Lesson 4 Unemployment and Inflation

Unemployment is a term referring to individuals who are

employable and actively seeking a job but are unable to find a
job. Included in this group are those people in the workforce
who are working but do not have an appropriate job.

Who Counts in Unemployment?

• Discouraged Workers: those who have stopped looking for

employment due to the lack of suitable positions available

• Out of the Labor Force: those who are not working and
not looking for work – whether they want employment or
not; also termed “not in the labor force”

• Underemployed: individuals who are employed in a job

that is below their skills

Who’s In or Out of the Labor Force?

• Employed: currently working for pay

• Unemployed: out of work and actively looking for a job

 • Out of the Labor Force: out of paid workforce and/or not
actively looking for a job

• Labor Force: the number of employed plus the

unemployed

Calculating the Unemployment Rate

• Labor Force Participation Rate: this is the percentage of

adults in an economy who are either employed or who are
unemployed and looking for a job

• Unemployment Rate: the percentage of adults who are in

the labor force and thus seeking jobs, but who do not have
jobs

Types of Unemployment

Cyclical Unemployment

• In a labor market with flexible wages, the equilibrium will

occur at wage We and quantity Qe, where the number of
people looking for jobs (shown by S) equals the number of
jobs available (shown by D)
 • Equilibrium in the labor market occurs at the wage rate
where the quantity of labor demanded equals the quantity
of labor supplied

Cyclical Unemployment: Why Wages May be Sticky

Downward
• Adverse Selection of Wage Cuts Arguments: if
employers reduce wages for all workers, the best
workers will leave

• Cyclical Unemployment: unemployment closely tied to

the business cycle, like higher unemployment during a
recession

• Efficiency Wage Theory: the theory that the

productivity of workers, either individually or as a
group, will increase if they are paid more

• Implicit Contract: an unwritten agreement in the labor

market that the employer will try to keep wages from
falling when the economy is weak or the business is
having trouble, and the employee will not expect huge
 salary increases when the economy or the business is
strong

• Insider-Outsider Model: those already working for the

firm are “insiders” who know the procedures; the
other workers are “outsiders” who are recent or
prospective hires

• Relative Wage Coordination Argument: across-the-

board wage cuts are hard for an economy to
implement, and workers fight against them

Frictional and Structural Unemployment

• Frictional Unemployment: unemployment that occurs as

workers move between jobs

• Natural Rate of Unemployment: the unemployment rate

that would exist in a growing and healthy economy from
the combination of economic, social, and political factors
that exist at a given time; the sum of frictional plus
structural unemployment

• Structural Unemployment: unemployment that occurs

because individuals lack skills valued by employers

The Natural Rate of Unemployment

 • The natural rate of unemployment includes only frictional
and structural unemployment, and not cyclical
unemployment

• related to two other important concepts: full employment

and potential real GDP
• Unexpected shifts in productivity can have a powerful
effect on the natural rate of unemployment

• On the supply side of the labor market, public policies to

assist the unemployed can affect how eager people are to
find work

• On the demand side of the labor market, government

rules social institutions, and the presence of unions can
affect the willingness of firms to hire

The Natural Rate of Unemployment in Recent Years

The underlying economic, social, and political factors that

determine the natural rate of unemployment can change over
time:
1. The Internet has provided a remarkable new tool through
which job seekers can find out about jobs at different
companies and can make contact with relative ease

2. The growth of the temporary worker industry has probably

helped to reduce the natural rate of unemployment
 3. The aging of the “baby boom generation”

Inflation

• Hyperinflation: an extremely high rate of inflation, in the

100s or 1000s percent per year

• Inflation: a general and ongoing rise in the level of prices

in an economy

Calculating Inflation with Index Numbers

• Base Year: arbitrary year whose value as an index number

is defined as 100; inflation from the base year to other
years can easily be seen by comparing the index number in
the other year to the index number in the base year—i.e.,
100; so, if the index number for a year is 105, then there
has been exactly 5% inflation between that year and the
base year

• Index Number: a unit-free measure of an economic

indicators; index numbers are based on a value of 100,
which makes it easy to measure percent changes

• Inflation Rate: the percentage change in some price index

 • Market Basket: hypothetical collection of goods and
services (or more precisely, the quantities of each good or
service) consumers typically buy

• Price Indices: essentially the weighted average of prices of

a certain type of good or service; price indices are created
to calculate the inflation rate, i.e. the percent change in
prices over time

• Price Level: the average of prices

Formula: (B-A)/ A x 100

Whereas B is the ending number, A is the starting
number.

Index Numbers
• A price index is essentially the weighted average of prices
of a certain type of good or service

• Price indices can measure a narrow range of goods and

services or a broader range of goods and services

• Price indices are created to help calculate the percent

change in prices over time

The Consumer Price Index

Consumer Price Index: the average price of the goods and
services typically purchased by urban consumers
The Eight Major Categories in the Consumer Price Index
1. Food and beverages
2. Housing
3. Apparel
4. Transportation
5. Medical Care
6. Recreation
7. Education and communication
8. Other goods and services

Benefits of Low Inflation

• An annual inflation rate of 2%, 3%, or 4% is a long way

from a national crisis

• If variability in inflation rates is a problem, then moderate

and high inflations are more likely to have significant
variability than are low inflations

• Low inflation is also better than deflation which occurs

with severe recessions

• Moderate inflation may help the economy by making

wages in labor markets more flexible

Confusion over Inflation

Inflation can cause three types of problems:
1. Blurred price signals

2. Unintended redistributions of purchasing power

3. Difficulties in long-term planning