Understanding Macroeconomic Price Stability and Unemployment | Key Economic Measurements

1. ECONOMICS, 5e Roger Arnold CHAPTER 5 Macroeconomic Measurements, Part I: Prices and Unemployment

2. Exhibit 1 Three Major Economic Goals

3. MACROECONOMIC VARIABLES • Price Levels • The economy's price level refers to a weighted average of the prices of its goods and services

4. PRICE STABILITY • INFLATION is an increase in the general price level over time • DEFLATION is a decrease in the general price level over time

5. INFLATION AND PURCHASING POWER • If prices on average rise • a given income buys fewer goods and services. • inflation decreases the purchasing power of the dollar.

6. MEASURING THE PRICE LEVEL • Measures of the Price Level • The consumer price index measures the average nominal prices of goods and services that a typical family living in an urban area buys

7. Consumer Price Index • The CPI is calculated by the Bureau of Labor Statistics (BLS, http://www.bls.gov). • The representative group of goods chosen is called the Market Basket. • To calculate the CPI we need the total dollar expenditure in the current year and the base year. • The base year is a benchmark year that serves as that basis of comparison for prices in other years.

8. CPI’s Basket

9. Calculating the CPI • CPI = (current expenditure/base expenditure) X 100 • Current expenditure = the total dollar expenditure on market basket in current year • Base expenditure = the total dollar expenditure on market basket in base year

10. Exhibit 2 Computing the Consumer Price Index

11. THE INFLATION RATE Inflation rate = {CPI (t) - CPI (t-1) } x 100 CPI (t-1)

12. US Inflation

13. COMPUTE THE INFLATION RATE USING THE FOLLOWING: • CPI 1997 = 159.1 • CPI 1996 = 156.9 • formula ({CPI 97 - CPI 96} / CPI 96) X 100 • 159.1-156.9 / 156.9 = 2.2/156.9 = .014 • .014 X 100 = 1.4%

14. USING THE CPI:REAL vs. NOMINAL INCOME • NOMINAL INCOME - money income measured in current period dollars

15. USING THE CPI:REAL vs. NOMINAL INCOME • REAL INCOME - money income adjusted for changes in the price level • real Y = nominal Y x 100 • CPI (t)

16. Are you keeping up with inflation? • Income in 2000 = $40,000 • Income in 1999 = $35,000 • CPI in 2000 = 120 • CPI in 1999 = 100 • Real income 1999 = 35,000/100 x 100 = $35,000 • Real income 2000 = 40,000/120 x 100 = $33,334 • Real income is falling $33,334 < $35,000

17. MEASURING THE PRICE LEVEL • Other Measures of the Price Level • The producer price index is a weighted average of the prices of inputs that producers buy to make final goods

18. MEASURING THE PRICE LEVEL

19. MACROECONOMIC VARIABLES • Price Levels • The GDP price deflator equals nominal GDP divided by real GDP • Nominal GDP measures the current dollar value of the economy • Real GDP measures output valued at constant prices • Nominal GDP = Real GDP X GDP price deflator • Real GDP = Nominal GDP / GDP price deflator

20. MEASURING THE PRICE LEVEL • Limitations of Price Indexes • Index and other measures are imperfect and have limitations • Ignores such things as changes in quality, technological advances, and other factors that alter results • People substitute other goods when prices rise

21. SUBSTITUTION BIAS To avoid a potential bias created by ignoring consumer substitutions the US moved to a CHAIN-WEIGHTED index in Dec. 1995

22. Exhibit 5 Breakdown of the U.S. Population and the Labor Force SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.

23. EMPLOYED • Worked at least 1 hour in a wage/salary paying position • Owned his/her own business • Worked 15 hrs. per week in family business or farm as “unpaid” worker • absent due to illness, strike, or vacation

24. UNDEREMPLOYMENT • Workers are classified as employed • If they worked as little as one hour for pay during the survey week and • Even if they are over qualified for the work • The reported rate of unemployment may be understated due to underemployment

25. UNEMPLOYED • Did not work in the survey week but willing and able to work and actively looked within the last 4 weeks. • Laid off and waiting to be called back • Waiting to report to a job within 30 days

26. DISCOURAGED WORKERS • people who have given up on the job search process • not considered unemployed because they are not actively searching for a job • Cause the reported unemployment rate to understate the true unemployment problem because they are not included in the labor force

27. Phantom Unemployed • Those who claim to be unemployment, when in fact they are not • May be due to qualify for unemployment benefits • Cause the reported unemployment rate to overstate the true unemployment problem because they are not actively seeking work

28. THE UNEMPLOYMENT RATE # people unemployed x 100 # people in labor force

29. FIND THE UNEMPLOYMENT RATE • population is 100 million • labor force is 50 million • 45 million are employed

30. UNEMPLOYMENT RATE U = 5m./50m. x 100 = 10%

31. Types of Unemployment • Frictional

32. FRICTIONAL UNEMPLOYMENT people moving between jobs or into the labor force.

33. Types of Unemployment • Frictional • Structural

34. STRUCTURAL UNEMPLOYMENT skills and/or location of workers does not match available jobs

35. Types of Unemployment • Frictional • Structural • Natural

36. NATURAL UNEMPLOYMENT a certain level of frictional and structural unemployment that is considered natural in a changing economy (usually 4-6.5%)

37. U.S. Unemployment, 1958-2002

38. FULL EMPLOYMENT The full employment rate is when unemployment is at its natural rate (not zero).

39. Types of Unemployment • Frictional • Structural • Natural • Cyclical

40. CYCLICAL UNEMPLOYMENT unemployment due to downturns in overall economic activity (recessions)  The difference between the existing unemployment rate and the natural unemployment rate

41. U.S. Unemployment, 1958-2002