Sessions 7 9

Macroeconomic Analysis and Policy
Session:7
Prof. Biswa Swarup Misra
Dean, XIMB
Discussion Points
1. Is GDP a measure of Welfare

2. How unemployment is measured
3. Types of Unemployment
4. What is meant by Full Employment
5. Unemployment measurement in India
1
GDP and Economic Well-Being

Real GDP per capita is the main indicator of the
average persons standard of living.
But GDP is not a perfect measure of

well-being.
Robert Kennedy issued a very eloquent

yet harsh criticism of GDP:
Gross Domestic Product

does not allow for the health of our
children, the quality of their
education, or the joy of their play.
It does not include the beauty of
our poetry or the strength of our
marriages, the intelligence of our
public debate or the integrity of our
public officials.
It measures neither our courage, nor our wisdom,
nor our devotion to our country. It measures everything,
in short, except that which makes life worthwhile, and it
can tell us everything about America except why we are
proud that we are Americans.
- Senator Robert Kennedy, 1968
GDP Does Not Value

the quality of the environment
leisure time
non-market activity, such as the child care
a parent provides his or her child at home
an equitable distribution of income
Then Why Do We Care About GDP?

Having a large GDP enables a country to afford
better schools, a cleaner environment,
health care, etc.
Many indicators of the quality of life are positively

correlated with GDP. For example
GDP and Life Expectancy in 12 Countries

90
Life
expectancy 85
(in years)
Japan
80
U.S.
75
Indonesia
China
70
Germany
Mexico
Brazil
65
India
60
Russia
Pakistan
Bangladesh
Nigeria
55
50
$0
$10,000
$20,000
$30,000
$40,000
Real GDP per capita, 2002

6
GDP and Adult Literacy in 12 Countries

Adult 100
Literacy
(% of 90
population) 80
Russia
China
Mexico
Germany
Brazil
Indonesia
70
Nigeria
60
India
50
U.S.
Japan
Pakistan
40
Bangladesh
30
$0
$10,000
$20,000
$30,000
$40,000

7
GDP and Internet Usage in 12 Countries

Internet
Usage
(% of
population)
60
U.S.
50
Japan
Germany
40
30
20
China
10
Mexico
Brazil
Russia
0
$0
$10,000
$20,000
$30,000
$40,000

8
Big Mac Index: The Economist

Looks at the prices of a Big Mac burger in McDonald's
restaurants in different countries.
If a Big Mac costs US$4 in the U.S. and GBP3 in Britain, the
PPP exchange rate would be 3 for $4.
The Big Mac Index is presumably useful because
it is based on a well-known good

whose final price, easily tracked in many countries
includes input costs from a wide range of sectors in the
local economy, such as agricultural commodities labour,

advertising, rent and real estate costs, transportation,
etc.
The Big Mac Index is inaccurate in certain cases because
of the different market conditions that exist in differing
9
McDonald's locations.
Why PPP Exchange Rates?

Currencies are traded for purposes other than trade in goods
and services, e.g., to buy capital assets whose prices vary
more than those of physical goods.
Also, different interest rates, speculation, hedging or
interventions by central banks can influence the foreignexchange market.
A purchasing power parity exchange rate equalizes the

purchasing power of different currencies in their home
countries for a given basket of goods.
It is often used to compare the standards of living between
countries, rather than a per-capita gross domestic products

comparison at market exchange rates
10
What has not changed

Federal Fund Rate at 0-0.25% between Dec
2008 and October 2015
The Fed, America's central bank, last raised

rates in June of 2006, by 25 basis points to
5.25%.
After June 2006 , Fed started reversing course,

as a housing bust gave way to the Great
Recession; since December of 2008, the Fed's
benchmark interest rate has been set at
between 0.0% and 0.25%.
11
What has not changed

The camp advocating caution won over the Federal
Open Market Committee, which voted 9-1 on Thursday
to keep its benchmark rate near zero-where it has been
since December 2008-to get a better read on how
global economic turbulence and unsettled markets
The new payroll data reveals that the rates are not
going to change for quite some more time.
September non-farm payroll data was released on

October 2, financial analysts, who seemed perfectly
sanguine that the Fed would hike its policy rate by the
year-end, suddenly swung around to the view that the
hike would now come only in 2016.
12
FED Decision
The consensus had expected an addition of
200,000 jobs to the workforce for the month; the
number printed at a paltry 142,000.
To be fair, it wasnt just one data point that drove

this volte-face. The August number was also
revised down.
The last two months saw a further decline in the

data when the average monthly gain in non-farm
payrolls dropped to 139,000, down from an
average of 214,000 in the first seven months of this
year and an average of 280,000 in the second half
of 2014.
13
FED Decision
There are other things about the labour

market that could be prudent to fret about.
First,wages or hourly earnings are not

growing and that somehow does not square
with the fact that the unemployment rate is a
very low 5.1 per cent and prima facie, should
suggest extreme tightness in the labour
market.
Some of this could be explained by the labour

force participation rate or the fraction of the
working age population that is looking for
jobs.
14
FED Decision
LFPR at 62.6 per cent, is at its lowest since the
mid-1970s.
Americans have simply dropped out of the

workforce and stopped searching for jobs.
The risk of these workforce dropouts re-entering

the workforce would itself hold down wages.
At the same time, it has kept the unemployment

rate down just by its numerical heft.
First, it highlights the fact that job additions

seem to have peaked towards late 2014 and
early 2015, but has been moderating since then.
15
Measuring Unemployment
There are more than 300 million people in the United States, and
monitoring and reporting on their activities regularly would be very
difficult and costly.
Instead, the U.S. Department of Labor reports estimates of

employment, unemployment, and other statistics related to the labor
force each month.
Labor force: The sum of employed and unemployed workers in the

economy.
Of these statistics, the most watched is known as the

unemployment rate: the percentage of the labor force that is
unemployed.
16
16
The Household Survey

Each month, the U.S. Bureau of the Census conducts the Current
Population Survey (the household survey).
~60,000 households selected to be representative

Household members of working age (16+ years old)
Asked about employment during reference week
Also asked about recent job-search activities
People are then classified as:

Employed: Worked 1+ hours in reference week (or were
temporarily away from their jobs).
Unemployed: Someone who is not currently at work but who is

available for work and who has actively looked for work during the
previous month
Not in the labor force, if neither of the above apply

17
17
August 2013 Civilian Working-Age Population
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.
The employment status

of the civilian working-age
population, August 2013
18
18
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
19
Labor Force Statistics

Unemployment rate (u-rate):
% of the labor force that is unemployed
u-rate
# of unemployed
= 100 x
labor force
Labor force participation rate:

% of the adult population that is in the labor force
labor force
labor force
= 100 x
participation rate
adult population
20
Unemployment Rate
Based on the CPS estimates,
we calculate several important
macroeconomic indicators.
The most-watched is the
unemployment rate:
Number of unemployed
100 Unemployment rate
Labor force
11.3 million
100 7.3%
155.5 million
This most-common measure

of unemployment is known
formally as BLS series U-3.

21
21
Labor Force Participation and Employment-Population

Also important are the labor force
participation rate (the percentage of
the working-age population in the labor
force)
Labor force
100 Labor force participation rate
Working - age population
155.9 million
100 63.2%
245.9 million
and the employment-population

ratio (the percentage of the workingage population that is employed):
Employment
100 Employment - population ratio
Working - age population
144.2 million
100 58.6%
245.9 million
22
22
A C T I V E L E A R N I N G 1:
Calculate labor force statistics
Compute the labor force, u-rate, adult population,

and labor force participation rate using this data:
Adult population of the U.S.
by group, January 2006
# of employed
143.1 million
# of unemployed
7.0 million
not in labor force
77.4 million
23
Answers
Labor force = employed + unemployed
= 143.1 + 7.0
= 150.1 million
U-rate
= 100 x (unemployed)/(labor force)
= 100 x 7.0/150.1
= 4.7%
24
Answers
Population
= labor force + not in labor force
= 150.1 + 77.4
= 227.5
LF partic. rate = 100 x (labor force)/(population)
= 100 x 150.1/227.5
= 66.0%
25
Exercise
In each of the following, what happens to the u-rate? Does

the u-rate give an accurate impression of whats happening in
the labor market?
A. Sue lost her job, and begins looking for a new one.
B. Jon, a steelworker who has been out of work since his mill
closed last year, becomes discouraged and gives up looking for
work.
C. Sam, the sole earner in his family of 5, just lost his $80,000 job
as a research scientist. Immediately, he takes a part-time job at
McDonalds until he can find another job in his field.
26
Answers
A. Sue lost her job, and begins looking for a new one.
u-rate rises
A rising u-rate gives the impression that the labor market is
worsening, and it is.
27
Answers
B. Jon has been out of work since last year,

becomes discouraged, stops looking for work.
Discouraged workers
would like to work but have given up looking for jobs
classified as not in the labor force rather than unemployed
u-rate falls, because Jon is no longer counted as unemployed.

A falling u-rate gives the impression that the labor market is
improving, but it is not.
28
Answers
C. Sam lost his $80,000 job, and takes a part-time job at

McDonalds until he finds a better one.
u-rate unchanged, because a person is employed whether they
work full or part time.
Things are worse, but the u-rate fails to show it.
29
Problems with Measuring the Unemployment Rate

The unemployment rate measured by the BLS is not a perfect
measure of joblessness. Why?
It may understate unemployment:

Distinguishing between people who are unemployed and not in the
labor force requires judgment (should we exclude discouraged
workers?)
Only measures employment, not intensity of employment (full-time

vs. part-time; some people are underemployed)
It may overstate unemployment:

People might claim falsely to be actively looking for work
May claim not to be working to evade taxes or keep criminal
activity unnoticed
30
30
Alternative Measures of Unemployment: U-6
Some people suggest that we should include

discouraged workers and underemployed workers in The official
unemployment rate
the unemployment statistics, to create a broader
and a broad measure
measure of unemployment.
of the unemployment
The BLS measures this, calling it BLS series U-6.
rate, 1996-2013
31
31
Trends in Labor Force Participation
The labor force participation rate of adult men
Figure
has declined gradually since 1948
Trends in the labor
but it has increased significantly for adult
force: participation
rates of adult men and
women since 1948
women, making the overall rate higher today than

it was then.
9.3
32
32
Is Falling Labor Force Participation Bad?

Politicians often like to point
to a falling labor force
participation rate as a strongly
negative sign for the economy.
Is this necessarily true?

The two major reasons why
the LFPR for men has fallen
over the last several decades
are:
Men have been going to school for longer and retiring earlier
than before (why?)
Increases in Social Security Disability Insurance availability

have allowed people with disabilities to stop work
Whether these are good or bad is a value judgment.
33
33
Unemployment Rates for Different Groups
Unemployment rates vary by ethnic group

and by education level.
These two observations are statistically
related.
Unemployment
rates in the
United States,
August 2013
34
34
How Long Are People Typically Unemployed?

Long periods of unemployment are bad for workers, as their skills
decay and they risk becoming discouraged and depressed.
During the Great Depression of the 1930s, some people were

unemployed for years at a time.
Since World War
II, average
lengths of
unemployment
have been
relatively low; but
that changed
dramatically with
the 2007-2009
recession.
35
35
The Employment Situation Following the 2007-2009 Recession
The fall of the employmentpopulation ratio may give an even

better indication of how weak the U.S. labor market was during
and after the 20072009 recession.
Explaining these changes is a top priority for labor economists.
36
36
Session:8
Dean, XIMB
The Establishment Survey

In addition to the household survey, the BLS also uses the
establishment survey, (a.k.a. the payroll survey).
This survey samples ~300,000 establishments, or places of

employment, about their employees. Disadvantages include:
Self-employed people not surveyed (not on a company payroll)

Newly-opened firms often omitted
Information on employment only, not unemployment
Numbers fluctuate depending on establishments included, often
requiring large revisions
However, a big advantage is that the data are determined by real

payrolls, not self-reporting like the household survey.
38
38
Comparing the Household and Establishment Surveys

The table below gives the data from the July and August 2013
household and establishment surveys:
Household Survey
July
Establishment Survey
August
Change
144,285,000
144,170,000
115,000
Unemployed
11,514,000
11,316,000
198,000
Labor force
155,798,000
155,486,000
312,000
Employed
Unemployment rate
7.4%
7.3%
July
August
135,964,000 136,133,000
Change
169,000
0.1%
Household and establishment survey

data for July and August 2013
Even if all surveys are truthfully and accurately answered, we do

not expect the numbers to be identical between the two surveys:
Different groups are measured
All surveys have measurement errors

But we get a more complete picture by considering both surveys.
39
39
Revisions to Employment Numbers
Over time, the BLS adjusts its estimates of

employment and unemployment for previous months. Revisions to
employment changes,
Revisions sometimes take place years later.
The large negative revisions were because the BLS

underestimated the severity of the 2007-2009
recession.
as reported in the
establishment survey
40
40
Job Creation and Destruction

Number of Jobs
Establishments Creating Jobs

Existing establishments
5,752,000
New establishments
1,299,000
Establishments Eliminating Jobs

Existing establishments
5,180,000
Closing establishments
1,203,000
Jobs are continually being created and destroyed

in the U.S. economy. In 2012, about 27.8 million
jobs were created, while about 25.5 million jobs
were destroyed.
This is a natural and normal process for the
Establishments
creating and
eliminating jobs,
SeptemberDecember 2012
economy.
The table shows jobs created and destroyed over a

three-month period from September to December
2012.
41
41
U.S. Annual Unemployment Rate over Time
Unemployment rates rise when the economy is

faltering, and fall when the economy is doing well.
But they never fall to zero.
To understand why, we will examine the types of

unemployment.
The annual
unemployment rate in
the United States,
1950-2012
42
42
US Employment Scenario-2015
Among the marginally attached, there were
635,000 discouraged workers in September,
little changed from a year earlier.
Discouraged workers are persons not currently

looking for work because they believe no jobs
are available for them.
The remaining 1.3 million persons marginally

attached to the labor force in September had not
searched for work for reasons such as school
attendance or family responsibilities.
43
US Employment Scenario-2015
US working age Population in Sep 2015=251.3 mn
Labour force=156.7 mn
The civilian labor force participation rate
declined to 62.4 percent in September
In September, the unemployment rate held at 5.1

percent, and the number of unemployed persons
(7.9million) changed little.
Over the year, the unemployment rate and the

number of unemployed persons were down by 0.8
percentage point and 1.3 million, respectively
44
Cyclical Unemployment vs. the Natural Rate
Theres always some unemployment, though the urate fluctuates from year to year.
The natural rate of unemployment
the normal rate of unemployment around which the
actual unemployment rate fluctuates
cyclical unemployment
the deviation of unemployment from its
natural rate associated with business cycles, which
well study in later sessions
45
Three Types of Unemployment

The three types of unemployment are:
Frictional unemployment
Structural unemployment
Cyclical unemployment
We will examine each in turn over the coming slides.
46
46
Unemployment Rate since 1960
This graph uses annual data on the U.S. unemployment rate to show the percentage
of the labor force without a job. The natural rate of unemployment is the normal level of
unemployment around which the unemployment rate fluctuates.
47
47
Explaining the Natural Rate: An Overview
Even when the economy is doing well, there is

always some unemployment, including:
Frictional unemployment
Occurs when workers spend time searching for
the jobs that best suit their skills and tastes
short-term for most workers
occurs when there are fewer jobs than workers
usually longer-term
48
Mankiw versus Other Books

Some books commonly define structural unemployment
as arising from a mismatch between the skills or
locations of workers and the skill requirements or
locations of jobs.
Mankiws treatment is as follows: If all wages were

flexible, then they would adjust after structural changes
so that all workers with any given skill set in any given
location would be employed.
The cause of structural unemployment therefore cannot
be changes in the structure of demand and production;
the cause must be wages that fail to adjust following
these changes.
49
Job Search
Workers have different tastes & skills, and jobs have
different requirements.
Job search is the process of matching workers with
appropriate jobs.
Sectoral shifts are changes in the composition of

demand across industries or regions of the country.
Such shifts displace some workers, who must search
for new jobs appropriate for their skills & tastes.
The economy is always changing, so some frictional
unemployment is inevitable.
50
Public Policy and Job Search

Govt employment agencies:
give out information about job vacancies to speed
up the matching of workers with jobs
Public training programs:
aim to equip workers displaced from declining
industries with the skills needed in growing
industries
51
Unemployment Insurance
Government program
Partially protects workers incomes
- When they become unemployed
Increases frictional unemployment
- Without intending to do so
Qualify only the unemployed who were laid off because
their previous employers no longer needed their skills
The unemployed who quit their jobs, were fired for cause, or
just entered the labor force are not eligible.
Benefits are paid only to the unemployed who were laid off
because their previous employers no longer needed their skills.
UI increases frictional unemployment. To see why, recall one of

the Ten Principles of Economics:
52
People respond to incentives.
52
Public Policy and Job Search

Unemployment insurance
50% of former wages for twenty-six weeks
Reduces the hardship of unemployment
Increases the amount of unemployment
- Unemployment benefits stop when a worker takes a
new job
- Unemployed
Devote less effort to job search
More likely to turn down unattractive job offers
Less likely to seek guarantees of job security
53
53
Many studies by labor economists have examined the
incentive effects of unemployment insurance. One study
examined an experiment run by the state of Illinois in
1985.
When unemployed workers applied to collect

unemployment insurance benefits, the state randomly
selected some of them and offered each a $500 bonus if
they found new jobs within 11 weeks.
This group was then compared to a control group not

offered the incentive.
The average spell of unemployment for the group offered

the bonus was 7 percent shorter than the average spell
for the control group.
This experiment shows that the design of the

unemployment insurance system influences the effort
that the unemployed devote to job search.
54
Several other studies examined search effort
by following a group of workers over time.
Unemployment insurance benefits, rather

than lasting forever, usually run out after six
months or a year.
These studies found that when the

unemployed become ineligible for benefits,
the probability of their finding a new job rises
markedly.
Thus, receiving unemployment insurance

benefits does reduce the search effort of the
unemployed.
55
Even though unemployment insurance reduces
search effort and raises unemployment, we should
not necessarily conclude that the policy is a bad one.
The program does achieve its primary goal of

reducing the income uncertainty that workers face.
In addition, when workers turn down unattractive
job offers, they have the opportunity to look for jobs
that better suit their tastes and skills.
Some economists have argued that unemployment

insurance improves the ability of the economy to
match each worker with the most appropriate job.
56
Minimum-Wage Laws
Number of jobs insufficient
Minimum-wage laws
Can cause unemployment
Forces the wage to remain above the
equilibrium level
- Higher quantity of labor supplied
- Smaller quantity of labor demanded
- Surplus of labor unemployment
57
57
Explaining Structural Unemployment

Structural
unemployment
occurs when not
enough jobs to
go around.
Occurs when wage
is kept above eqm.
There are three reasons for
this
unemployment S
actual
wage
W1
WE
58
1. Minimum-Wage Laws
The min. wage may exceed the eqm wage
for the least skilled or experienced workers,
causing structural unemployment.
But this group is a small part of the labor force, so
the min. wage cant explain most unemployment.
59
Minimum Wage Laws

Minimum wage laws are designed to help low-income workers; but
raising the wage that firms have to pay will likely result in them hiring
fewer workers.
Federal minimum
wage
Inflation-adjusted
minimum wage
1938 (first year of federal

minimum wage)
$0.25 per hour
$4.15 per hour
2013
$7.25 per hour
$7.25 per hour
Year
Relatively few full-time adults earn minimum wage. The group most
likely to receive minimum wage is teenagers.
How much unemployment does the minimum wage really cause?
Economists are uncertain, but believe it to be relatively small.
Studies suggest a 10% increase in the minimum wage would
reduce teenage employment by about 2%.
60
60
2. Unions
Union: a worker association that bargains with
employers over wages, benefits, and working
conditions
Unions exert their market power to negotiate higher
wages for workers.
The typical union worker earns 20% higher wages
and gets more benefits than a nonunion worker
for the same type of work.
61
2. Unions
When unions raise the wage above eqm,
quantity of labor demanded falls and
unemployment results.
Insiders workers who remain employed,

they are better off
Outsiders workers who lose their jobs,
they are worse off
Some outsiders go to non-unionized labor markets,
which increases labor supply and reduces wages
in those markets.
62
2. Unions
Are unions good or bad? Economists disagree.
Critics:
Unions are cartels. They raise wages above eqm,
which causes unemployment and/or depresses
wages in non-union labor markets.
Advocates:
Unions counter the market power of large firms,
make firms more responsive to workers concerns.
63
3. Efficiency Wages
The theory of efficiency wages:
firms voluntarily pay above-equilibrium
wages to boost worker productivity.
Different versions of efficiency wage theory
suggest different reasons why firms pay
high wages.
64
3. Efficiency Wages
Four reasons why firms might pay efficiency wages:
1. Worker health
In less developed countries, poor nutrition is a
common problem. Paying higher wages allows
workers to eat better, makes them healthier,
more productive.
2. Worker turnover
Hiring & training new workers is costly.
Paying high wages gives workers more incentive
to stay, reduces turnover.
65
3. Efficiency Wages
Four reasons why firms might pay efficiency wages:
3. Worker quality
Offering higher wages attracts better job applicants,
increases quality of the firms workforce.
4. Worker effort
Workers can work hard or shirk. Shirkers are fired
if caught. Is being fired a good deterrent?
Depends on how hard it is to find another job.
If market wage is above eqm wage, there arent
enough jobs to go around, so workers have more
incentive to work not shirk.
66
Exercise
Which of the following would be most likely to

reduce frictional unemployment?
A.
B.
C.
D.
The govt eliminates the minimum wage.

The govt increases unemployment insurance benefits.
A new law bans labor unions.
More workers post their resumes at Monster.com, and more
employers use Monster.com to find suitable workers to hire.
E. Sectoral shifts become more frequent.
67
Answers

A. The govt eliminates the minimum wage.
C. A new law bans labor unions.
These are likely to reduce

structural unemployment,
not frictional unemployment.
68
Answers

B. The govt increases unemployment insurance benefits.
E. Sectoral shifts become more frequent.
These are likely to increase

frictional unemployment, not reduce it.
69
Answers

D. More workers post their resumes at Monster.com, and more
employers use Monster.com to find suitable workers to hire.
Likely to speed up the process of matching

workers & jobs, which would
reduce frictional unemployment.
70
Explaining the Natural Rate of

Unemployment: A Summary
The natural rate of unemployment consists of
frictional unemployment
it takes time to search for the right jobs
occurs even if there are enough jobs to go around
structural unemployment
when wage is above eqbm, not enough jobs
due to min. wages, labor unions, efficiency wages
In later sessions, we will learn about cyclical

unemployment, the short-term fluctuations in
unemployment associated with business cycles.
71
LFPR and Unemployment Rate

Labour Bureau-Shimla - The labour force estimates are derived for the
persons of age 15 years and above.
Labourforce Participation Rate
Unemployment Rate
72
Labour Bureau
A fixed reference period of Agriculture Year 2010-11
i.e. July, 2010 to June, 2011 is used to derive the
estimates based on usual status approach.
For current weekly and current daily status approach,

the week comprising of seven days preceding the date
of the survey is taken as the reference period.
A sample of 1,28,298 households has been covered,

out of which 81,430 households are in the rural sector
and the remaining 46,868 households in the urban
sector.
From the households covered, 6,29,753 members are

surveyed out of which 4,03,271 members reside in
rural households and rest 2,26,482 in the urban
households.
73
Formulae for Measuring

Unemployment in India
74
75
Capturing Unemployment in India

The NSSO collects data on employment and unemployment using
alternative reference periods relating to three approaches.
These are: the 'usual status' (US) approach, based on the a
reference period of one year;
the 'current weekly status' (CWS) approach, based on a reference
period of one week; and
the 'current daily status' (CDS), based on the activity pursued on
each day of the reference week.
While all three approaches are used for collection of data on
employment and unemployment in the quinquennial surveys, the
first two approaches are only used for the intervening annual
surveys.
The definitions of these three approaches are set out below.
76

In a number of earlier rounds, the NSSO has experimented
with various concepts and methodologies in trying out and
standardizing a proper framework to estimate, in
quantitative terms, the characteristics of labour force,
employment, unemployment and under-employment.
The experimental surveys were followed by regular annual

sample surveys till late sixties.
Afterwards, the quinquennial surveys started in 27th round
(1972-73), with the follow up surveys in 32nd round
(1977-78), 38t h round (1983) and 43rd round (1987-88)
and 50t h Round (1993-94).
The NSSO now also gives annual estimate of employment and

unemployment on the basis of a thin sample.
77

The data are obtained through sample surveys conducted by the
National Sample Survey Organisation (NSSO).
Every fifth year, the sample size is of the order of 120,000
households.
In intervening years, the sample size is of the order of 40,000
households.
Each survey is divided into four sub-rounds, with each subround of three months duration.
(The results of each sub-round are not presently compiled
separately.)
The survey covers the whole of the rural and urban areas of
India, except for a few inaccessible and difficult pockets.
The activity status of each person in the household is collected
with reference to the previous 365 days, the previous 7 days 78
and daily for 7 days.
'Usual Status' Approach

'Usual Status' approach. This is based on the status of the
activity on which a person spent the majority of the 365
days preceding the date of the survey.
A person is considered to be 'working or employed' if
he/she was engaged for a relatively longer time during the
past year in any one or more work-related (economic)
activities.
A person is considered to be 'seeking or available' for work
or 'unemployed' if the person was not working but was
either seeking or available for work for a relatively longer
period of time during the past year.
79
Concept of work
The NSSO has defined work or gainful activity
as the activity pursued for pay, profit or family
gain or in other words, the activity which adds
value to the national product.
Normally, it is an activity, which results in
production of goods and services for exchange.
However, all activities in agricultural sector in
which a part or whole of the agricultural
production is used for own consumption and does
not go for sale are also considered as gainful.
80
'Current Weekly Status' Approach

'Current Weekly Status' approach. A person is considered
to be working or employed if the person was engaged for
at least one hour on any one day of the previous week on
any work related (economic) activity.
A person who has not worked for even one hour on any
one day of the week, but has been seeking or has been
available for work at any time for at least one hour during
the week, is considered to be 'seeking/available for work'
(unemployed).
Others are considered to be 'not available for work' (not in
the labour force).
81
Relevance of CWS, CDS and US

CWS reflects the unemployment during the current week of
those classified as being employed in the US criterion.
The difference between the unemployment rates on the CWS
and US provides one measure of seasonal unemployment.
CDS captures the within week unemployment status of those
classified as employed as per the CWS status.
US unemployment rate gives us the percentage of individuals

in the labour force classified as unemployed.
CDS tells us unemployment in terms of person days.
82
'Current Daily Status' Approach

'Current Daily Status' approach.
This approach attempts to classify employment by
person-days, rather than by persons.
A person is considered to be 'working' (employed) for
the entire day if he/she has worked 4 hours or more
during the day.
If a person has worked one hour or more, but less than 4
hours, he/she is considered to be 'employed' for half the
day, and 'seeking/available for work' (unemployed) or
'not available for work' (not in the labour force) for the
other half of the day depending on whether he/she is
seeking or available for work.
83
Session-9
Dean, XIMB
We address these questions

1. What are the facts about living standards and growth
rates around the world?

2. Why does productivity matter for living standards?
3. What determines productivity and its growth rate?
4. What is the basis of Convergence behaviour
5. How can public policy affect growth and living
standards?
Introduction
Every year 1.8 million children die from
diarrhea.
Preventing these deaths requires only one

thing: economic growth.
Health and wealth go together.

The next figure shows that the higher the
GDP per capita the greater is the survival
rate of newborns.
86
Introduction
87
Introduction
Wealth is clearly important. This leads us to

ask three questions:
Why are some nations wealthy while others

are poor?
Why are some nations getting wealthier faster
than others?
Can anything be done to help poor nations
become wealthy?
In this session, we will try to answer some of

these questions.
88
A typical family with all their possessions in the U.K.,

an advanced economy
Real GDP per capita: $30,800

Life expectancy: 88 years
Adult literacy: 99%
89
A typical family with all their possessions in Mexico,

a middle income country
Real GDP per capita: $9,800

Life expectancy: 84 years
Adult literacy: 92%
90
A typical family with all their possessions in Mali, a

poor country
Real GDP per capita:$1,000

Life expectancy:41 years
Adult literacy:46%
91
Wealthy Nations and Economic Growth
Three Key Facts
1.GDP per Capita Today Varies
Enormously among Nations

2.Everyone Used to Be Poor
3.There are Growth Miracles and
Growth Disasters
Lets look at each of these in turn.

92

1. GDP per Capita Today Varies Enormously
Among Nations
93
2. Everyone Used to Be Poor
94
Primer on Growth Rates
How is economic growth measured?
y t y t 1
gt
100
y t 1
Where yt is per capita real GDP in year t
Example:
g2009
Year
real GDP per capita

2008
$15,000
2009
$15,500
15,500 15,000
100 3.33%
15,000
95
The Rule of 70 (The Magic of Compounding)

The rule of 70:
70
Doubling time
growth rate in %
Example: If real GDP per capita is growing at an annual

growth rate of 3.5%, it will double in:
70
20 years.
3.5
The moral? Small improvements in growth add up fast

(the power of compounding).
96
A Little Growth Goes

a Long Way
97
3. Growth Miracles and Growth Disasters
The U.S. is one of the wealthiest
countries due to long-run steady

growth.
Real growth of other countries can be
evaluated by comparing theirs to the
U.S.
98
Two Growth Miracles

Japan:
- annual rate of real growth1950-80 = 8.5%
South Korea:
- annual rate of real growth1950-80 = 8.2%
Two Growth Disasters

Argentina
- 1900: one of the richest countries in the world

- Now: per capita real GDP is 1/3 that of the U.S.
Nigeria
- Has barely grown since 1950

- Poorer now than it was in 1984
99
100
Incomes
(PPP terms)
and Growth
Around the
World
FACT 1:
There are
vast
differences
in living
standards
around the
world.
China
Singapore
Japan
Spain
Israel
India
United States
Canada
Colombia
New Zealand
Philippines
Argentina
Saudi Arabia
Rwanda
Haiti
GDP per
Growth rate,
capita, 2004 1960-2004
$5,495
5.6%
28,283
5.4%
29,539
3.9%
25,341
3.2%
24,082
2.6%
3,115
2.5%
39,618
2.2%
31,129
2.1%
8,121
1.8%
22,912
1.4%
4,558
1.3%
12,823
0.8%
14,022
0.8%
1,326
0.2%
1,685
1.3% 101
Incomes
(PPP terms)
and Growth
Around the
World
FACT 2:
There is
also great
variation
in growth
rates across
countries.
China
Singapore
Japan
Spain
Israel
India
United States
Canada
Colombia
New Zealand
Philippines
Argentina
Saudi Arabia
Rwanda
Haiti
GDP per
Growth rate,
capita, 2004 1960-2004
$5,495
5.6%
28,283
5.4%
29,539
3.9%
25,341
3.2%
24,082
2.6%
3,115
2.5%
39,618
2.2%
31,129
2.1%
8,121
1.8%
22,912
1.4%
4,558
1.3%
12,823
0.8%
14,022
0.8%
1,326
0.2%
1,685
1.3% 102
Incomes and Growth Around the World

Since growth rates vary, the country rankings can
change over time:
Poor countries are not necessarily doomed to
poverty forever e.g., Singapore, incomes were

low in 1960 and are quite high now.
Rich countries cant take their status for granted:

They may be overtaken by poorer
but faster-growing countries.
103
Incomes and Growth Around the World

Questions:
Why are some countries richer than others?

Why do some countries grow quickly while others
seem stuck in a poverty trap?
What policies may help raise growth rates and

long-run living standards?
104
Productivity
Recall one of the Ten Principles of Economics: A
countrys standard of living depends on its ability
to produce g & s.
This ability depends on productivity:

the average quantity of g&s produced
per unit of labor input.
Y = real GDP = quantity of output produced

L = quantity of labor
so we can write productivity as
Y/L (output per worker)
105
Why Productivity Is So Important

When a nations workers are very productive, real
GDP is large and incomes are high.
When productivity grows rapidly, so do living

standards.
What, then, determines productivity and its

growth rate?
106
Physical Capital Per Worker

Recall: The stock of equipment and structures
used to produce g&s is called [physical] capital,
denoted K.
K/L = capital per worker.

Productivity is higher when the average worker
has more capital (machines, equipment, etc.).
i.e.,
an increase in K/L causes an increase in Y/L.
107
Human Capital Per Worker

Human capital (H):
the knowledge and skills workers acquire through
education, training, and experience
H/L = the average workers human capital

Productivity is higher when the average worker
has more human capital (education, skills, etc.).
i.e.,
an increase in H/L causes an increase in Y/L.
108
Natural Resources Per Worker

Natural resources (N): the inputs into production
that nature provides, e.g., land, mineral deposits
Other things equal,

more N allows a country to produce more Y.
In per-worker terms,
an increase in N/L causes an increase in Y/L.
Some countries are rich because they have abundant

natural resources
(e.g., Saudi Arabia has lots of oil)
But countries need not have much N to be rich

(e.g., Japan imports the N it needs).
109
Technological Knowledge
Technological knowledge: societys
understanding of the best ways to produce g&s
Technological progress does not only mean

a faster computer, a higher-definition TV,
or a smaller cell phone.
It means any advance in knowledge that boosts

productivity (allows society to get more output
from its resources).
e.g., Henry Ford and the assembly line.
110
Tech. Knowledge vs. Human Capital

Technological knowledge refers to societys
understanding of how to produce g&s.
Human capital results from the effort people

expend to acquire this knowledge.
Both are important for productivity.
111
The Production Function

The production function is a graph or equation
showing the relation between output and inputs:
Y = A F(L, K, H, N)
F( ) a function that shows how inputs are
combined to produce output
A the level of technology
A multiplies the function F( ),

so improvements in technology (increases in A)
allow more output (Y) to be produced from any
given combination of inputs.
112

Y = A F(L, K, H, N)
The production function has the property

constant returns to scale: Changing all inputs
by the same percentage causes output to change
by that percentage. For example,
Doubling all inputs (multiplying each by 2)

causes output to double:
2Y = A F(2L, 2K, 2H, 2N)
Increasing all inputs 8% (multiplying each by 1.1)

causes output to increase by 8%:
1.1Y = A F(1.1L, 1.1K, 1.1H, 1.1N)
113

Y = A F(L, K, H, N)
If we multiply each input by 1/L, then

output is multiplied by 1/L:
Y/L = A F(1, K/L, H/L, N/L)
This equation shows that productivity

(output per worker) depends on:
the level of technology (A)
physical capital per worker
human capital per worker
natural resources per worker
114
ACTIVE LEARNING
1:
Discussion question
Which of the following policies do you think would
be most effective at boosting growth and living
standards in a poor country over the long run?
a. offer tax incentives for investment by local firms
b. by foreign firms
c. give cash payments for good school attendance

d. crack down on govt corruption
e. restrict imports to protect domestic industries
f. allow free trade
115
Saving and Investment

We can boost productivity by increasing K,
which requires investment.
Since resources scarce, producing more capital

requires producing fewer consumption goods.
Reducing consumption = increasing saving.

This extra saving funds the production of
investment goods.
Hence, a tradeoff between

current and future consumption.
116
Diminishing Returns and the Catch-Up Effect
The govt can implement policies that raise saving

and investment.
Then K will rise, causing productivity and living
standards to rise.
But this faster growth is temporary,

due to diminishing returns to capital:
As K rises, the extra output from an additional unit
of K falls.
117
The Production Function & Diminishing Returns

If workers
Output per
have little
K,
worker
giving
them more
(productivity)
increases their
productivity a lot.
If workers already
have a lot of K,
giving them more
increases
productivity
fairly little.
Y/L
K/L
Capital per worker
118
The catch-up effect: the property whereby poor

countries tend to grow more rapidly than rich ones
Y/L
Rich countrys
growth
Poor countrys
growth
K/L
Poor country
starts here
Rich country starts here

119
Example of the Catch-Up Effect

Over 1960-1990, the U.S. and S. Korea devoted a
similar share of GDP to investment, so you might
expect they would have similar growth
performance.
But growth was >6% in Korea and only 2% in the

U.S.
Explanation: the catch-up effect.

In 1960, K/L was far smaller in Korea than
in the U.S., hence Korea grew faster.
120
Investment from Abroad

To raise K/L and hence productivity, wages, and
living standards, the govt can also encourage
Foreign direct investment:
a capital investment (e.g., factory) that is

owned & operated by a foreign entity.
Foreign portfolio investment:
a capital investment financed with foreign money
but operated by domestic residents.
Some of the returns from these investments

flow back to the foreign countries that supplied
the funds.
121
Investment from Abroad

Especially beneficial in poor countries that cannot
generate enough saving to fund investment projects
themselves.
Also helps poor countries learn state-of-the-art

technologies developed in other countries.
122
Education
Govt can increase productivity by promoting
educationinvestment in human capital (H).
public schools, subsidized loans for college

Education has significant effects: In the U.S., each
year of schooling raises a workers wage by 8%.
But investing in H also involves a tradeoff

between the present & future:
Spending a year in school requires
sacrificing a years wages now
to have higher wages later.
123
Health and Nutrition

Health care expenditure is a type of investment in human
capital healthier workers are more productive.
In countries with significant malnourishment, raising

workers caloric intake raises productivity:
Over 1962-95, caloric consumption rose 44% in

S. Korea, and economic growth was spectacular.
Nobel winner Robert Fogel:

30% of Great Britains growth from 1890-1980 was due
to improved nutrition.
124
Are Natural Resources a Limit to Growth?
Some argue that population growth is depleting the

Earths non-renewable resources, and thus will limit
growth in living standards.
But technological progress often yields ways to avoid

these limits:
Hybrid cars use less gas.

Better insulation in homes reduces the energy
required to heat or cool them.
As a resource becomes scarcer, its market price rises,

which increases the incentive to conserve it and
develop alternatives.
125
Free Trade
Inward-oriented policies
(e.g., tariffs, limits on investment from abroad)
aim to raise living standards by avoiding
interaction with other countries.
Outward-oriented policies (e.g., the elimination

of restrictions on trade or foreign investment)
promote integration with the world economy.
126
Free Trade
Recall: Trade can make everyone better off.
Trade has similar effects as discovering new
technologies it improves productivity and living
standards.
Countries with inward-oriented policies have

generally failed to create growth.
e.g., Argentina during the 20th century.
Countries with outward-oriented policies have

often succeeded.
e.g., South Korea, Singapore, Taiwan after 1960.
127
Research and Development

Technological progress is the main reason why
living standards rise over the long run.
One reason is that knowledge is a public good:

Ideas can be shared freely, increasing the
productivity of many.
Policies to promote tech. progress:

patent laws
tax incentives or direct support for
private sector R&D

grants for basic research at universities
128
Population Growth
may affect living standards in 3 different ways:
1. Stretching natural resources
200 years ago, Malthus argued that pop. growth

would strain societys ability to provide for itself.
Since then, the world population has increased

sixfold. If Malthus was right, living standards
would have fallen. Instead, theyve risen.
Malthus failed to account for technological

progress and productivity growth.
129
Population Growth
2. Diluting the capital stock
more population = higher L = lower K/L

= lower productivity & living standards.
This applies to H as well as K:

fast pop. growth = more children
= greater strain on educational system.
Countries with fast pop. growth tend to have lower

educational attainment.
130
Population Growth
2. Diluting the capital stock
To combat this, many developing countries use policy
to control population growth.
Chinas one child per family laws

contraception education & availability
promote female literacy to raise opportunity cost of
having babies
131
Population Growth
3. Promoting tech. progress
More people
= more scientists, inventors, engineers
= more frequent discoveries
= faster tech. progress & economic growth
Evidence from Michael Kremer:

Over the course of human history,
growth rates increased as the worlds population
increased
more populated regions grew faster than
less populated ones
132
ACTIVE LEARNING
2:
Productivity
List the determinants of productivity.

List three policies that attempt to raise living
standards by increasing one of the determinants of
productivity.
133
ACTIVE LEARNING
2:
Answers
Determinants of productivity:
physical capital per worker (K/L)
human capital per worker (H/L)
natural resources per worker (N/L)
technological knowledge (A)
Policies to boost productivity:
Encourage saving and investment, to raise K/L
Encourage investment from abroad, to raise K/L

Provide public education, to raise H/L
134
ACTIVE LEARNING
2:
Answers
Determinants of productivity:
physical capital per worker (K/L)
human capital per worker (H/L)
natural resources per worker (N/L)
technological knowledge (A)
Policies to boost productivity:
Patent laws or grants, to increase A
Control population growth, to increase K/L
135
What Causes Economic Growth?
136
Incentives and Institutions

The amount of available resources only
tells part of the story.
Why do some countries have more physical

and human capital and use more advanced
technology?
Why do some countries obtain greater
output from the resources they have than
others?
The answers lie in the institutions and
incentives that countries adopt.
137
What are Institutions?

Institutions are a broad category including
Laws
Regulations
Customs
Practices
Values
Culture
138

A natural experiment - North and South Korea
Before division after WWII

- Shared the same people and culture.
- Had similar levels of physical capital.
- Had access to the same technology.
North Korea became a communist state with a
centrally planned economy.
South Korea adopted the capitalist free market
model.
The result 50 years later is dramatic as seen in the

following photo from outer space.
139

North and South Korea at Night
140
Institutions
1. Property rights:
- Provide incentives to work hard.
- Encourage investment and innovation.
Without property rights:

Effort is divorced from payment, reducing
incentives.
Free riders become a problem.
141
Institutions
Free rider = someone who consumes a resources without
working or contributing to the resources upkeep.
Chinas Great Leap Forward- which introduced
farming collectives- reduced incentives. 20-40 million

starved.
1978, farmers in Xiaogang met in secret to devise a plan

to keep some of their produce.
Productivity improved so quickly the government

allowed the experiment to proceed.
Food production increased 50% in 5 years 1978-1983.

142
Institutions
On October 1, 1949, Mao Zedong proclaimed the
establishment of the People's Republic of China.
Before 1949, peasants had farmed their own small

pockets of land, and observed traditional practicesfestivals, banquets, and paying homage to ancestors.
It was realized that Mao's policy of using a state

monopoly on agriculture to finance industrialization
would be unpopular with the peasants and therefore
It was proposed that the peasants should be brought

under Party control by the establishment of agricultural
collectives which would also facilitate the sharing of tools
and draft animals.
143
Institutions
This policy was gradually pushed through between
1949 and 1958 in response to immediate policy
needs, first by establishing "mutual aid teams" of 515 households, then in 1953 "elementary agricultural
cooperatives" of 20-40 households, then from 1956 in
"higher co-operatives" of 100-300 families.
From 1954 onward peasants were encouraged to form

and join collective-farming associations, which would
supposedly increase their efficiency without robbing
them of their own land or restricting their livelihoods.
144
Institutions
By 1958 private ownership was entirely abolished and
households all over China were forced into state-operated
communes. Mao insisted that the communes must produce
more grain for the cities and earn foreign exchange from
exports.
These reforms (sometimes now referred to as The Great Leap

Forward) were generally unpopular with the peasants and
usually implemented by summoning them to meetings and
making them stay there for days and sometimes weeks until
they "voluntarily" agreed to join the collective.
Apart from progressive taxation on each household's harvest,

the state introduced a system of compulsory state purchases of
grain at fixed prices to build up stockpiles for famine-relief and
meet the terms of its trade agreements with the Soviet Union.
145
Institutions
Together, taxation and compulsory purchases
accounted for 30% of the harvest by 1957, leaving
very little surplus.
Rationing was also introduced in the cities to curb

'wasteful consumption' and encourage savings (which
were deposited in state-owned banks and thus
became available for investment), and although food
could be purchased from state-owned retailers the
market price was higher than that for which it had
been purchased.
This too was done in the name of discouraging

excessive consumption.
146
Institutions are the rules of the game that

structure economic incentives.
Institutions of Economic Growth
1. Property rights
2. Political stability
3. Honest government
4. A dependable legal system
5. Competitive and open markets
147
Property Rights and Political Stability
Recall: Markets are usually a good

way to organize economic activity.
The price system allocates resources
to their most efficient uses.
This requires respect for property rights,

the ability of people to exercise authority
over the resources they own.
148
In many poor countries, the justice system doesnt

work very well:
contracts arent always enforced

fraud, corruption often go unpunished
in some, firms must bribe govt officials for permits
Political instability (e.g., frequent coups) creates
uncertainty over whether property rights will be
protected in the future.
149
When people fear their capital may be stolen by

criminals or confiscated by a corrupt govt,
there is less investment, including from abroad,
and the economy functions less efficiently.
Result: lower living standards.
Economic stability, efficiency, and healthy growth

require law enforcement, effective courts,
a stable constitution, and honest govt officials.
150
Institutions of Economic Growth (cont.)

1. Property rights: the right to benefit from ones
effort.
- Provide incentives to work hard.
- Encourage investment in physical and human
capital.
- Are important for encouraging technological
innovation.
- Without property rights:
Effort is divorced from payment
incentive to work
Free riders become a problem
151

2. Political Stability
- Changing governments without the rule of
law results in uncertainty which leads to
less investment in physical and human
capital.
- In many nations civil war, military
dictatorship, and anarchy have destroyed
the institutions necessary for economic
growth.
152
Institutions
3. Honest Government
- Property rights are meaningless unless
government guarantees property rights.
- Corruption bleeds resources away from

productive entrepreneurs.
- Corruption takes resources away from more

productive government activity.
153

3. Honest Government
- Property rights are meaningless unless
government guarantees property rights.
- Corruption bleeds resources away from
productive entrepreneurs.
- Corruption takes resources away from more
productive government activity.
- Next is a list of the 10 most and the 10 least
corrupt countries. Are you surprised to see
who is or who isnt on these lists?
154
Honest Government: The Good and the Bad
155
Honest Government: The Good and the Bad
156

4. Dependable Legal System
- A good legal system facilitates contracts and
protects property from others including
government.
- Poorly protected property rights can result from
too much government or too little government.
The legal system in some governments is so
poor that no one knows who owns what.
Example: In India, residents who purchase
land have to do so more than once because of
lack of proper record keeping.
157

5. Competitive and Open Markets
- Encourage the efficient organization of
resources.
- About half the differences in per capita income
across countries is explained by a failure to use
capital efficiently.
- Example: One study found that if India used its
physical and human capital as efficiently as the
U.S., India would be four times richer than it is
today.
158

Why do poor countries use their capital
inefficiently?
Inefficient and unnecessary regulations
Create monopolies
Impede markets
Example: until recently in India, it was
illegal to produce shirts using largescale production
Expensive red tape increases time and cost
159
Institutions and Growth Revisited
Economic growth would become more common if

more countries changed their institutions.
Where do institutions come from?
- Culture?
- History?
- Geography?
- Luck?
Key research question in economics:
Understanding institutions, where they come
from and how they can be changed.
160

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Macroeconomic Analysis and Policy

1. Is GDP a measure of Welfare

GDP and Economic Well-Being

But GDP is not a perfect measure of

Robert Kennedy issued a very eloquent

Gross Domestic Product

GDP Does Not Value

an equitable distribution of income

Then Why Do We Care About GDP?

Many indicators of the quality of life are positively

GDP and Life Expectancy in 12 Countries

Real GDP per capita, 2002

GDP and Adult Literacy in 12 Countries

Real GDP per capita, 2002

GDP and Internet Usage in 12 Countries

Real GDP per capita, 2002

Big Mac Index: The Economist

The Big Mac Index is presumably useful because

it is based on a well-known good

local economy, such as agricultural commodities labour,

Why PPP Exchange Rates?

Also, different interest rates, speculation, hedging or

interventions by central banks can influence the foreignexchange market.

A purchasing power parity exchange rate equalizes the

It is often used to compare the standards of living between

countries, rather than a per-capita gross domestic products

What has not changed

The Fed, America's central bank, last raised

After June 2006 , Fed started reversing course,

What has not changed

September non-farm payroll data was released on

To be fair, it wasnt just one data point that drove

The last two months saw a further decline in the

There are other things about the labour

First,wages or hourly earnings are not

Some of this could be explained by the labour

Americans have simply dropped out of the

The risk of these workforce dropouts re-entering

At the same time, it has kept the unemployment

First, it highlights the fact that job additions

Instead, the U.S. Department of Labor reports estimates of

Labor force: The sum of employed and unemployed workers in the

Of these statistics, the most watched is known as the

The Household Survey

~60,000 households selected to be representative

People are then classified as:

Unemployed: Someone who is not currently at work but who is

Not in the labor force, if neither of the above apply

August 2013 Civilian Working-Age Population

Discouraged workers: People

The employment status

Measuring the Unemployment Rate

The labor force participation rate measures the

Labor Force Statistics

Labor force participation rate:

This most-common measure

The employment status

Labor Force Participation and Employment-Population

and the employment-population

Calculate labor force statistics

Compute the labor force, u-rate, adult population,

not in labor force

Labor force = employed + unemployed

= 100 x (unemployed)/(labor force)