor Force divided by the Civilian Non-Labor Force divided by the Civilian Non-institutionalized Population.institutionalized Population.

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Classifying the Classifying the UnemployedUnemployed

Job LoserJob Loser: was employed in the civilian : was employed in the civilian labor force, was either fired or laid off.labor force, was either fired or laid off.

Job LeaverJob Leaver: was employed in the civilian : was employed in the civilian labor force, quit his or her job.labor force, quit his or her job.

ReentrantReentrant: was employed, hasn’t been for : was employed, hasn’t been for a period of time and is currently reentering a period of time and is currently reentering the labor force.the labor force.

New EntrantNew Entrant: has never held a full time job : has never held a full time job for two weeks or longer, but is now looking.for two weeks or longer, but is now looking.

Unemployed PersonsUnemployed Persons = Job Losers+ Job = Job Losers+ Job Leavers +Reentrants + New EntrantsLeavers +Reentrants + New Entrants

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Discouraged WorkersDiscouraged Workers

A person who gives up looking for a A person who gives up looking for a job, for whatever reason, is no longer job, for whatever reason, is no longer considered part of the unemployment considered part of the unemployment rate.rate.

The unemployed worker gets counted The unemployed worker gets counted and the discouraged worker does not.and the discouraged worker does not.

Does this give us a good count of the Does this give us a good count of the “true unemployment problem” “true unemployment problem” today?today?

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Types of Types of UnemploymentUnemployment Frictional UnemploymentFrictional Unemployment: unemployment : unemployment

due to the natural “frictions” of the economy, due to the natural “frictions” of the economy, which is caused by changing market conditions which is caused by changing market conditions and is represented by qualified individuals with and is represented by qualified individuals with transferable skills who change jobs.transferable skills who change jobs.

Structural UnemploymentStructural Unemployment: unemployment : unemployment due to structural changes in the economy that due to structural changes in the economy that eliminate some jobs and create others for eliminate some jobs and create others for which the unemployed are unqualified.which the unemployed are unqualified.

Natural Unemployment RateNatural Unemployment Rate: The sum of : The sum of the Frictional Unemployment Rate and the the Frictional Unemployment Rate and the Structural Unemployment Rate.Structural Unemployment Rate.

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Full Employment?Full Employment?

Full EmploymentFull Employment: when the : when the unemployment rate is equal to unemployment rate is equal to the natural unemployment rate.the natural unemployment rate.

Cyclical Unemployment Cyclical Unemployment RateRate: the difference between : the difference between the unemployment rate and the the unemployment rate and the natural unemployment rate.natural unemployment rate.

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Self-TestSelf-Test

What is the major difference What is the major difference between a person who is between a person who is frictionally unemployed and one frictionally unemployed and one who is structurally unemployed?who is structurally unemployed?

If the cyclical unemployment rate If the cyclical unemployment rate is positive, what does this imply?is positive, what does this imply?

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Coming Up (Ch. 6): Coming Up (Ch. 6): Macroeconomic Macroeconomic Measurements, Part II: GDP Measurements, Part II: GDP and Real GDPand Real GDP