ECON 2105 Exam II

Labor Force

Working-age population currently employed or actively looking for jobs. Described by the equation:
Labor Force = Employed + Unemployed

Unemployed

People without jobs actively looking for jobs

Equilibrium Unemployment Rate

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

Labor Force Participation Rate

Percentage of working age population currently in the labor force

Not in labor force

Neither employed nor unemployed, may include retired workers, students, full-time parents, or disabled/chronically ill

Underemployed

People who would prefer better jobs, including part-time workers who want a full-time job or workers whose job does not adequately utilize their skills

Marginally Attached

Not currently job searching, but has looked for a job within the past year, so does not count as unemployed

Involuntarily Part Time

Has a part-time job but is looking for a full time job

Types of Unemployment

Frictional, structural, or cyclical

Frictional Unemployment

Time it takes for employers to search for workers and for workers to search for jobs

Structural Unemployment

Structural barriers prevent wages from falling to the point where labor demand and labor supply are in equilibrium

Cyclical Unemployment

Unemployment caused by a temporary downturn in the Economy

Sources of Frictional Unemployment

1. Efficiency of job search resources

2. Misalignment of skills

3. Unemployment insurance and support

Sources of Structural Unemployment

1. Efficiency Wages: higher wages paid to encourage greater worker productivity

2. Institutional causes: unions, job protection regulations, minimum wage

Economic Costs of Unemployment

Worse career opportunities, discrimination, lower tax revenue and higher government spending

Social Costs of Unemployment

Isolation, health problems & higher death rates, familial stress due to loss of household income

Official Unemployment Rate

Percentage of labor force currently unemployed

U-5 Employment Rate

Percentage of labor force, including marginally attached workers, who are currently unemployed

U-6 Unemployment Rate

Percentage of labor force currently unemployed, including unemployed, marginally attached, and involuntary part-time workers

Consumer Price Index

Tracks the average price consumers pay over time for a representative basket of goods and services

Inflation

A generalized rise in the overall level of prices, including rise in the cost of living and a decline in the purchasing power of money

Inflation Rate

Percentage different in price levels from one year to another

Converting to Modern Prices

Today’s Dollar = Another year’s dollar x CPI today/CPI in another year

Real Interest Rate

Nominal Interest rate - Inflation Rate

Real Growth

Percent change in nominal value - percent change CPI/prices

Money Illusion

The tendency to focus on nominal dollar amounts instead of inflation-adjusted amounts, causing nominal wage rigidity

Personal Consumption Expenditure Deflator

Target for monetary policy

Core Inflation

Forecasting underlying inflation trends by excluding food & energy (Which have volatile prices)

Producer Price Index

Cost of inputs into production process

GDP deflator

Illustrates changing prices of all goods & services produced (Nominal GDP/Real GDP x 100)

Challenges of CPI

Unmeasured quality improvements hide price decreases, new products reduce cost of living, substitution bias saves money

Effects of Expected Inflation

Lead to more frequent price adjustments (menu costs), marginal cost of holding money is high, so people hold less (Shoe-leather costs)

Effects of Unexpected Inflation

Confuses signals prices send, redistributes from savers & lenders to borrowers

Consumption

Household spending on final goods and services

Slope of Consumption Function

Marginal Propensity to Consume (Change in consumption/Change in Income)

Saving

Portion of income you set aside rather than consuming (Income - Consumption)

Rational Rule for Consumers

Consume more today if the marginal benefit of a dollar today is greater than or equal to the marginal benefit of spending a dollar-plus-interest tomorrow

Consumption Smoothing

People maintain steady or smooth path for consumption over time, despite income fluctuation

Permanent Income Hypothesis

Choose how much you consume based on your long-term average income rather than current income

Hand-to-mouth consumers

Spend all their current income as they get it

Effect of Temporary Change in Income

Little effect on consumption smoothers, high effect on hand-to-mouth consumers

Permanent Change in Income

Leads to large change in consumption for both

Anticipated Change in Income

No change for smoothers, big change for hand-to-mouth consumers

Future Income Change

Big effect on consumption smoothers, little effect on hand-to-mouth consumers

Consumption Function Shift Factors

Real interest rates, expectations, taxes, & wealth

Effect of Real Interest Rates on Consumption

Higher interest rates make borrowing more expensive and increase savings benefits, decreasing overall consumption

Optimist Expectations

Increase consumption, as people feel more secure about their future income and financial health

Taxes

Higher taxes reduce disposable income and consumption

Effect of Wealth on Consumption

Greater wealth, such as financial assets or property, leads to greater consumption at any given income level

Investment

Spending on new capital that increases economic productive capacity

Types of Investment

Business investment, housing, inventory

Capital Stock

Investment adds to capital stock, total quantity of capital at a point in time,

Depreciation

Decline in capital such as wear and tear, obsolescence, accidental damage, and aging

Compounding

Calculates how much money grows over time when you leave it to accumulate interest given:
Future Value = Current Value x (1 + interest rate)^t

Discounting

Opportunity cost of benefits you may receive in the future given:
Present Value = Future Value / (1 + interest rate)^t

Rational Rule For Investment

Present value of future profits is greater than the upfront cost:
C < next year’s profit / rate of interest + depreciation rate

User Cost of Capital

Extra cost associated with using one more machine next year:
Next year’s profit (Marginal Benefit) > (rate of interest + depreciation rate) x Up-front cost (Marginal Cost)

Depreciation Rate

The proportion of an investments remaining productive capacity you lose each year due to depreciation

Market for Loanable Funds

The market for the funds used to buy, rent, or build-up capital

Supply of Loanable Funds

Comes from saving, shifted by changes in personal saving, government saving shifts due to budget surpluses or deficits, or foreign saving shifts due to global stocks

Demand of Loanable Funds

Comes from investment, shifted by technological advances, expectations, corporate taxes, or lending standards and cash reserves