ECON 151 – PRINCIPLES OF MACROECONOMICS

Chapter 7:
The Macroeconomy: Unemployment,
Inflation, and Deflation

Materials include content from Pearson Addison-Wesley which has been modified by the
instructor and displayed with permission of the publisher. All rights reserved.
1
Unemployment
 Unemployment
 Totalnumber of adults (aged 16 years or
older) willing and able to work and who are
actively looking for work and have not found a
job

7-2
Unemployment (cont'd)
 Civilian Labor Force
 Individuals aged 16 years or older who either
have jobs or who are looking and available for
jobs; the number of employed plus the
number of unemployed

7-3
Employment & Unemployment Calculations

Total Population (A)

Less Institutionalized Population
Non-Institutionalized Population
Less Not in Work Force
Total Workforce (B)
Less Military
Civilian Workforce (C)
Less Employed
Unemployed (D)

Labor Force Participation Rate = (B) / (A)

Unemployment Rate = (D) / (C)

7-4
Unemployment (cont'd)
 Costs of unemployment
 Lost output
 During early 2000s, unemployment rate rose by 2
percentage points
 Factory output was 80% of potential
 Lost output was $200 billion of goods and services
that could have been produced

 Personal psychological impact

7-5
Figure 7-1 More Than a Century
of Unemployment

Source: U.S. Department of Labor, Bureau of Labor Statistics

7-6
Figure 7-2 Adult Population

7-7
Unemployment (cont'd)
 The unemployment rate is the percentage
of the measured labor
force that is unemployed.

7-8
Unemployment (cont'd)
Labor force = The employed + The unemployed
152.7* = 145.4 + 7.3

Unemployed
Unemployment rate = x 100
Labor force

7.3
= x 100 = 4.8%
152.7
*U.S., millions of people; as of 2007

7-9
Unemployment (cont'd)
 Stock
 The quantity of something, measured at
a given point in time—for example, an
inventory of goods

 Flow
A quantity measured over time, such as the
income you make per year, or the number of
individuals fired every month

7-10
Unemployment (cont'd)
 Categories of individuals without work
 Job loser
 Reentrant

 Job leaver
 New entrant

7-11
Unemployment (cont'd)
 Job Loser
 An individual whose employment was
involuntarily terminated or who was laid off
 40–60% of the unemployed

7-12
Unemployment (cont'd)
 Reentrant
 An individual who has worked a full-time job
before but left the labor force and has now
reentered it looking for a job
 20–30% of the unemployed

7-13
Unemployment (cont'd)
 Job Leaver
 An individual who voluntarily quit
 10 to 15% of the unemployed

7-14
Unemployment (cont'd)
 New Entrant
 Anindividual who has never worked a full-
time job for two weeks or longer
 10 to 15% of the unemployed

7-15
Unemployment (cont'd)
 Duration of unemployment
 More than a third of job seekers find work
within one month.
 Approximately another third find employment
within a second month.
 About a sixth are still unemployed after
six months.
 Average duration is just over 15 weeks
throughout the last 15 years.

7-16
Unemployment (cont'd)

 Discouraged Workers
 Individualswho have stopped looking for a job
because they are convinced they will not find
a suitable one (no longer in work force)

 Question
 Howdoes the existence of discouraged
workers bias the unemployment rate?

7-17
Unemployment (cont'd)
Question
How does the existence of discouraged workers bias the
unemployment rate?

Unemployed
Unemployment rate = x 100
Labor force

7.3
= x 100 = 4.8%
152.7
Assume that there are 3 million discouraged workers.
10.3
= x 100 = 6.6%
155.7 7-18
Unemployment (cont'd)
 Labor Force Participation Rate
 The proportion of non-institutionalized
working-age individuals who are employed or
seeking employment

7-19
The Major Types of
Unemployment
 The major types of unemployment
 Frictional

 Structural

 Cyclical

 Seasonal

7-20
The Major Types
of Unemployment (cont'd)
 Frictional Unemployment
 Results from the fact that workers must
search for appropriate job offers
 Thistakes time, so they remain
temporarily unemployed

7-21
The Major Types
of Unemployment (cont'd)
 Structural Unemployment
 Results from a poor match of workers’ abilities
and skills with current requirements of
employers

7-22
The Major Types
of Unemployment (cont'd)
 Cyclical Unemployment
 Results from business fluctuations that occur
when aggregate (total) demand is not at a
level that would result in full employment
 Can be positive or negative

7-23
The Major Types of Unemployment
 Seasonal Unemployment
 Results from the seasonal pattern of work in
specific industries
 Adjustments are made to offset the effects of
seasonal unemployment so that meaning
comparisons can be made between different
periods of the year. This adjustment is
needed in order to assess the affects of the
other types of unemployment.

7-24
Full Employment and the Natural Rate
of Unemployment (cont'd)
 Full Employment
 Anarbitrary level of unemployment that
corresponds to “normal” friction in the
labor market

7-25
Full Employment and the Natural Rate
of Unemployment (cont'd)
 Natural Rate of Unemployment
 The unemployment rate that is
estimated to prevail in the long-run
macroeconomic equilibrium
 Should not reflect cyclical unemployment
 When seasonally adjusted, the natural rate
should include only frictional and structural
unemployment.
7-26
Inflation and Deflation
 Inflation
A sustained increase in the average
of all prices of goods and services in
an economy

 Deflation
A sustained decrease in the average
of all prices of goods and services in
an economy
7-27
Inflation and Deflation (cont'd)
 Purchasing Power
 Thevalue of money for buying goods
and services
 Varies with prices and income

7-28
Inflation and Deflation (cont'd)
 Nominal value
 Price expressed in today’s dollars

 Real value
 Value expressed in purchasing power,
adjusted for inflation

7-29
Measuring the rate of inflation
 Price Index The cost of today’s market basket
of goods expressed as a percentage of the
cost of the same market basket during a base
year
 Market Basket Representative bundle of
goods and services
 Base Year The point of reference for
comparison of prices in other years
Cost today of market basket
Price index =  100
Cost of market basket in base year

7-30
Table 7-1 Calculating a Price Index for
a Two-Good Market Basket

7-31
Inflation and Deflation (cont'd)
 Real-world price indexes
 Consumer Price Index (CPI)
 Producer Price Index (PPI)
 GDP deflator
 Personal Consumption Expenditure (PCE)

7-32
Inflation and Deflation (cont'd)
 Consumer Price Index (CPI)
A statistical measure of a weighted average of
prices of a specified set of goods and services
purchased by wage earners in urban areas
 Market basket of goods and services of
typical consumer

7-33
Inflation and Deflation (cont'd)
 Producer Price Index (PPI)
A statistical measure of a weighted average of prices
of goods and services that firms produce and sell
 Used as a short-run leading indicator (before CPI)
 PPIs for
 Foodstuffs
 Intermediate goods
 Finished goods

7-34
Inflation and Deflation (cont'd)
 GDP Deflator
A price index measuring the changes in prices
of all new goods and services produced in the
economy
 Broadestmeasure of prices; reflects both
price changes and the public’s market
responses to those price changes

7-35
Inflation and Deflation (cont'd)
 Personal Consumption Expenditure (PCE)
Index
A statistical measure of average price using
annually updated weights based on consumer
spending
 Primary inflation index used by the
Federal Reserve

7-36
Figure 7-4 Inflation and Deflation
in U.S. History

Source: U.S. Department of Labor, Bureau of Labor Statistics

7-37
Anticipated versus
Unanticipated Inflation
 Anticipated versus unanticipated inflation
 To determine who is hurt by inflation we
distinguish between the two types.
 The effects of inflation on individuals depend
upon which type of inflation exists.

7-38
Anticipated versus
Unanticipated Inflation (cont'd)
 Anticipated Inflation
 The inflation rate that we believe will occur

 Unanticipated Inflation
 Inflation at a rate that comes as a surprise

7-39
Anticipated versus
Unanticipated Inflation (cont'd)
 Inflation and interest rates
 Nominal Rate of Interest
 The market rate of interest expressed in today’s
dollars

 Real Rate of Interest

 The nominal rate of interest minus the anticipated
rate of inflation

7-40
Anticipated versus
Unanticipated Inflation (cont'd)
 Real interest rate
 Nominal interest rate = 10%
 Expected inflation rate = 6%
 Real rate = 10% – 6% = 4%

7-41
Anticipated versus
Unanticipated Inflation (cont'd)
 Inflation affects people differently
 Unanticipated inflation
 Creditors lose
 Debtors gain

7-42
Anticipated versus
Unanticipated Inflation (cont'd)
 Protecting against inflation
 Cost-Of-Living Adjustments (COLAs)
 Clauses in contracts that allow for increases in
specified nominal values to take account of
changes in the cost of living

7-43
Anticipated versus
Unanticipated Inflation (cont'd)
 The resource cost of inflation
 Repricing or Menu Cost of Inflation
 The cost associated with recalculating
prices and printing new price lists when there
is inflation

7-44
Changing Inflation and Unemployment:
Business Fluctuations

 Business Fluctuations
 The ups and downs in business activity
throughout the economy

7-45
Changing Inflation and Unemployment:
Business Fluctuations (cont'd)

 Expansion
A business fluctuation in which the pace of
national economic activity is speeding up

 Contraction
A business fluctuation during which the pace
of national economic activity is slowing down

7-46
Changing Inflation and Unemployment:
Business Fluctuations (cont'd)

 Recession
A period of time during which the rate of
growth of business activity is consistently less
than its long-term trend or is negative

 Depression
 An extremely severe recession

7-47
Figure 7-5 The Idealized
Course of Business Fluctuations

7-48
Figure 7-6 National Business Activity,
1880 to the Present

7-49
Changing Inflation and Unemployment:
Business Fluctuations (cont'd)

 Leading Indicators
 Eventsthat have been found to occur before
changes in business activity
 Economic downturns often follow
 Reduction in the average workweek
 Rise in unemployment insurance claims
 Decrease in prices of raw materials
 Drop in the quantity of money circulating

7-50
 End of
ECON 151 – PRINCIPLES OF MACROECONOMICS
Chapter 7
Chapter 7:
The Macroeconomy: Unemployment,
Inflation, and Deflation

Materials include content from Pearson Addison-Wesley which has been modified by the
instructor and displayed with permission of the publisher. All rights reserved.
51