Macroeconomics Unemployment, Inflation, and AD/AS Analysis

Unemployed

Unemployment is the outcome when people enter the labor force, are looking for work, but haven't found a mutually beneficial match with a firm yet.

Unemployment Rate

The ratio of unemployed to the civilian labor force expressed as a percent.

Labor Force

People engaged in the labor market (engaged = currently employed or actively seeking employment).

Labor Force Participation Rate

Fraction of the civilian, non-institutionalized, working age population that is employed or actively seeking employment.

Discouraged workers

Jobless individuals who have given up looking for work but who would still like to find a job.

Underemployment

When workers take a part time job but they really want full time jobs.

Lagging indicator

An economic statistic that confirms a trend after it has already happened.

Frictional Unemployment

Short-term unemployment caused by the ordinary difficulties of matching employee to employer.

Structural Unemployment

Persistent, long-term unemployment caused by long-lasting shocks or permanent features of an economy.

Employment-at-will doctrine

The policy that an employee may quit and an employer may fire an employee at any time and for any reason.

Labor Market Rigidity

Anything that slows down wage or employment adjustments.

Active labor policies

Policies that focus on getting unemployed workers back to work.

Cyclical Unemployment

Unemployment correlated with the business cycle.

Full Employment

When the economy is operating at its natural rate of unemployment.

Natural Unemployment Rate

The rate of structural plus frictional unemployment.

Potential GDP

The level of real GDP the economy would produce if it were at full employment.

GDP Gap / Output Gap

Output Gap = Actual GDP - Potential GDP / Potential GDP x 100.

Inflation

An increase in the general (average) price level, cost of living, and decrease in the purchasing power of a dollar.

Deflation

A decrease in the general (average) price level, cost of living, and an increase in the purchasing power of a dollar.

Disinflation

A reduction in the inflation rate.

CPI

Measures the change in the price of a market basket full of consumer goods and services.

Inflation Measurement Bias

Systematic errors in the CPI that cause it to overstate the true increase in the cost of living.

Core inflation

A measure of inflation that excludes volatile items like food and energy prices.

Nominal variables

Variables, such as nominal GDP, that have not been adjusted for changes in prices.

Real variables

Variables such as real GDP, that have been adjusted for changes in prices.

Real Price

A price that has been corrected for inflation.

Equation of Exchange

M x v = P x Yr.

Quantity Theory of Money

Sets out the general relationship between money, velocity, real output, and prices.

Money Supply

The total quantity of money available in the economy at a given time.

Velocity of Money

The average number of times a dollar is spent on finished goods and services in a year.

Money Neutrality

The idea that in the long run, changes in money supply do not affect real variables.

Price confusion

When unexpected changes in the overall price level make it hard for producers to tell whether a change is a real signal.

Money Illusion

The false perception that occurs when people mistake changes in nominal prices for changes in real prices.

Hyperinflation

Extremely rapid inflation.

Fisher Effect

The tendency of nominal interest rates to rise one to one with expected inflation rates.

Business Fluctuations

The short-run movements in real GDP around its long-term trend.

Recession

A significant, widespread decline in real income and employment.

Aggregate Demand Curve (AD)

Curve that shows all the combinations of inflation and real growth that are consistent with a specified rate of spending growth.

Solow Growth Curve

Long-run vertical line in the dynamic AD/AS model at the economy's potential (sustainable) real growth rate.

Real Shocks

Any shock that increases or decreases the potential growth rate.

Aggregate Demand Shock

A rapid and unexpected shift in the AD curve (spending).

Short Run-Aggregate Supply Curve

Short Run

The period before entry occurs.

Long Run

The time it takes for substantial new investment and entry to occur.

Sticky Prices and Wages

Prices and wages that do not adjust quickly to changes in supply and demand.

Menu Costs

The costs of changing prices.

Long Run Transition

The process by which the economy moves from a short-run equilibrium (after a shock) back to the long-run equilibrium on the Solow Growth Curve (potential output / full employment).

Inflation Rate

Inflation rate = P2−P1 / P1 × 100 (also works with CPI: CPI2 - CPI1 / CPI1 ×100)

Nominal to real conversion

Real Value = Nominal Value / Price Index

Quantity Theory of Money (long-run version)

M x v = P x Yr

Output Gap

Output Gap = Actual GDP - Potential GDP / Potential GDP x 100

CPI Formula

CPI = Price of Market basket (current prices) / Price of Market Basket (base-year prices) x 100

Real Growth Rate

Real Growth Rate = Nominal Growth Rate - Inflation Rate

Unemployment

The outcome when people enter the labor force, are looking for work, but haven't found a mutually beneficial match with a firm yet.

Employed

All people who during the reference week did any work as paid employees or worked in their own business or profession.

Source of Structural Unemployment

Long lasting shocks that require the economy to restructure.

Shifts in Labor Demand

Changes due to technology and automation, globalization, changes in product demand, changes in energy costs, and policy.

Pro of Structural Unemployment

Allows for creative destruction, allowing society to produce goods in the least cost method.

Con of Structural Unemployment

Workers might be 'left behind'.

Key of Structural Unemployment

Jobs exist but workers' skills are not in demand, at least not in their current location.

Factors Affecting Structural Unemployment

Cost of retraining, labor mobility, and policies affecting labor markets.

Source of Cyclical Unemployment

Depressed demand in the overall economy, occurring with lower growth and recessions.

Key of Cyclical Unemployment

The number of job seekers is greater than the job vacancies.

Policies Increasing Structural Unemployment

Unemployment benefits, minimum wages, unions, employment protection laws.

Policies Decreasing Structural Unemployment

Job retraining, job-search assistance, work tests, early employment bonuses.

Factors Determining Natural Unemployment Rate

Speed of information exchange, demographics, amount of structural change, cost of training, labor mobility, labor policies.

Output Gap Formula

Output Gap = ((Actual GDP - Potential GDP) / Potential GDP) x 100.

Social Costs of Unemployment

Social alienation, depression, substance abuse, divorce, crime, social instability.

Effect of Long-Term Unemployment

Costs are more severe when there is more long-term unemployment.

Consumer Price Index (CPI)

Measures the change in the price of a market basket full of consumer goods and services.

Rate of Inflation Calculation

(CPI2 - CPI1) / CPI1 x 100.

Core CPI

CPI excluding food and energy prices to measure the underlying trend in inflation.

Bias in CPI

Systematic errors due to fixed weight methodology, including new goods bias, quality change bias, and substitution bias.

Nominal Values

Values that have not been adjusted for inflation.

Real Values

Values that have been adjusted for inflation.

Nominal Value

Value measured in current dollars, not adjusted for inflation.

Real Value

Nominal Value divided by Price Index; reflects the purchasing power.

Real Growth

Nominal Growth minus Price Growth; indicates growth adjusted for inflation.

Cause of Inflation

Supply of money growing faster than needed to handle Real GDP growth causes inflation.

Unexpected Inflation

Distorts price signals and leads to arbitrary redistribution of income/wealth.

Cost of Deflation

Unexpected deflation distorts price signals and leads to real income redistribution.

Preferred Rate of Inflation

Mild and predictable inflation is preferred to avoid the costs of unexpected inflation.

Aggregate Demand Curve

Shows combinations of inflation and real growth consistent with specified spending growth.

Sources of Real Shocks

Include technology changes, resource price changes, natural disasters, labor force changes, and government regulations.

Aggregate Demand Shocks

Sudden shifts in total spending that affect the AD curve.

Sources of Aggregate Demand Shocks

Changes in consumer spending, investment, government spending, net exports, and monetary factors.

Short Run in AD/AS Model

Period where prices and wages are sticky, and output can change with demand.

Long Run in AD/AS Model

Period where prices and wages are flexible, and output returns to natural level.

Pain of Stopping Inflation

Actions to stop inflation can cause recessions and financial hardship.

Redistribution of Real Income/Wealth

Some gain at the expense of others due to unexpected inflation.

Financial Intermediation Failure

Increased risk due to inflation can slow growth or cause recession.

Deflationary Spiral

A situation where expected deflation decreases demand, leading to further deflation.

Phantom Gains

Taxation based on nominal gains rather than real gains due to inflation.

Temporary Swings in Price Levels

Short-term periods of price instability can occur due to various economic factors.

Imbalance Between Money Supply and Output

The mismatch between money supply growth and output needs causes inflation.