Explorations in Economics

1. Explorations in Economics Alan B. Krueger & David A. Anderson

2. Chapter 14: Unemployment and Inflation • Module 41: Unemployment • Module 42: Inflation • Module 43: Unemployment, Inflation, and the Business Cycle

3. Summary • Business cycle = expansion and contraction of GDP • Recessions and depressions increase unemployment. • Changes in aggregate supply and demand create cycles. Think ripples of water in a pond. • External shocks include changes in technology, government taxes and spending, financial crises, natural resource discoveries, and consumer expectations. Chapter 13-Mods 38-40

4. MODULE 42:INFLATION KEY IDEA: Inflation is an increase in the price level. It results in a decrease in the value of money. OBJECTIVES: • Define inflation • To explain how inflation is measured. • To explain what causes inflation and why high inflation is a problem. • To identify the dangers of deflation.

5. DEFINING INFLATION Inflation is a rise in the price level. The inflation rate is the annual percentage increase in the price level. Deflation is a decline in the price level.

6. Measuring Inflation – Basket Concept • To measure changes in the price level, economists look at the cost of a “basket” of goods and services. • The consumer price index looks at: • Housing • Transportation • Food • Medical Care • Education • Recreation • Which one do you think is the largest? Smallest? Chapter 14-Modules 41-43

7. MEASURING INFLATION The Consumer Price Index (CPI) is a measure of the overall price level faced by a typical consumer.

8. MEASURING INFLATION A market basket is a bundle of goods and services that an average consumer might buy. Calculating the CPI:

9. Measuring Price Changes of a Basket Chapter 14-Modules 41-43

10. Measuring Price Changes of a Basket Chapter 14-Modules 41-43

11. Calculating Inflation 2014 Basket Cost – 2013 Cost x 100 2013 Basket Cost $500 - $450 x 100 = 11.1% $450 Try this method using the worksheet. Chapter 14-Modules 41-43

12. Challenge Question What are the limitations to the way inflation is calculated? Chapter 14-Modules 41-43

13. Do Now – Inflation Experiment • Why did prices increase? • What would happened to prices if the auctioneer had increased the lollipops every time the number of clips increased? • What conclusions can you draw about the reasons behind inflation? Chapter 14-Modules 41-43

14. Reasons for Inflation • Money supply is increasing faster than real economic growth. • And, usually the economy is near capacity – that is labor, capital and natural resources are fully utilized. • Typically happens near peak of an economic cycle. Chapter 14-Modules 41-43

15. U.S. Inflation History Chapter 14-Modules 41-43

16. Inflation Winners and Losers History of inflation - YouTube In your notes, take a page and split between winners and losers. As you listen to the video, note who gains and who loses with inflation. Chapter 14-Modules 41-43

17. THE COSTS OF INFLATION The Inflation Myth Price Stability exists when inflation is low—2 or 3% per year. Inflation reduces the number of goods and services we can buy with each dollar that we earn.

18. THE COSTS OF INFLATION The True Costs of High Inflation Hyperinflation is very rapid inflation. Hyperinflation usually leaves a country’s currency worthless.

19. THE COSTS OF INFLATION The True Costs of High Inflation The Costs of Unexpected Inflation In general, people who borrow money benefit when inflation turns out to be higher than expected. But people who lend money lose from higher- than expected inflation. Unexpected inflation makes borrowing and lending more risky. Lenders may be hesitant to lend and borrowers may not wish to borrow.

20. Summary • Inflation = sustained increase in the price level. • Inflation winners • People who own physical assets. • People who owe money. • Inflation losers • People who own money. • People who loan money (unless loan tied to inflation). • Most workers. Chapter 14-Modules 41-43

21. DEFLATION AND ITS EFFECTS Deflation is a decrease in the price level. • Causes consumers to reduce spending • Postpone major purchases • Decrease in Aggregate Demand, contraction in economic activity • Dollar incomes also fall • More difficult to pay debts that do not change • Banks’ losses mount as more bankruptcies occur • Economic activity becomes risky and spending decreases

22. Summary • Deflation = sustained decrease in the price level. • Deflation winners • People who own money. • People who loan money to others. • Deflation losers • People who own physical assets. • People who borrow money (unless loan tied to inflation). Chapter 14-Modules 41-43

23. MODULE 42 REVIEW What is… A. Inflation? B. Inflation rate? C. Deflation? D. Consumer price index? E. Market basket? F. Base period? G. Producer price index? H. Hyperinflation? I. Shoe leather costs? J. Menu costs?

24. MODULE 41:UNEMPLOYMENT KEY IDEA: High unemployment is costly to the economy. OBJECTIVES • To explain how unemployment is measured. • To explore the types of unemployment and what causes each type. • To identify the economic costs of unemployment.

25. EMPLOYMENT AND UNEMPLOYMENT Total employment in an economy is the total number of employed workers, whether they work part time or full time. The labor force is the combination of the employed workers and the unemployed workers, excluding those in the military or in prison. Total unemployment in an economy is the number of workers who are actively seeking jobs but not actually working.

26. EMPLOYMENT AND UNEMPLOYMENT The unemployment rate is the percentage of the labor force without a paid job. Issues in Measuring Unemployment • Discouraged workers would like to work but have given up on their job search. • Underemployed workers would like to work more hours or prefer a job that better matches their skills. • Some unemployed hide their status since they are trying to avoid paying income tax.

27. TYPES OF UNEMPLOYMENT AND THEIR CAUSES Frictional unemployment is short-term unemployment that occurs while workers search for the jobs best suited for their skills and interests. Seasonal unemployment occurs when workers lose their jobs due to a change of seasons. Seasonal Adjustment The Bureau of Labor Statistics remove the typical and predictable changes in unemployment from each month’s unemployment numbers.

28. TYPES OF UNEMPLOYMENT AND THEIR CAUSES Structural unemployment arises from a mismatch between job seekers and the types of jobs available. Cyclical unemployment is joblessness caused by an economic contraction. The natural rate of unemployment is the unemployment rate in the absence of cyclical unemployment, around which the actual unemployment rate fluctuates.

29. TYPES OF UNEMPLOYMENT AND THEIR CAUSES Full employment is the level of employment when there is no cyclical unemployment. Due to the existence of other types of unemployment, the achievement of full employment does not mean that every worker is employed.

30. THE COSTS OFUNEMPLOYMENT • Unemployment will affect families in financial and personal ways. • Some purchases are delayed, savings are depleted or homelessness may happen. • Family issues arise that include difficulty in school, family separation, abuse or crime. • Unemployment is costly to the national economy • Total output will be reduced. • Government must pay more for unemployment insurance, and nutrition assistance. • Lower income tax revenues collected.

31. How The Costs Of Unemployment Are Distributed • Not an equal distribution among groups or locations within the nation • Work Experience • Lack of Opportunity • Discrimination • Location by state

32. MODULE 41 REVIEW What is… A. Total employment B. Total unemployment C. Labor force D. Unemployment rate E. Frictional unemployment F. Seasonal unemployment G. Structural unemployment H. Cyclical unemployment I. Natural rate of unemployment J. Full employment K. Discouraged workers L. Underemployed M. Jobless recovery

33. MODULE 43:UNEMPLOYMENT, INFLATION AND THE BUSINESS CYCLE KEY IDEA: Changes in unemployment and inflation are caused by changes in aggregate demand and aggregate supply. OBJECTIVES: • To explain how changes in aggregate demand and aggregate supply affect both unemployment and inflation. • To discuss the short- run tradeoff between unemployment and inflation. • To describe stagflation.

34. ONGOING INFLATIONAND UNEMPLOYMENT The “norm” in the economy may be some level of unemployment and some degree of inflation. Some levels of frictional and structural unemployment are part of a dynamic labor market. As wages increase and prices increase to cover higher costs, the expected inflation becomes a reality.

35. HOW AGGREGATE DEMAND AFFECTS UNEMPLOYMENT AND INFLATION The economy’s potential output is the level of real GDP that is produced when there is full employment.

36. HOW AGGREGATE DEMAND AFFECTS UNEMPLOYMENT AND INFLATION The economy’s potential output is the level of real GDP that is produced when there is full employment.

37. AGGREGATE SUPPLY AND STAGFLATION Stagflation is a combination of sluggish economic growth, high inflation, and high unemployment. A negative supply shock causes aggregate supply to decrease. • costs rise and output falls • unemployment increases but price levels increase A positive supply shock causes aggregate supply to increase. • costs fall and output increases • unemployment decreases and price levels decrease

38. MODULE 43 REVIEW What is… A. Potential output B. Stagflation C. Negative supply shock D. Positive supply shock