6.1 Examining Unemployment

• When an economy performs poorly, it imposes costs on individuals and society.

How Is Unemployment Defined and Measured?

• The unemployed are those individuals who do not currently have a job but who are actively looking for work.

• The employed are individuals who currently have jobs.

• Together, the unemployed and employed comprise the labor force:

  • Labor = employed + unemployed

• The unemployment rate is the number of unemployed divided by the total labor force

  • Unemployment rate = (unemployed/labor force) x 100

• Labor force participation rate which is the labor force divided by the population 16 years of age and older.

  • Labor force participation rate = (labor force/participation 16 years and older) x 100

Alternative Measures of Unemployment and Why They are Important

• Individuals who want to work and have searched for work in the prior year, but are not currently looking for work because they believe they won’t be able to find a job are called discouraged workers.

• Marginally attached workers are individuals who would like to work and have searched for work in the recent past, but have stopped looking for work for a variety of reasons. There are two groups:

  • Discouraged workers

  • Workers who are not looking for jobs for other reasons, including lack of transportation or childcare

• Individuals working part-time for economic reasons are those workers who would like to be employed full time but hold part-time jobs.

Who are the Unemployed?

• Adults have substantially lower unemployment rates than teenagers.

• Minorities have higher unemployment rates.

• On average, men and women have similar unemployment rates, but the unemployment rates for married men and married women are lower than the unemployment rates of women who maintain families alone.

• Unemployment due to recurring calendar effects is called seasonal unemployment.

6.2 Categories of Unemployment

Types of Unemployment: Cyclical, Frictional, and Structural

• Economists call the unemployment that occurs during fluctuations in real GDP cyclical unemployment.

• Cyclical unemployment rises during periods when real GDP falls or grows at a slower-than-normal rate and decreases when the economy improves.

• Frictional unemployment is the unemployment that occurs naturally during the normal working of an economy. It occurs because it simply takes time for people to find the right jobs and for employers to find the right people to hire.

• Structural unemployment occurs when the economy evolves. It occurs when different sectors give way to other sectors or certain jobs are eliminated while new types of jobs are created.

The Natural Rate of Unemployment

• The level of unemployment at which there is no cyclical unemployment is called the natural rate of unemployment, consisting of only frictional unemployment and structural unemployment.

• The natural rate of unemployment is the economist’s notion of what the rate of unemployment should be when there is full employment.

• The general rise in prices for the entire economy is commonly called inflation.

6.3 The Costs of Unemployment

• Unemployment insurance, payments received from the government upon becoming unemployed, can cushion the blow to some degree, but unemployment insurance is typically only temporary and does not replace a worker’s full earnings.

• Workers who suffer from a prolonged period of unemployment are likely to lose some of their skills.

• Losing a job can impose severe psychological costs.

• Although unemployment insurance can temporarily offset some of the financial costs of job loss, the presence of unemployment insurance also tends to increase the length of time that unemployed workers remain unemployed.

6.4 The Consumer Price index and the Cost of Living

• Real-Nominal Principle: What matters to people is the real value of money or income -its purchasing power- not the face value of money or income.

• Economists have developed a number of different measures to track the cost of living over time. The best-known measure is the Consumer Price Index (CPI).

• The CPI measures changes in prices of a fixed basket of goods - a collection of items chosen to represent the purchasing pattern of a typical consumer.

• The base year is the cost of the basket of goods in a given year.

• CPI in year K = (cost of the basket in year K/cost of the basket in the base year) x 100

The CPI versus the Chain Index for GDP

• The chain-weighted index for GDP and the CPI are both measures of average prices for the economy.

• Reasons they are different are:

  1. The CPI measures the costs of a typical basket of goods for consumers which includes goods produced in prior years, as well as imported goods. The chain-weighted price index for GDP does not measure prices changed from either used goods or imports.

  2. Unlike the chain-weight price index for GDP, the CPI asks how much a fixed basket of goods costs in the current year compared to the cost of those same goods in a base year.

Problems in Measuring Changes in Prices

• Most economists believe that in reality all the indexes, including the chain-weighted index for GDP and the CPI, overstate actual changes in prices.

• Some government programs, such as SOcial Security, automatically increase payments when the CPI goes up.

• Some union contracts also have cost-of-living adjustments (COLAs), automatic wage changes based on the CPI.

• If the CPI overstates increases in the cost of living, the government and employers might be overpaying Social Security recipients and workers for changes in the cost of living.

6.5 Inflation

• The percentage rate of change of a price index is the inflation rate.

• Inflation refers not to the level of prices, whether they are high or low, but to their percentage change.

The Perils of Deflation

• Deflation is the negative inflation or falling prices of goods and services.

6.6 The Costs of Inflation

• Economists separate the costs of inflation into two categories:

  1. Anticipated inflation: costs associated with fully expected

  2. Unanticipated inflation: costs associated with unexpected

Anticipated Inflation

• There are physical costs to physically changing prices, which economists call menu costs.

• Economists use the term shoe-leather costs to refer to the additional costs people incur to hold less cash.

Unanticipated Inflation

• The cost of unexpected inflation is arbitrary redistributions of income.

• If you miscalculate and the inflation rate turns out to be higher, the purchasing power of your wages will be less than you anticipated.

• As long as the inflation rate differs from what is expected, there will be winners and losers.

• If a society experiences unanticipated inflation, individuals and institutions will change their behavior.

• If unanticipated inflation becomes extreme, individuals will spend more of their time trying to profit from inflation rather than working at productive jobs.

• Indeed, when inflation rates exceed 50 percent per month, we have what is called hyperinflation.

• Even in less extreme cases, the costs of inflation are compounded as inflation rises.

• At high inflation rates, these costs grow rapidly, and at some point, policymakers are forced to take action to reduce inflation.