PowerPoint to accompany Chapter 14 Unemployment and Inflation

PowerPoint

to accompany

Chapter 14

Unemployment and Inflation

Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

Learning Objectives

1. Define the unemployment rate and the labour force participation rate, and understand how they are calculated.

2. Explain the economic costs of unemployment.

3. Identify the types of unemployment

4. Explain what factors determine the natural rate of unemployment.


Learning Objectives

5. Define the price level and the inflation rate, and understand how they are calculated.

6. Use price indexes to adjust for the effects of inflation.

7. Discuss the problems caused by inflation.

8. Understand the difference between demand-pull and cost-push inflation.


Why is unemployment important to Woolworths?

Low unemployment may increase production costs.

Shortages of labour may lead to a rise in wages.


The labour force survey.

Labour force: The sum of employed and unemployed workers in the economy.

Unemployment rate: The percentage of the labour force that is unemployed.

Discouraged workers: People who are available for work but have not looked for a job during the previous four weeks because they believe no jobs are available for them.

LEARNING OBJECTIVE 1

Measuring the unemployment rate and the labour force participation rate


The Australian Bureau of Statistics (ABS) labour force survey:

Monthly sample of <0.5% of the population aged 15 and over.

To be classified as employed, a person must have worked only 1 hour or more in the week before the survey.

To be classified as unemployed, a person must not have worked at all in the week before the survey, must have been actively looking for work in the past 4 weeks, and must be ready to start work immediately.



Not in the labour force

6.02 million

The employment status of the population, Australia, February 2009: Figure 14.1

Working age population

17.39 million

Labour force

11.37 million

Employed

10.81 million

Unemployed

0.56 millionNot available

for work

5.86 million

Available for work, but not

currently looking

0.16 million

Not currently looking for work due to

other reasons

0.07 million

Discouraged workers

0.09 millionHubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

Source: Australian Bureau of Statistics (2009), Australian Labour Market Statistics, Cat. No. 6105.0, April.



The unemployment rate measures the percentage of the labour force that is unemployed.





Labour force participation rate: The percentage of the working age population that is in the labour force.




Measuring unemployment and labour force participation

Use the Labour Force data provided on the following slide to calculate:

a) The unemployment rate for June 2008.

b) The number of people in the labour force in June 2008.

c) Suppose the working age population in Australia is 17 million people, what is the labour force participation rate?





Seasonally adjusted June 2008

Employed persons (‘000) 10 710.6

Unemployed persons (‘000) 475.5



Solving the problem:

STEP 1: Review the material. This problem is about calculating the unemployment and labour force participation rates, so you may wish to review the section in the text book ‘The labour force survey’.

STEP 2: Answering (a) Use the formula to calculate the unemployment rate.







STEP 3: Answering (b). The labour force is the sum of the employed plus the unemployed workers.

Labour force = 10 710.6 million + 475.5 million

= 11 186.1 million people

STEP 4: Answering (c). Use the formula to calculate the labour force participation rate.






Problems with measuring the unemployment rate.

1. The number of discouraged workers increases during a recession, therefore the official unemployment rate appears lower than it would otherwise be.

2. Under-employed workers – people who work part-time but would like to work more hours.

3. People who claim to be unemployed but are not can lead to the unemployment rate being overstated.




Trends in labour force participation.

The higher the participation rate, the more labour is available and the higher the level of potential GDP.

1978 – 2009: male participation rate fell from 79% to 72.2% in Australia.

1978 – 2009: female participation rate rose from 44% to 58.7% in Australia.




How long are people usually unemployed?

2009, Australia: More than 60% of unemployed people found a job within 3 months, and more than 75% within 6 months.

Long-term unemployed: Those in the labour force who have been continuously unemployed for a year or longer.

2009, Australia: 13% of the unemployed were long-term unemployed.



Duration Per cent

Under 4 weeks 27.0

4-13 weeks 35.2

13-26 weeks 14.7

26-52 weeks 9.7

52 weeks and under 104 weeks 7.3

104 weeks and over 6.1

Total 100.0

Duration of unemployment, Australia, February 2009: Table 14.1

Source: Australian Bureau of Statistics (2009), Australian Labour Market Statistics, Cat. No. 6105.0, April. Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia


Job creation and destruction

The Australian economy creates and destroys hundreds of thousands of jobs every year.

New firms begin; existing firms expand.

Some firms contract; some firms go out of business.

Job creation and destruction is a normal part of an economy, and is due to changes in: consumer tastes, technological change, and entrepreneurial success and failure.



Growth in employment in Australia, 1978 – 2009: Figure 14.2

Source: Australian Bureau of Statistics (2009), Labour Force, Australia, Spreadsheets, Cat. No. 6202.0.55.001.

1 000

2 000

3 000

4 000

5 000

6 000

7 000

8 000

9 000

10 000

11 000

1978 1983 1988 1993 1998 2003 2008

Th

ou

san

ds

of

per

son

s

Part-time employmentFull-time employmentTotal employment



What explains the increase in welfare recipients?

The number and proportion of people receiving welfare payments has generally increased over time.

MAKING THE CONNECTION14.1


Costs to the economy as a whole.

Loss of Gross Domestic Product.

Loss of human capital.

Re-training costs.

Unemployment benefit payments are a net drain on federal budget.

The opportunity cost of funds directed towards unemployment benefits.

Loss of tax revenue – personal income tax, company tax, GST and excise taxes.


The costs of unemployment


Costs to the unemployed people.

Loss of income.

Loss of skills.

Re-training costs.

Loss of self esteem.

Unemployment may contribute to family break-ups, health problems, mental illness, crime and political unrest.


The costs of unemployment


Unemployment follows the business cycle.

Rises during and soon after recessions.

Falls during economic upturns and booms.


Types of unemployment

The annual unemployment rate in Australia, 1960-2009: Figure 14.3

Source: Australian Bureau of Statistics (2008), Labour Force, Cat. No. 6203.0 (earlier editions); Labour Force, Cat. No. 6202.0. Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia


Cyclical unemployment: Unemployment caused by a business cycle recession.

Also known as ‘demand deficient’ unemployment.

Falling sales lead to cut-backs on production and the sacking of workers.

When the economy begins to recover, the unemployment rate usually continues to rise for 1-2 years because:

Discouraged workers re-enter the workforce.

Some firms have excess capacity, and also want to wait until the recovery is lasting before hiring new workers.




Frictional unemployment: Short-term unemployment arising from the process of matching workers with jobs.

School leavers, college and university graduates looking for their first job.

People re-entering the workforce after an absence.

People who have lost or quit their job and are looking for their new job.




Seasonal unemployment: Unemployment due to factors such as weather, variations in tourism and other calendar related events.

Structural unemployment: Unemployment arising from a persistent mismatch between the skills and characteristics of workers and the requirements of jobs.

Eg: New technology and changes in consumer tastes may make some workers redundant.




Full employment - Occurs where there is no cyclical unemployment.

At full employment the ‘normal’ types of unemployment still exist – frictional and structural.

Natural rate of unemployment: The normal rate of unemployment consisting of structural unemployment plus frictional unemployment.




Full employment.

Non-accelerating inflation rate of unemployment (NAIRU): The level of unemployment below which the rate of inflation will rise.




Government policies and the unemployment rate.

Job Services Australia: A national network of private and community recruitment agencies that find jobs for unemployed people and other job seekers.


Explaining frictional and structural unemployment


Social security and other payments to the unemployed

These may have two main effects:

1. Allow more time for job search and therefore improve labour market efficiency.

2. Reduce the opportunity cost of unemployment and therefore lead to longer periods of unemployment.




Labour market regulation and deregulation.

Over time, Australia has moved from a highly centralised wage and industrial relations system (most of the 20th century) to a relatively deregulated system in the 1990s and early 2000s.

Some re-regulation is occurring post 2007 with the change in federal government.





Deregulation through enterprise bargaining.

Enterprise Bargaining: Wages and working conditions negotiations between employers and unions or employers and employees at the workplace level.





Possible advantages of deregulation:

Flexible work arrangements may reduce frictional and structural unemployment.

Improved performance can be rewarded with higher wages.

Dispute resolution can occur in the workplace.





Possible disadvantages of deregulation:

Individual work contracts may reduce individual bargaining power between workers and employers.

Increased labour market flexibility may cause a decline in the position of low-paid workers.

Minimum wages may be used to ensure some protection for low-paid workers.




Minimum wages The majority of workers in Australia are

‘covered’ by minimum wage laws. Most workers earn wages that are much higher

than the minimum. Minimum wage laws increase the wages of the

lowest paid. Economists argue over the effect minimum

wages may have on employment: Some argue that they have little or no effect on

employment. Others argue that minimum wages reduce

employment among the low paid, as more people would have been employed if wages were lower.




Trade unions - Organisations of workers that bargain with employers for higher wages and better working conditions for their members.

In earlier times many Australian workers belonged to unions.

In 2008, only about 20% of the Australian workforce belonged to unions.

Unions may improve working conditions and pay for their members. In doing so, they also increase employer costs, which may reduce employment.




Efficiency wages: An efficiency wage is a higher than market wage paid by a firm to increase worker productivity.

May reduce the need for worker monitoring.

May provide motivation for more productive work.

But, efficiency wages increases the labour supply, so may increase unemployment.




Why did Henry Ford pay his workers twice as much as other car manufacturers?

Henry Ford claimed that paying a wage twice as high as his competitors was the best cost cutting move he ever made, as output per worker increased.

MAKING THE CONNECTION14.2


Price level: A measure of the average prices of goods and services in the economy.

Inflation: The sustained increase in the price level in the economy.

Inflation rate: The percentage increase in the price level from one year to the next.


Measuring inflation

Source: Reserve Bank of Australia (2009), Statistics, ‘Measure of consumer price inflation’, Table G01, viewed 2 May 2009, at <www.rba.gov.au>

Annual inflation rate, Australia, 1970-2008: Figure 14.4

-2

0

2

4

6

8

10

12

14

16

18

20

1970 1975 1980 1985 1990 1995 2000 2005

Infl

ati

on

ra

te (

pe

r ce

nt

per

yea

r)



Consumer Price Index: An average of the prices of the goods and services purchased by the typical urban family of four.

The ABS surveys households on their spending habits.

The goods and services typically purchased by households is the ‘market basket’.

The prices of goods and services in the market basket are given a weight according to their fraction of a ‘typical’ family budget.

The CPI measures the rate of change in the prices of the goods and services in the market basket.


Measuring inflation

Source: Australian Bureau of Statistics (2005), Consumer Price Index 15th Weighting Pattern,Cat. No. 6430.0, Table 1, Percentage contribution to all groups, CPI, June quarter, eight capital cities.

The CPI market basket: Figure 14.5


The following is a simplified example of the market basket to show how the CPI is constructed.


Measuring inflation



The table on the previous slide shows that the statisticians use base year quantities to measure the cost of the basket for the base year and the years that follow.


FORMULA APPLIED TO 2007 APPLIED TO 2008

120100750$

900$

122100750$

915$

CPI = 100year base in the esExpenditur

yearcurrent in the esExpenditur

Measuring inflation


Is the CPI accurate?

The CPI is the most widely used measure of inflation.

Four sources of bias in the CPI may lead to it overstating the inflation rate.

Substitution bias

Increase in quality bias

New product bias

Outlet bias


Measuring inflation


The producer price index (PPI): An average of the prices received by producers of goods and services at all stages of the production process.


Measuring inflation


Calculating the CPI

Suppose we are looking at a simplified economy where households consume only three goods and services: vegemite, juice and petrol. The table that follows presents price and quantity data for these three items in 2007 (the base period) and 2008.



Calculating the CPI

PRICE AND QUANTITY DATA FOR 2007 AND 2008


E$: Expenditure in dollarsP$: Price in dollars

Base Period Current Period

Item Quantity P$ E$ P$ E$

Vegemite 40 jars 2.00 p/jar 2.10 p/jar

Juice 60 bottles 1.50 p/bottle 1.60 p/bottle

Petrol 120 litres 1.20 p/litre 1.50 p/litre

Total Total


Calculating the CPI

a) Complete the table by calculating expenditures for the base period (2007) and the current period (2008).

b) Calculate the value of the basket for the base year and the current year.

c) What are the CPI figures for both years.




Solving the problem:

STEP 1: Review the material in the section ‘The consumer price index’ in the text book.

STEP 2: Answering (a) and (b): Calculate the expenditure on the items in the basket for each year. Prices for 2007 and 2008 are multiplied by the base year quantities. Then find the total expenditure for each year. This is the cost of the basket for that year.

Calculating the CPI


Calculating the CPI


STEP 2: continued. Calculating the cost of the basket for both years

Base Period (2007) Current Period (2008)

Item Quantity P$ E$ P$ E$

Vegemite 40 jars 2.00 p/jar 80.00 2.10 p/jar 84.00

Juice 60 bottles 1.50 p/bottle 90.00 1.60 p/bottle 96.00

Petrol 120 litres 1.20 p/litre 144.00 1.50 p/litre 180.00

Total 314.00 Total 360.00

E$: Expenditure in dollarsP$: Price in dollars


Calculating the CPI

STEP 3: Answering (c). Use the following formula to calculate the CPI figures for both years. Note, because 2007 is the base year, the expenditure in the current and base year will be the same, so the CPI figure will be 100.


100100314$

314$

CPI = 100year base the in esExpendituryear current the in esExpenditur

114.65100$314

$360

CPI 2008 =


The purchasing power of the dollar falls over time as prices rise.

Price indexes, such as the CPI, enable the adjustment to be made for the effects of inflation, so dollar values can be compared over time.

The 2008 purchasing power equivalent of a $20 000 salary in 1980 can be found in the following example.


Using price indexes to adjust for the effects of inflation


The formula:


Using price indexes to adjust for the effects of inflation

Value in 2008 dollars = Value in 1980 dollars

1980inCPI

2008inCPI

= 20 000 098 $46182

189


Nominal incomes generally rise with inflation.

For the ‘average’ person, nominal wages increase with inflation.


Does inflation impose costs on the economy?


Inflation and the distribution of income.

People on fixed incomes are likely to experience reduced purchasing power due to inflation.

The extent of redistribution depends, in part, on the degree to which inflation was anticipated or unanticipated.




The problem with anticipated inflation.

Menu costs: The costs to firms of changing prices.

Income redistribution, as some people’s income will fall behind anticipated inflation.

Those holding wealth in paper money.




The problem with unanticipated inflation.

There are winners and losers, depending on whether inflation is higher than or lower than anticipated.

For example: those on fixed incomes, such as aged pensions, will lose if inflation is higher than anticipated.

Borrowers may gain and lenders may lose when inflation is higher than anticipated.

People on fixed payment contracts may gain or lose.




Deflation: A decline in the general price level in the economy.

The inflation rate is negative.

Problems with deflation include:

Increases debt burdens.

Reduces asset values and wealth.

Gains to consumers from falling prices may be negated by falling wages.

The real interest rate rises above the nominal interest rate, discouraging business borrowing and reducing the effectiveness of monetary policy.




Hyperinflation: Extremely rapid increases in the general price level.

In periods of hyperinflation, money loses value so rapidly, that firms and households try to avoid holding it.

Hyperinflation is often associated with political instability and usually accompanied by a severe recession and economic and political turmoil.




Demand pull inflation: Inflation that is caused by an increase in the aggregate demand for goods and services.

Production levels are unable to meet this demand immediately, especially if the economy is at full employment.

Upward pressure is put on prices and nominal wages and can lead to a wage-price spiral.


What causes inflation?

Price level

Real GDP (billions of dollars)

0$1200


SRAS1

AD1

LRAS

AD2

B112

1300

A

An increase in aggregate demand shifts AD to the right, causing demand-pull inflation.

108

Demand-pull inflation: Figure 14.6a

Price level


0$1200


115

SRAS1

AD1

LRAS

AD2

C

B112

1300

SRAS2

A

2. As firms and workers adjust to the price level

being higher than expected, costs will rise, and cause SRAS to shift

to the left.

3. Equilibrium moves from point B back to potential GDP at point C, with a higher price level.

108

1. An increase in aggregate demand shifts AD to the right, causing demand-pull inflation.

Demand-pull inflation and a wage-price spiral: Figure 14.6b


Cost-push inflation: Inflation that arises as a result of a negative supply shock - that is, anything that causes a decrease in the aggregate supply of goods and services.

Increases in import prices.

Increases in wages.

Increases in indirect taxation.

Increases in monopoly power in product markets.

Natural disasters, such as droughts, floods, earthquakes.


What causes inflation?

Price level


01200


SRAS1

AD1

LRAS

B112

$1100

SRAS2

A

1. An increase in production costs shifts SRAS to the left …

2. … moving short-run equilibrium to point B, with lower real GDP and a higher price level.

108

Cost-push inflation: Figure 14.7


A natural disaster, such as a severe drought, can cause a supply shock.


An Inside LookPork fuels China inflation to decade high

An Inside LookFigure 1 The effects of cost-push and demand-pull inflation



Statisticians at the Australian Bureau of Statistics (ABS), have developed eleven groups of goods and services which cover all the items consumed by a typical Australian household.

What are these eleven categories?

Of these eleven categories, which have contributed most significantly to any changes in the CPI over the last quarter?

Follow the link below to the ABS website, and from the homepage click on the Consumer Price Index.

www.abs.gov.au

Get Thinking!

http://www.abs.gov.au/


Key Terms Consumer price index

(CPI)

Cost-push inflation

Cyclical unemployment

Deflation

Demand-pull inflation

Discouraged workers

Efficiency wage

Enterprise bargaining

Frictional unemployment

Hyperinflation

Inflation rate

Job Services Australia

Labour force

Labour force participation rate

Long-term unemployed

Menu costs

Natural rate of unemployment

Non-accelerating inflation rate of unemployment (NAIRU)

Price level

Producer price index (PPI)

Seasonal unemployment

Structural unemployment Unemployment rate


Q1. Which of the following groups is included in the labour force?

a. The unemployed.

b. Retirees, homemakers, and full-time students.

c. People who could have a civilian job but are on active military service, in prison, or in mental hospitals.

d. None of the above.

Check Your Knowledge


Q1. Which of the following groups is included in the labour force?

a. The unemployed.

b. Retirees, homemakers, and full-time students.

c. People who could have a civilian job but are on active military service, in prison, or in mental hospitals.

d. None of the above.



Q2. Which of the following demographic groups typically experiences a higher rate of unemployment than the unemployment rate for the total population in Australia?

a. University educated males.

b. Skilled tradespeople.

c. Young unskilled males and females.

d. None of the above. The unemployment rates for all three groups are typically lower than the national average.



Q2. Which of the following demographic groups typically experiences a higher rate of unemployment than the unemployment rate for the total population in Australia?

a. University educated males.

b. Skilled tradespeople.

c. Young unskilled males and females.

d. None of the above. The unemployment rates for all three groups are typically lower than the national average.



Q3. When the economy is at full employment, which types of unemployment remain?

a. Cyclical and structural.

b. Frictional and structural.

c. Frictional and cyclical.

d. None of the above. Full employment means there is no unemployment, so the unemployment rate would be zero.



Q3. When the economy is at full employment, which types of unemployment remain?

a. Cyclical and structural.

b. Frictional and structural.

c. Frictional and cyclical.

d. None of the above. Full employment means there is no unemployment, so the unemployment rate would be zero.



Q4. Which of the following is the best measure of the average of the prices of the goods and services consumed by a typical household?

a. The consumer price index.

b. The producer price index.

c. The GDP deflator.

d. None of the above provide a good measure of the price changes facing a typical household.



Q4. Which of the following is the best measure of the average of the prices of the goods and services consumed by a typical household?

a. The consumer price index.

b. The producer price index.

c. The GDP deflator.

d. None of the above provide a good measure of the price changes facing a typical household.



Q5. If the inflation rate turns out to be higher than expected, then:

a. Borrowers pay lenders a higher real interest rate than they expected.

b. Borrowers pay lenders a lower real interest rate than they expected.

c. Borrowers pay only a nominal interest rate but not a real interest rate.

d. Borrowers pay only a real interest rate but not a nominal interest rate.



Q5. If the inflation rate turns out to be higher than expected, then:

a. Borrowers pay lenders a higher real interest rate than they expected.

b. Borrowers pay lenders a lower real interest rate than they expected.

c. Borrowers pay only a nominal interest rate but not a real interest rate.

d. Borrowers pay only a real interest rate but not a nominal interest rate.



The Phillips curve: A curve showing the short-run trade off between the unemployment rate and the inflation rate.

APPENDIX

A short-run trade off between unemployment and inflation?

The Phillips Curve: Figure 14A.1



Explaining the Phillips curve with aggregate demand and aggregate supply analysis.

The AD-AS model shows that slow growth in AD leads to both higher unemployment and lower inflation.

This is consistent with the Phillips curve, which shows a short-run trade-off between unemployment and inflation under these conditions.

APPENDIX


Using aggregate demand and aggregate supply analysis to explain the Phillips curve: Figure 14A.2



Is the Phillips curve a policy menu?

Structural relationship: A relationship that depends on the basic behaviour of consumers and firms and remains unchanged over long periods of time.

The Phillips curve is not a policy menu, as economists realised that there was not a permanent trade-off between unemployment and inflation.

APPENDIX



Is the short-run Phillips curve stable?

It appeared to be stable during the 1960s.

Later found not to be stable, and that the Phillips curve could not be downward sloping in the long run.

APPENDIX



The long-run Phillips curve.

Economists Milton Friedman and Edmund Phelps argued that in the long run, the Phillips curve was vertical, at potential GDP.

If real GDP automatically returns to its potential level in the long run, the unemployment rate must also return to its natural rate.

Therefore there is no trade-off between unemployment and inflation in the long run.

APPENDIX


A vertical long-run aggregate supply curve means a vertical long-run Phillips curve: Figure 14A.3



The role of expectations of future inflation.

Friedman and Phelps: An increase in the inflation rate increases employment and decreases unemployment only if the increase in the inflation rate is unexpected.

APPENDIX


The impact of unexpected price level changes on the real wage: Table 14A.1


The basis for the short-run Phillips curve: Table 14A.2



Do workers understand inflation?

If workers and firms mistakenly expect the inflation rate to be lower that it turns out to be, higher inflation can lead to lower unemployment.

If firms forecast inflation correctly but workers do not, higher inflation can lead to lower unemployment.

If workers and firms correctly anticipate inflation, there will be no trade-off between inflation and unemployment.

APPENDIX


Documents

PowerPoint to accompany Chapter 14 Unemployment and Inflation