Macro exam three

Working age population

those age 16 or older who are not in the military or institutionalized

Employed

working-age people who are working

• work for at least one hour for pay, self employed, even if temporarily absent

Unemployed

working age people without jobs who are trying to get jobs

labor force

the employed + the unemployed

Labor force participation rate calculation

Employed + unemployed/ working age population x 100

(patterns: growth in women’s participation, decline in men’s)

Unemployment rate

the percentage of the labor force that is unemployed

unemployment rate calculation

unemployed/laborforce x 100

Global unemployment rates

• Spain, italy, france: higher unemployment than US 

• Germany, Japan: lower than US

• Equilibrium in US: between 4% and 5%

Equilibrium unemployment rate

The unemployment rate to which the economy tends to return to in the long run

A dynamic labor market

makes it easy for new people to find jobs quickly (each more in US, 6 million start a job and 6 million leave)

Job seekers

most job seekers already have jobs, but are looking for better options

• makes it tougher for unemployed people to compete

• employers prefer candidates who are currently employed

Unemployment spells

how long it takes to find a job

• most are short, less than 10 weeks

• Risk of long-term unemployment (6+ months), chances of getting employed significantly goes down

Implications

long-term unemployed face employer discrimination, skill loss and losing connections

Official rate

measure of unemployment that only counts active job seekers

Marginally attached

measure of unemployment that counts workers who want work, but aren’t currently searching (but searched in past year). includes discouraged workers

Discouraged workers

stop searching because they believe no jobs are avaliable

Involuntary part time

someone who wants full-time work and is working part time because they haven’t found a full-time job

Labor supply

Workers supply labor for a price (wage)

Upward sloping: higher wages creates more labor supplied 

Labor demand

employed buy labor

Downward sloping: higher wages less labor demanded 

Equilibrium

where the quantity of labor demanded is equal to the quantity of labor supplied 

frictional unemployment

unemployment due to the time it takes for employers to search for workers and for workers to search for jobs, they must find each other

Factor 1 of frictional unemployment

The efficiency of of the resources employers and workers use to find each other (matching tools)

Factor 2 of frictional unemployment

The alignment of the skills workers have and the skills that employers desire (technological change and international trade shift job demand: growth in services, decline in manufacturing)

Factor 3 of frictional unemployment

unemployment insurance and other income support during unemployment

Structural unemployment

unemployment that occurs because wages don’t fall to bring labor demand and supply into equilibrium

• When prevailing market wage is above the equilibrium (employers demand fewer workers, more workers want those jobs) 

• The gap = structural unemployment

Efficiency wages

 a higher wage paid to encourage greater work productivity

Institutional causes of structural unemployment

unions can keep wages high for some workers, job protection regulations make it hard to fire workers, the minimum wage keeps wages at a minimum

minimum wage

keeps wages from falling below the set minimum wage. Higher wage means employers want to hire fewer workers, but more workers want to work

Cyclical unemployment

as the economy moves up and down, the unemployment rate also fluctuates. Due to temporary downturn in the economy

Time and earnings lost

unemployed spend weeks/months searching: lower current and future wages

• Skills, experience, and career prospects decline: permanent earnings loss 

• Mass layoffs: men lose 1.4 years of earnings when unemployment is low, 2.8 years when unemployment is high

Hysteresis

High unemployment can raise the natural unemployment rate, creates slower job recover 

Government budget stress

less tax revenue + higher safety-net spending

Understanding what inflation is and how to measure it

• The price of a basket of goods and services 

• Consumer price index 

• The challenges of measuring the true cost of living 

Inflation

a generalized rise in the overall level of prices

Consumer price index (CPI)

an index that tracks the average price consumers pay over time for a representative basket of goods and services

Inflation rate

annual precentage increase in the average price level

Calculate inflation rate

(price level this year - price level last year/ price level last year) x 100

To measure inflation

1. find out what people buy

2. collect prices

3. tally up the prices

creating the price index

pick an arbitrary year, called the base year, scale the cost of that basket to $100, and then track changes in the cost of that basket over time

Deinflation

a generalized decrease in the overall level of prices

Things CPI misses: Quality improvements can hide price decreases

Measured rise in prices is likely due to unmeasured quality improvements ex. Iphones are more expensive compared to first model, but higher quality 

Things CPI misses: Doesn’t account for the reduction in the cost of living due to the introduction of new products.

The iPhone replaced many goods and services on which people previously spent lots of money ex. Landline, answering machine, etc.

Things CPI misses: substitution

When prices rise, you substitute what's in your basket to find cheaper ways to achieve the same quality of life

The CPI is used for cost-of-living adjustments

• Indexation clause in employment contracts 

• Social Security payments and government program income cutoffs are adjusted for inflation

Personal Consumption Expenditure deflator (PCE deflator) 

• Basket includes items you consume but don’t directly pay for (i.e., medical care paid for by employer) 

Core inflation

used by forecasters to examine the underlying trend in inflation 

• Excludes food and energy because their prices are often volatile

Producer price index (PPI)

a price index that tracks the prices of inputs into the production process (helps businesses see how the prices that matter to them are changing 

GDP deflator:

a price index that tracks the prices of all goods and services produced domestically

• Used when adjusting the dollar amounts describing what the economy produces 

• Used to convert nominal GDP to real GDP 

• GDP deflator = nominal GDP/real GDP x 100

Adjusting for the effects of inflation

Use the inflation adjustment formula to adjust for changing prices 

• Convert dollar amounts from the past into today’s dollar amounts 

Calculate for effects of inflation

Today's dollars = another time’s dollars x (price level today/ price level in another time)

Inflation can distort comparisons from different time periods

• Real value in 2012 dollars = nominal value in year t dollars x (price level in 2012/price level in year t)  

Nominal variable

a variable measured in dollars (whose value may fluctuate over time) 

Real variable

a variable that has been adjusted to account for inflation 

Real and nominal interest rates

The benefits and costs of saving or borrowing money are impacted by inflation 

• When you save, you receive interest payments. When you borrow, you pay interest

Nominal interest rate

the stated interest rate without a correction for the effects of inflation 

Real interest rate

the interest rate in terms of changes in your purchasing power 

Calculate real interest rate

nominal interest rate - inflation rate (only use this shortcut for low inflation rates) 

Money illusion

The (mistaken) tendency to focus on nominal dollar amounts instead of inflation-adjusted amounts

Money illusion can

• Distort decisions. What if all prices throughout the economy (including incomes) rose by 25% 

• Lead to mis-pricing. Make sure you correctly value your home that you bought a few years ago 

• Create nominal wage rigidity. Employers often choose to stick with last year’s wage. Money illusion leads workers to feel okay, even though their real wage fell

What money is

money is an asset regularly used in transactions 

Money is a medium of exchange

Use money as medium of exchange whenever you (must be widely accepted)  

• Hand it over to buy stuff 

• Accept it from your employer in exchange for your work 

Without money as a medium of exchange, then you either

• Make everything you want or need for yourself 

• Barter for things you want or need – double coincidence of wants!

Money creates opportunities for you to specialize

 focus on tasks where your skills are most valuable, and then spend the money you earn to buy a smartphone from apple, or pizza from a local restaurant 

Money is a unit of account

Money is a common unit that people use to measure economic value (must be stable)

Money is a store of value

When you save money, you are using money as a store of value 

• Shift your wealth to the future (perhaps for retirement) 

• Other options include: storing gold bricks, fine art, canned food. But these aren’t ideal “stores of value.” Their prices fluctuate, difficult to store

Hyperinflation

extremely high rates of inflation (can make life harder and erode all functions of money)

Costs of expected inflation: inflation creates menu costs for sellers

• Businesses devote valuable resources to reprinting menus, adjusting price tages, and reprogramming vending machines more often 

• This is because inflation made money an unstable unit of account 

• A higher price better covers the rising costs of your inputs this year 

• The marginal benefit of raising your price exceeds the marginal cost of adjusting the price

menu costs

the marginal cost of adjusting prices

Shoe-leather costs

the costs incurred trying to avoid holding cash

• Inflation undermines money’s function as a store of value 

• People are spending time trying to keep their wealth in assets that better maintain their value

As prices rise…

The cast in your wallet become

• You don’t want to store your wealth in money (hold money) 

• This means spending money quickly, or trying to move money around, to preserve its value

Unexpected inflation confuses the signals that prices send

prices help coordinate economic activity

Unexpected inflation redistributes from savers and lenders toward borrowers

• Most loans specify repayment schedules in nominal terms 

• Unexpected inflation changes the real value of the repayments

Inflation fallacy

the mistaken belief that inflation destroys purchasing power

Indexation

automatically adjusting wages, benefits, tex brackets to compensate for inflation

Lon-run economic growth

reflects growth in a country’s potential output. However, in the short run the economy may fail to reach its potential

potential output

 the level of output that occurs when all resources are fully employed (equal to aggregate production function) 

business cycle

short-term fluctuations in economic activity 

• Cause actual output to deviate from potential output

the business cycle causes…

the unemployment rate to rise and fall sharply

recissions have

a lasting impact on people’s careers (decades later, people who graduated in a recession tend to earn less than those who graduated in better economic times)

output gap

the difference between actual and potential output, measured as a percentage of potential output

calculate output gap

Actual output - potential output/ potential output x 100

positive output gap

the economy is producing more than its potential (called a boom). when actual GDP is above the potential GDP

• this unsustainable intensity is possible only for a short while

negative output gap

the economy is producing less than it can (called a bust), the actual GDP is below the potential.

• idle resources: workers can’t find jobs, storefronts are shuttered

peak

a high point in economic activity

trough

a low point in economic activity

recession

a period of declining economic activity

• runs from peak to trough

expansion

a period of increasing economic activity

• runs from trough to peak

• expansions keep going until they’re killed by an adverse shock

the business cycle has…

one recession and one expansion!!!! no business cycles are the same

expansions are equivalent to…

increases in GDP!

common features of the business cycle

• recessions are short and sharp, expansions are long and gradual

• business cycles are persistent

• business cycles impact many parts of the economy

unusual expansion

rapid bounce-back following the coronavirus shutdowns

recessions are triggered by

various disruptions

persistence

the state of the economy this year is closely related to the conditions next year

comovement

variables that move up and down together. If one part of the economy is doing well (or one area of the world) then other parts of the economy are probably also doing well

Goods-producing and private service-providing

 industries rise and fall together, though goods-producing industries are usually more sensitive to the business cycle

leading indicators

variables that tend to predict the future path of the economy (tend to change first)

ex of leading indicators

business confidence, consumer confidence, the stock market

lagging indicators

variables that tend to follow business cycle movements with a bit of delay

lagging indicators example

unemployment

okrun’s rule of thumb

for every percentage point that actual output is less than potential output, the unemployment rate will be around half a percentage point higher

seasonally adjusted

data stripped of predictable seasonal patters (helps you see the underlying trends)

• ex: ice cream production has a regular seasonal cycle