Unemployment and Inflation - 2013

CHAPTER
20-1
Chapter 20: Unemployment and Inflation
Unemployment
and
Inflation
Chapter Outline and

Learning Objectives
20.1 Measuring the Unemployment
Rate and the Labor Force
Participation Rate
Define unemployment rate and labor
force participation rate and
understand how they are computed.
20.2 Types of Unemployment

Identify the three types of
unemployment.
20.3 Explaining Unemployment
Explain what factors determine the
unemployment rate.
Copyright 2010 Pearson Education, Inc. Economics R. Glenn Hubbard, Anthony Patrick OBrien, 3e.
1 of 52
CHAPTER
20 Unemployment
and Inflation
1/22/201310112:
: 1,140 8
: 58.45
47 7
4
2
1
: 4.18
27.3
1 7 4
http://www.stat.gov.tw/public/Attachment/312116382071.pdf
Measuring the Labor Force Participation

Rate and the Unemployment Rate
20.1 LEARNING OBJECTIVE

The Household Survey
Labor force =
employed +
unemployed
workers
FIGURE 20-1
The Employment Status of the
Civilian Working-Age Population,
July 2009
3 of 52
Measuring the Unemployment Rate

and the Labor Force Participation Rate

The Household Survey

The unemployment rate measures the
percentage of the labor force that is unemployed.
Number of unemployed
100 Unemployment rate
Labor force
The labor force participation rate measures the
percentage of the working-age population in the
labor force.
Labor force
100 Labor force participation rate
Working-age population
See the handout for the case of Taiwan (HO: 1)
4 of 52


Trends in Labor Force Participation

Trends in the Labor Force Participation Rates of
Adult Men and Women Since 1948
FIGURE 20-2
5 of 52
Making Why Was Male Unemployment

the
Connection
So High During the

Recent Recession?

YOUR TURN: Test your understanding by doing related problem 1.7 at the end of
this chapter.
6 of 52


Problems with Measuring the Unemployment Rate
The unemployment rate is far from an exact

measure of joblessness in the economy.
Discouraged workers are not included.
Great differences across genders,

ages, and other demographical
categories.
See the handout for the case of Taiwan (HO: 2 (iii) )
7 of 52


How Long Are People Typically Unemployed?

Table 20-1
Duration of Unemployment
LENGTH OF TIME UNEMPLOYED
PERCENTAGE OF TOTAL UNEMPLOYED
(a) Duration of unemployment during an economic expansion.
35.6%
Less than 5 weeks
5 to 14 weeks
Short-term
unemployment
31.3
15 to 26 weeks
15.7
27 weeks or more
17.5
(b) Duration of unemployment during an economic recession.

Less than 5 weeks
22.0%
5 to 14 weeks
24.2
15 to 26 weeks
19.9
27 weeks or more
33.8
8 of 52


The Establishment (Payroll) Survey: another measure of

employment with Job Creation and Job Destruction over Time
Table 20-3
Establishments Creating and Eliminating

Jobs, September-December 2008
NUMBER OF
ESTABLISHMENTS
NUMBER OF
JOBS
1,376,000
5,367,000
368,000
1,345,000
Existing establishments
1,686,000
6,977,000
Closing establishments
405,000
1,490,000
ESTABLISHMENTS CREATING JOBS

Existing establishments
New establishments
ESTABLISHMENTS ELIMINATING JOBS
9 of 52
Types of Unemployment
FIGURE 20-4

unemployment..
The Annual Unemployment Rate in the United States,

19502008
The unemployment rate rises during recessions

and falls during expansion. Shaded areas indicate
recessions.
10 of 52

unemployment..
Cyclical Unemployment
Unemployment caused by a business cycle recession.
During the 2008-09 recession, the unemployment rate in US peaked
at 10.2%; in Taiwan peaked at 6.13% in Aug. 09 (5.85% on avg. in 09)
Frictional Unemployment and Job Search
Short-term unemployment that arises from the process of matching
workers with jobs.
Quit a job or just graduate from school, need time for job search
()
Structural Unemployment
Unemployment arising from a persistent mismatch between the skills
and attributes of workers and the requirements of jobs.
Major advances in technology & finding lower costs of labor overseas,
lead to this type of unemployment.
()
11 of 52

unemployment..
Full Employment
Natural rate of unemployment

The normal rate of unemployment,
consisting of frictional
unemployment plus structural
unemployment.
Learning NRU within 10 min!

See the video post on:
http://education-portal.com/academy/lesson/natural-rate-ofunemployment-definition-and-formula.html
12 of 52
Making i. The US sub-prime crisis

the
Connection
during the second half of 2008

adversely affected Taiwans
electronics and IT industries.

unemployment..
Unemployment rate (quarterly data): Taiwan, 1990-2012
2012s avg.
annual rate:
4.24%
Source:
http://ebas1.ebas.gov.tw/pxweb/igraph/MakeGraph.asp?onpx=y&pxfile=LM01
07A1M2012220153940.px&PLanguage=9&menu=y&gr_type=0
Making
the
Connection
15
10
14.49
5.85

unemployment..
ii. Youth Unemployment

Rate in Taiwan
13.09
5.21
12.47
4.39
12.66
4.27
0
2009
2010
2011
2012
(15-24)
Source: http://www.stat.gov.tw/public/Attachment/312116382071.pdf
()
See 3 (ii) in the handout for explanation
Explaining Unemployment

unemployment rate.
Government Policies and the Unemployment Rate

Unemployment Insurance and Other Payments
to the Unemployed: increase job-search time
In the United States and most other industrial countries, the
unemployed are eligible for unemployment insurance
payments from the government.
In the United States, these payments are generally equal to

about half the average wage.
Unemployment insurance helps the unemployed maintain

their income and spending, which lessens the personal
hardship of being unemployed and also helps reduce the
severity of recessions.
See 4 (i) in the handout for extra materials

15 of 52

unemployment rate.
Government Policies and the Unemployment Rate

Minimum Wage Laws: firms disincentives to hire workers
In 1938, the federal government enacted a national minimum

wage law.
If the minimum wage is set above the market wage

determined by the demand and supply of labor, the quantity of
labor supplied will be greater than the quantity of labor
demanded.
Economists agree that the current minimum wage is above
the market wage for some workers, but they disagree on the
amount of unemployment that has resulted.
See the video post on:
http://education-portal.com/academy/lesson/minimum-wage-and-itseffects-on-employment.html
16 of 52

unemployment rate.
Labor Unions: firms disincentives to hire workers

Labor unions are organizations of workers that
bargain with employers for higher wages and better
working conditions for their members.
Efficiency Wages: firms keeping wages above market level to

increase worker productivity; a market failure explanation
of unemployment
Costco pay its workers much more than WalMart does, why?
Its relatively high wages and health benefits reduce
employee turnover and raise morale and productivity.
17 of 52
Okuns Law: relationship of GDP growth and

changes of Unemployment in data
A 1% decrease in
unemployment is
associated with 2%
of additional growth
in real GDP
Percentage
change 10
in real GDP
8
6
1951
1984
2000
1999
1993
4%
1975
0
-2
-3
2%
-2
-1
1982
4
Change in
unemployment
rate
18 of 52
CHAPTER
20-2
Unemployment
and
Inflation
Chapter Outline and

Learning Objectives
20.4 Measuring Inflation
Define price level and inflation rate and
20.5 Using Price Indexes to Adjust for the

Effects of Inflation
20.6 Real versus Nominal Interest Rates

Distinguish between the nominal interest rate
and the real interest rate.
20.7 Does Inflation Impose Costs on the
Economy?
Discuss the problems that inflation causes.
Measuring Inflation
The Consumer Price Index
Define price level and inflation rate

and understand how they are
computed.
CPI: an average of the prices of the goods and

services purchased by the typical urban family
of four.
Published by the Bureau of Labor Statistics (BLS:
http://www.bls.gov/cpi/) and used to
track changes in the typical households cost of living
adjust many contracts for inflation (i.e. COLAs)

allow comparisons of dollar figures from different
years
Inflation rate: percentage increase in the price

level from one year (month) to the next.
20 of 52
Measuring Inflation

computed.

FIGURE 20-6
The CPI Market Basket,

December 2008
Housing, transportation,
and food make up about
of the market basket.
The BLS surveys

30,000 households on
their spending habits.
The results are used to
construct a market
basket of goods and
services purchased by
the typical urban family
of four.
Source: Bureau of Labor Statistics,

http://www.bls.gov/cpi/cpi_methods.htm
21 of 52
CPI Market Basket: Taiwan

7%
16%
25%
4%
5%
12%
31%
Source:
2007/ 7
Measuring Inflation

computed.

BASE YEAR (1999)
PRODUCT
QUANTITY
PRICE
$100.00
$85.00
$85.00
15.00
300.00
14.00
280.00
25.00
500.00
27.50
550.00
EXPENDITURES
PRICE
$50.00
$50.00
$100.00
Pizzas
20
10.00
200.00
Books
20
25.00
500.00
TOTAL
$750.00
2011
EXPENDITURES
(ON BASE-YEAR
QUANTITIES)
PRICE
Eye
examinations
2010
EXPENDITURES
(ON BASE-YEAR
QUANTITIES)
$900.00
FORMULA
APPLIED TO 2010
Expenditur es in the current year

100
CPI =
Expenditur es in the base year
$900
100 120
$
750
$915.00
APPLIED TO 2011
$915
100 122
$
750
122 120
Inflation rate:
100 1.7%
120
23 of 52
Measuring Inflation

computed.
Is the CPI Accurate?

It is important that the CPI be as accurate as
possible, but there are four biases that cause
changes in the CPI to overstate the true inflation
rate:
Substitution bias.
Increase in quality bias.

New product bias.
Outlet bias.
24 of 52
Using price indexes to adjust for the effect

of inflation: wage
When your parents graduated from college, they received a
salary of $10,000 per month, what 10,000 in 1985 was
equivalent to in 2012?
Suppose: CPI1985 = 100; CPI2012 = 200 (base year = 1985)
Y1985 / CPI1985 = Y2012 / CPI2012
Y2012 = $20,000
Economic variables calculated in current-year prices are
nominal variables.
We can use the CPI to adjust the nominal variables for the
effects of inflation.
Solved Problem
20-5
Use price indexes to adjust for the

effects of inflation..
Calculating Real Average Hourly Earnings

NOMINAL AVERAGE
HOURLY EARNINGS
YEAR
CPI
(1982-1984 = 100)
2006
$16.76
201.6
2007
17.43
207.3
2008
18.08
215.3
YEAR
NOMINAL AVERAGE
HOURLY EARNINGS
CPI
(1982-1984 = 100)
REAL AVERAGE
HOURLY EARNINGS
(1982-1984 DOLLARS)
2006
$16.76
201.6
$8.31
2007
17.43
207.3
8.41
2008
18.08
215.3
8.40
YOUR TURN: For more practice, do related problems 5.3 , 5.4, 5.5 and 5.6 at the
end of this chapter.
Using price indexes to adjust for the effect

of inflation: housing price in Hong Kong
Average price of an apartment on HK Island with an area
between 100m2 and 160m2
In Dec. 2005: HK$112,012/m2
In Dec. 1982: HK$14,742/m2
The Hong Kong CPI (2000=100) was 35.5 in December 1982
and 94.5 in December 2005.
How much did an apartment cost back then when expressed
in todays dollars? (t=1982)
Real
t
PRef
94.5
Nt
14, 742
39,242.79
Pt
35.5
Using price indexes to adjust for the

effect of inflation: box office
Compare the box office take of Shrek 2 and Sound
of Music in 2004 dollars.
Movie
Shrek 2
Sound of Music
Year
2004
Box Office
436,471,036
1965
163,214,286
P
189
32
Measuring Inflation

computed.
Example: for good i = 1, 2, 3

CPI in month t 100
Et
P C + P2t C 2 + P3t C 3
100 1t 1
Eb
Eb
C1
C2
C3
100 P1t P2t P3t
Eb
Eb
Eb
Et : the cost of the CPI basket in month t

Eb : the cost of the basket in the base period
Ci : the amount of good i in the CPIs basket
Pit : the price of good i in month t
The CPI is a weighted sum of prices.

The weight on each price reflects
that goods relative importance in the CPIs
basket.
Weights remain fixed over time.
Real GDP versus Nominal GDP
Discuss the difference between real

GDP and nominal GDP.
iii. Understanding the GDP deflator

P1t Q1t P2t Q2t P3t Q3t
NGDPt
100
GDP deflator 100

RGDPt
RGDPt
Q1t
Q2t
Q3t
100
P1t
P2t
P3t
RGDPt
RGDPt
RGDPt
The GDP deflator is a weighted sum of prices.
The weight reflects relative importance of

each good in GDP.
Weights change over time.
Measuring Inflation

computed.
CPI vs. GDP deflator

Recap: GDP is the market value of all final goods and services
produced within a country's domestic borders during a specific year.
Prices of capital goods

included in GDP deflator (if produced domestically)
excluded from CPI
Prices of imported consumer goods

included in CPI
excluded from GDP deflator
The basket of goods
CPI: fixed
GDP deflator: changes every year
31 of 52
Two measures of inflation

CPI increased
much faster than
the GDP deflator.
Why?
Percentage
change 16
14
CPI
12
10
8
6
4
2
GDP deflator
0
-2
1948
1953
1958
1963
1968
1973
1978
1983
1988
1993
1998
Year
Note: the data are the percentage changes, not the levels, of the CPI and
the GDP deflator.
32 of 52
Real versus Nominal Interest

Rates

Distinguish between the nominal
interest rate and the real interest rate.
Nominal interest rate:

The stated interest rate on a loan.
Real interest rate:
Nominal Interest Rate Inflation Rate

Deflation:
A decline in the price level.
33 of 52
Real versus Nominal Interest

Rates

You make a $100 loan to your friend for one year at nominal interest rate
6%, the only good you purchase is apple,
price = $10 each.
Suppose inflation rate = 2%, what is the rate of change of your purchasing
power resulting from the loan? i.e., the real interest rate =?
100/10 = 10: purchasing power at the beginning of the year
106/10.2 = 10.392: purchasing power at the end of the year
You can purchase almost 4% more of apples.
[(10.392-10)/10 = 3.92%]
Real interest rate = nominal interest rate inflation rate
rt
(1 it ) X t Pt 1 X t
X t Pt
1 rt
Pt
1 it
rt it t 1
1 t 1
X: principal
(1+i)X: repayment
Real versus Nominal Interest Rates
FIGURE 20-7

Nominal and Real Interest Rates, 19702008
3 month U.S. Treasury bills.
R = 5.5%
(1975)
r = 1.5%
(1975)
better measure of the true cost

of borrowing and the true
return on lending
35 of 52
Does Inflation Impose

Costs on the Economy?

Discuss the problems that inflation
causes.
Inflation Affects the Distribution of Income

The extent to which inflation redistributes income depends in part on
whether the inflation is anticipatedin which case consumers, workers,
and firms can see it coming and can prepare for it or unanticipatedin
which case they do not see it coming and do not prepare for it.
The Problem with Anticipated Inflation

Menu costs The costs to firms of changing prices.
The Problem with Unanticipated Inflation

When the actual inflation rate turns out to be very different from
the expected inflation rate, some people gain, and other people
lose. This apparently unfair redistribution is a key reason why
people dislike unanticipated inflation.
36 of 52
Making Whats So Bad about
Discuss the problems that inflation

causes.
the Falling Prices?
Connection
1929 1930
Nominal interest rate
Change in the consumer

price level
Real interest rate
1931
1932
1933
5%
5%
5%
5%
5%
-2.3
-9.0
-9.9
-5.1
7.30
14.00
14.90
10.10
Postpone
consumption
and rising
burden of
borrowers
YOUR TURN: Test your understanding by doing related problem 7.7 at the end of
this chapter.
37 of 52
Hyperinflation in Pictures: The Monetary

Crisis in Zimbabwe
231 million %
inflation and
80% unemployment
rate.
http://mjperry.blogspot.com/2008/10/itcould-be-worse-lot-worse.html
Here's how restaurant

checks are settled:
A restaurant check of more

than 1 billion dollars!
Only a few months

later, three eggs cost
100 billion dollars...
Source:
http://ebas1.ebas.gov.tw/px
web/Dialog/Saveshow.asp
Source:
http://ebas1.ebas.gov.
tw/pxweb/Dialog/Save
show.asp

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CHAPTER

Chapter 20: Unemployment and Inflation

Chapter Outline and

20.2 Types of Unemployment

Measuring the Labor Force Participation

20.1 LEARNING OBJECTIVE

The Household Survey

Chapter 20: Unemployment and Inflation

Measuring the Unemployment Rate

20.1 LEARNING OBJECTIVE

The Household Survey

Chapter 20: Unemployment and Inflation

Measuring the Unemployment Rate

20.1 LEARNING OBJECTIVE

Trends in Labor Force Participation

Chapter 20: Unemployment and Inflation

Making Why Was Male Unemployment

Chapter 20: Unemployment and Inflation

So High During the

20.1 LEARNING OBJECTIVE

Measuring the Unemployment Rate

20.1 LEARNING OBJECTIVE

Problems with Measuring the Unemployment Rate

Chapter 20: Unemployment and Inflation

The unemployment rate is far from an exact

Discouraged workers are not included.

Great differences across genders,

See the handout for the case of Taiwan (HO: 2 (iii) )

Measuring the Unemployment Rate

20.1 LEARNING OBJECTIVE

How Long Are People Typically Unemployed?

LENGTH OF TIME UNEMPLOYED

PERCENTAGE OF TOTAL UNEMPLOYED

(a) Duration of unemployment during an economic expansion.

Less than 5 weeks

Chapter 20: Unemployment and Inflation

(b) Duration of unemployment during an economic recession.

20.1 LEARNING OBJECTIVE

Measuring the Unemployment Rate

Define unemployment rate and labor

The Establishment (Payroll) Survey: another measure of

Establishments Creating and Eliminating

ESTABLISHMENTS CREATING JOBS

20.2 LEARNING OBJECTIVE

Identify the three types of

The Annual Unemployment Rate in the United States,

Chapter 20: Unemployment and Inflation

The unemployment rate rises during recessions

20.2 LEARNING OBJECTIVE

Identify the three types of

20.2 LEARNING OBJECTIVE

Identify the three types of

Chapter 20: Unemployment and Inflation

Natural rate of unemployment

Learning NRU within 10 min!

20.2 LEARNING OBJECTIVE

Making i. The US sub-prime crisis

during the second half of 2008

Identify the three types of

Unemployment rate (quarterly data): Taiwan, 1990-2012

20.2 LEARNING OBJECTIVE

ii. Youth Unemployment

See 3 (ii) in the handout for explanation