Chapter 9: Unemployment and Inflation

Measuring Unemployment and Labor Market Indicators

The labor market is analyzed using several key statistics that help economists understand employment trends and economic health.

• Labor Force: The sum of employed and unemployed workers in the economy.

• Employed: Individuals currently working or temporarily away from their job.

• Unemployed: Individuals not working but available for work and actively seeking employment in the past month.

• Not in the Labor Force: Individuals neither employed nor unemployed (e.g., retirees, students).

• Discouraged Workers: People available for work but not actively seeking employment due to belief that no jobs are available.

• Unemployment Rate: Percentage of the labor force that is unemployed.

• Labor Force Participation Rate (LFPR): Percentage of working-age population in the labor force.

• Employment-Population Ratio: Percentage of working-age population that is employed.

• Problems with Measurement: Unemployment rate may understate (due to underemployed or discouraged workers) or overstate (false claims of job search) actual unemployment.

• Surveys: The U.S. Census Bureau conducts the Current Population Survey (household survey); the Bureau of Labor Statistics (BLS) also uses the establishment (payroll) survey.

Types of Unemployment

Unemployment is classified based on its causes and duration.

• Frictional Unemployment: Short-term unemployment from the process of matching workers with jobs. It can increase efficiency by improving job matches.

• Structural Unemployment: Unemployment from a persistent mismatch between workers' skills and job requirements.

• Cyclical Unemployment: Unemployment caused by downturns in the business cycle (recessions).

• Natural Rate of Unemployment: The sum of frictional and structural unemployment; represents the "normal" rate absent cyclical factors.

Explaining Unemployment

Government policies and labor market institutions can affect unemployment rates.

• Unemployment Insurance: May increase the time spent searching for jobs, as workers are less pressured to accept low-paying jobs immediately.

• Minimum Wage: Studies suggest increases in minimum wage can reduce teenage employment.

• Labor Unions: Not a major cause of unemployment in the U.S.; only about 6% of private sector workers are unionized.

• Efficiency Wage: Firms may pay above-market wages to increase worker productivity.

Measuring Inflation

Inflation is tracked using price indexes that measure changes in the average price level.

• Price Level: Average prices of goods and services in the economy.

• Inflation Rate: Percentage increase in the price level from one year to the next.

• Consumer Price Index (CPI): Measures the average prices paid by a typical urban family for goods and services.

• Problems with CPI:

  • Substitution Bias: Consumers may switch to cheaper goods.

  • Increase in Quality Bias: Difficult to separate price increases from quality improvements.

  • New Product Bias: Delay in including new products in the basket.

  • Outlet Bias: Changes in where consumers shop may not be fully captured.

• Producer Price Index (PPI): Measures average prices received by producers; can signal future consumer price changes.

Using Price Indexes to Adjust for Inflation

Price indexes allow economists to compare purchasing power across time periods.

• Adjusting Dollar Values: To convert old dollar values to current-year dollars:

• Nominal Variables: Values measured in current dollars (e.g., wages).

• Real Variables: Values adjusted for inflation, reflecting true purchasing power.

Nominal vs. Real Interest Rates

Interest rates are distinguished by whether they account for inflation.

• Nominal Interest Rate: The stated rate on a loan, not adjusted for inflation.

• Real Interest Rate: Nominal rate minus the inflation rate.

Costs of Inflation

Inflation, even when anticipated, imposes various costs on the economy.

• Redistribution of Income: Some prices and incomes remain fixed, causing shifts in purchasing power.

• Real Costs of Holding Cash: Inflation reduces the value of cash holdings.

• Menu Costs: Firms incur costs when changing prices.

• Taxation on Nominal Returns: Investors are taxed on nominal, not real, returns, increasing tax burden.

• Unpredictable Inflation: Makes borrowing and lending riskier.

• Deflation: More dangerous than inflation; can lead to delayed purchases and economic stagnation.

Chapter 10: Economic Growth, the Financial System, and Business Cycles

Long-Run Economic Growth

Long-run economic growth refers to sustained increases in productivity and living standards over time.

• Real GDP per Capita: Production per person, adjusted for price changes.

• Average Annual Growth Rate: Average of yearly growth rates.

• Rule of 70: Estimates years to double an economic variable.

• Labor Productivity: Output per hour worked; increases drive real GDP per capita.

• Factors Affecting Productivity:

  • Capital per Hour Worked: More capital increases productivity.

  • Technological Change: Improvements in capital or production methods.

  • Property Rights: Secure property rights encourage investment and innovation.

• Potential GDP: Real GDP when all firms operate at capacity (normal hours and workforce).

Saving, Investment, and the Financial System

The financial system channels funds from savers to borrowers, facilitating investment and economic growth.

• Retained Earnings: Firms reinvest profits for expansion.

• Financial System: Includes financial markets and intermediaries.

• Financial Markets: Where securities (stocks, bonds) are bought and sold.

  • Stock: Partial ownership in a firm.

  • Bond: Loan from household to firm, repaid with interest.

• Financial Intermediaries: Banks, mutual funds, pension funds, insurance companies; borrow from savers, lend to borrowers.

• Key Services:

  • Risk Sharing: Distributes financial risk among participants.

  • Liquidity: Converts assets to cash easily.

  • Information: Provides data for investment decisions.

• Macroeconomics of Savings and Investment: In a closed economy, total saving equals total investment. Rearranged: Private Savings: Public Savings: Total Savings: Therefore:

• Market for Loanable Funds: Conceptual market where borrowers and lenders determine interest rates and loanable funds quantity.

  • Firms borrow more when real interest rates are low.

  • Households supply more funds when real interest rates are high.

  • Government saving or dissaving affects available funds.

  • Crowding Out: Increased government purchases can reduce private investment.

The Business Cycle

The business cycle describes fluctuations in economic activity, including expansions and recessions.

• Expansion: Period of rising real GDP.

• Recession: Period of falling real GDP.

• Peaks: End of expansion phase.

• Troughs: End of recession phase.

• Cycle Dynamics:

  • Near end of expansion: Interest rates and wages rise, firm profits fall.

  • Recession begins: Firms reduce investment, households consume less, employment falls.

  • Recovery: Firms and households increase investment and consumption, employment recovers.

• Inflation Trends: High during expansions, low or negative during recessions.

• Great Moderation: Since mid-1980s, business cycles have been mild due to:

  • Increasing importance of services

  • Unemployment insurance

  • Active federal stabilization policies

  • Financial system stability

Example Table: Types of Unemployment

Additional info: The notes above expand on brief points with academic context, definitions, and examples to ensure completeness and clarity for exam preparation.