Unemployment

Definition and Economic Impact

Unemployment refers to the condition in which individuals who are capable of working and are actively seeking work are unable to find employment. It has significant economic and social consequences.

• Lost incomes and production: Unemployment leads to a loss of potential output and income for individuals and the economy.

• Loss of human capital accumulation: Prolonged unemployment can erode skills and reduce future productivity, as individuals miss out on job training and learning by doing.

• Unavoidable unemployment: Some level of unemployment is inevitable, even in a healthy economy, due to normal labor market turnover.

Labor Force and Measurement

• Civilian working-age population: The number of people aged 16 and over who are not institutionalized or in the military.

• Labor force: The sum of employed and unemployed individuals actively seeking work.

• To be counted as unemployed, a person must:

  1. Be without work but have made specific efforts to find a job within the past 4 weeks.

  2. Be waiting to be called back to a job after being laid off.

  3. Be waiting to start a new job within 30 days.

Key Formulas

• Unemployment rate:

• Labor force participation rate:

Trends and Cycles

• Unemployment rate typically rises during recessions.

• Employment/population ratio decreases during recessions.

Types of Unemployment

• Frictional unemployment: Arises from normal labor market turnover, such as people changing jobs or entering the workforce.

• Structural unemployment: Caused by changes in technology or foreign competition that alter the skills needed for jobs or the locations of jobs. This type often lasts longer than frictional unemployment and increases the natural rate of unemployment.

• Cyclical unemployment: Occurs when recessions temporarily raise unemployment above its natural rate, typically when GDP is below potential.

Inflation

Definition and Effects

Inflation is the general rise in the price level of goods and services in an economy over time. It affects purchasing power and economic decision-making.

• Causes: Can be due to increased costs, demand outpacing supply, or expansion of the money supply.

• Consequences: Erodes the value of money, can lead to higher interest rates, and may disrupt economic planning.

• Deflation: A general decline in prices, which policymakers try to avoid due to its negative economic effects.

• Hyperinflation: Extremely rapid inflation that can destroy the value of currency and disrupt economic activity.

Consumer Price Index (CPI)

The CPI measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

• CPI basket: Based on a consumer expenditure survey, updated infrequently.

CPI Calculation

Example: If the cost of the basket is 140 in the current year and 100 in the base year, then CPI = (140/100) × 100 = 140. The price level is 40% higher than in the base year.

Biases in the CPI

• CPI may overstate true inflation because it keeps the basket fixed and does not account for consumers substituting cheaper goods.

• It does not adjust for new or higher quality goods.

Nominal and Real Interest Rates

Definitions

• Nominal interest rate: The stated rate, not adjusted for inflation; the price of money now vs. in the future.

• Real interest rate: The nominal rate adjusted for inflation; the price of goods and services now vs. in the future.

Phillips Curve

Relationship Between Unemployment and Inflation

The Phillips Curve illustrates an inverse relationship between unemployment and inflation, particularly observed in historical data from the 1960s and 1970s. When unemployment was high, inflation tended to be low, and vice versa.

• This relationship is not always stable and can shift due to changes in expectations and economic conditions.