Unemployment and Inflation

The evil twins of the

Macroeconomy

GDP, Unemployment & Inflation

• As GDP changes it also changes the level of employment and the prices we pay for goods and services.

• The problem for government is trying to cure both evils at one time.

GDP increases and so does employment and inflation.PRICE

LEVEL

REAL GDP and EMPLOYMENT

AS

AD1 AD2

If GDP increases, people earn more and spend more (good) and price level (inflation) increases (bad).

GDP decreases and so does employment and inflation.PRICE

LEVEL

REAL GDP and EMPLOYMENT

AS

AD1 AD2

If GDP decreases, people earn less and spend less (bad) and price levels (inflation) decreases (good).

Employment: You are considered employed if

• You are at least 16 years or older and:

• You worked at least 1 hour for pay within the last week

• You worked 15 hours or more at a family business without pay

• You held a job but did not work due to illness, vacation, labor dispute or bad weather

Unemployment

• Unemployed - to be without work and to be actively seeking employment

• Unemployment rate – number of unemployed divided by number in civilian labor force x 100

• Unemployment rate is the measure of joblessness in the U.S.

UNEMPLOYMENTMeasurement of Unemployment, 2000

Employed

Not inlaborforce

Under 16and/or

institutionalized

TotalPopulation275,400,000

Civilian Laborforce

140,800,000

65,800,000

68,800,000

Unemployed 5,600,000

135,200,000

Problems with Unemployment Rate• Those who have become so frustrated

and stop looking are no longer considered unemployed - discouraged workers.

• Many people are underemployed. Those who work minimally (a least one hour) are considered employed. Also many people take jobs below their skill level.

Who’s Employed and Who’s Not Classify each of the following individuals as

EMPLOYED, UNEMPLOYED or NOT IN THE LABOR FORCE

• Steve worked forty hours last week in a music supply store.

• Last week, Elizabeth worked 10 hours as a computer programmer for the National Video Company and attended night classes at the local college. She would prefer a full-time job.

• Roger lost his job at the R-Gone Manufacturing Company. Since then he has been trying to find a job at other local factories.

• Linda is a homemaker. Last week she was occupied with her normal household chores. She neither held a job nor looked for a job.

• Linda’s father is unable to work.

Classify each of the following individuals as EMPLOYED, UNEMPLOYED or NOT IN THE

LABOR FORCE

Types of Unemployment• Frictional unemployment - people who are

temporarily between jobs. Their skills are in demand (ex: recent graduates, those who have relocated)

– Seasonal unemployment - workers who due to weather or other variations are not working presently

• Structural unemployment - involves mismatches between job seekers and job openings. People lack skills needed.

• Cyclical unemployment - caused by recessions. People aren’t buying goods so workers are laid off.

Full Employment Ratea.k.a. Natural Rate of Unemployment

• It is the lowest possible unemployment rate with the economy growing (maximum potential employment) .

• It takes into account unavoidable unemployment such as structural, frictional and seasonal, but not cyclical.

• The full employment rate is considered to be about 5% unemployed.

Inflation• Inflation is a general rise in the

price level• Inflation reduces the value or

purchasing power of your money• The inflation rate is the

percentage change in prices over time.

Causes of inflation

• Demand Pull Theory – demand for goods & services exceeds existing supply (Demand shifts right).

• Quantity Theory of Money – too much money causes price levels to rise.

• Cost Push Theory - producers raise prices in order to meet increased costs (Supply shifts left).

Demand-pull Cost-push PRICE

LEVEL

PRICE

LEVEL

REAL GDP REAL GDP

AS

AD1 AD2

AS2AS1

AD

Consequences of inflation• Purchasing power eroded - the

dollar buys less

• Income reduced if it is a fixed income.

• Savers lose money - Interest Rates may not keep up with inflation. (You’re saving at a 5% interest rate but inflation is 7% so your real return is a -2%

Some people are helped by inflation

• Borrowers - the money you are paying back is worth less than the money you borrowed. (Fixed payer)

• Flexible income earners – if you are a store owner or you have a cost of living adjustment built into your wage your income rises with inflation.

Some people are hurt by inflation

• Lenders - the money you are receiving back is worth less than the money you loaned. (Fixed income earner)

• Flexible payer – if your costs rise as inflation rises you are hurt by inflation.

Price Indexes• Because GDP is a dollar measure, inflation

can distort it. Price indexes help economists measure real changes in output over time.

• A price index is a measurement of how the average price of a standard group of goods changes over time.

Price Indexes• The most famous index is the

Consumer Price Index (CPI).

• The CPI is determined by using a constant priced “market basket”.

• This market basket is a group of goods bought by the “typical urban” consumer.

Housing

Food/Beverages

Transportation

Medical Care

Apparel

Recreation

Other

Education andcommunication

What’s in the CPI’s Basket?

40%40%

16%16%

17%17%

6%6%5%5%

6%6% 5%5% 5%5%

Calculating the CPI

• Current price / base period price x 100

$400/$200 x 100 = 200

This would tell us that prices doubled over the past year.

Calculating the Inflation RateStart With CPI for current year Minus - CPI for previous year Divided by / CPI for previous year Multiplied by x 100

For example: If the CPI for 1999 was 166 and the CPI for 1998 was 163

Then,166 -163 = 33/163 = .018.018 X 100 = 1.8 % is the inflation rate for 1999(current CPI – previous CPI) / previous x 100