Understanding Economics: Unemployment, Inflation, and Growth

1. 7 Unemployment, Inflation, and Long-Run Growth C H A P T E R O U T L I N E Unemployment Measuring Unemployment Components of the Unemployment Rate The Costs of Unemployment Inflation The Consumer Price Index The Costs of Inflation Long-Run Growth Output and Productivity Growth

2. Unemployment Measuring Unemployment employedAny person 16 years old or older (1) who works for pay, either for someone else or in his or her own business for 1or more hours per week, (2) who works without pay for 15 or more hours per week in a family enterprise, or (3) who has a job but has been temporarily absent with or without pay (such as maternity leave). unemployedA person 16 years old or older who is not working, is available for work, and has made specific efforts to find work during the previous 4 weeks.

3. not in the labor forceA person who is not looking for work because he or she does not want a job or has given up looking. labor forceThe number of people employed plus the number of unemployed. labor force = employed + unemployed adult population = labor force + not in labor force population = adult population + population below 16 years old

4. unemployment rateThe ratio of the number of people unemployed to the total number of people in the labor force. labor force participation rateThe ratio of the labor force to the total population 16 years old or older.

6. E C O N O M I C S I N P R A C T I C E A Quiet Revolution: Women Join the Labor Force In 1955, the labor force participation rate of women was 36 percent. In 1996, the labor force participation rate was 60 percent for all women. By comparison, the participation rate for men declined over this period—from 85 percent in 1955 to 75 percent in 1996. No doubt, some men dropped out to assume more traditional women’s roles, such as child care. • THINKING PRACTICALLY • When a household decides to hire someone else to clean their house and uses their extra time to watch television, the wages paid to that household worker increase GDP. • Is economic output in fact larger?

7. Components of the Unemployment Rate Unemployment Rates for Different Demographic Groups

8. Unemployment Rates in States and Regions

9. Discouraged-Worker Effects discouraged-worker effectThe decline in the measured unemployment rate that results when people who want to work but cannot find jobs grow discouraged and stop looking, thus dropping out of the ranks of the unemployed and the labor force. The BLS (Bureau of Labor Statistics) survey provides some evidence on the size of the discouraged-worker effect. Respondents who indicate that they have stopped searching for work are asked why they stopped. If the respondent cites inability to find employment as the sole reason for not searching, that person might be classified as a discouraged worker. Some economists argue that adding the number of discouraged workers to the number who are now classified as unemployed gives a better picture of the unemployment situation.

10. The Duration of Unemployment

11. The Costs of Unemployment Some Unemployment Is Inevitable When we consider the various costs of unemployment, it is useful to categorize unemployment into three types: • Frictional unemployment • Structural unemployment • Cyclical unemployment

12. Frictional, Structural, and Cyclical Unemployment frictional unemploymentThe portion of unemployment that is due to the normal turnover in the labor market; used to denote short-run job/skill-matching problems. structural unemploymentThe portion of unemployment that is due to changes in the structure of the economy that result in a significant loss of jobs in certain industries. natural rate of unemployment The unemployment rate that occurs as a normal part of the functioning of the economy. Sometimes taken as the sum of the frictional unemployment rate and the structural unemployment rate. cyclical unemploymentUnemployment that is above frictional plus structural unemployment.

13. Social Consequences The costs of unemployment are neither evenly distributed across the population nor easily quantified. The social consequences of the Depression of the 1930s are perhaps the hardest to comprehend. Few emerged from this period unscathed. At the bottom were the poor and the fully unemployed, about 25 percent of the labor force. Even those who kept their jobs found themselves working part-time. Many people lost all or part of their savings as the stock market crashed and thousands of banks failed.

14. E C O N O M I C S I N P R A C T I C E The Consequences of Unemployment Persist Throughout the recession of 2008–2009 and the slow recovery afterwards, many young college graduates found themselves unemployed for a number of months. Economists believe that the negative effect of early unemployment lasts for many years! Even fifteen years following the recession in 1979–1982, wage rates of those with post-college unemployment lagged substantially. Not only did low wages persist, but fewer graduates in recessionary periods were able to enter high prestige jobs, even when the economy recovered. • THINKING PRACTICALLY • Describe a mechanism that might help explain the persistence of wage-effects from a recession.

15. Inflation The Consumer Price Index consumer price index (CPI) A price index computed each month by the Bureau of Labor Statistics using a bundle that is meant to represent the “market basket” purchased monthly by the typical urban consumer. producer price indexes (PPIs)Measures of prices that producers receive for products at all stages in the production process. Once called wholesale price indexes, PPIs are calculated separately for various stages in the production process. The three main categories are finished goods, intermediate materials, and crude materials, although there are subcategories within each of these categories.

16. ▲ FIGURE 7.1 The CPI Market Basket The CPI market basket shows how a typical consumer divides his or her money among various goods and services. The CPI market basket for December 2007 shows that most of a consumer’s money goes toward housing, transportation, and food and beverages.

17. Example: CPI Calculation. Consumers purchase only 4 goods: 2x4s, shirts, tires, and chicken. Let 2014 be the market basket. The prices for each year are as follows. 2013 2014 Good Price Quantity Good Price Quantity 2x4s $7.50 1000 2x4s $8.00 1050 Shirts $20.00 200 Shirts $20.50 230 Tires $50.00 500 Tires $52.50 520 Chicken $4.50 250 Chicken $4.00 300

18. Compute CPI in 2013 and 2014, and find the inflation between these two years. Cost of the basket in 2013 = Cost of the basket in 2014 = Cost of the basket in base (basket) year = CPI (2013) = CPI (2014) = Inflation rate =

20. E C O N O M I C S I N P R A C T I C E Chain-Linked Consumer Price Index in the News Throughout the last months of 2012 and into early 2013, as Republicans and Democrats argued over the federal budget, chain linking became a hot topic. The fixed-weight version of the consumer price index (CPI) is the one that is used to adjust social security benefits and veteran benefits to price changes. If the chain-linked CPI were used instead, benefits would tend to increase more slowly because in general, the chain-linked CPI increases less than does the fixed-weight CPI (because of product substitution). The nonpartisan Congressional Budget office estimated that if the chain-linked CPI were adopted, it would save the federal government about $145 billion over a ten year period from the lower benefits. • THINKING PRACTICALLY • Tax brackets are also tied to the fixed-weight CPI. • How would tax revenue be affected if the chain-linked CPI were used instead?

21. The Costs of Inflation During inflations, most prices—including input prices like wages—tend to rise together, and input prices determine both the incomes of workers and the incomes of owners of capital and land. So inflation by itself does not necessarily reduce ones purchasing power. Inflation May Change the Distribution of Income One way of thinking about the effects of inflation on the distribution of income is to distinguish between anticipated and unanticipated inflation. The effects of anticipated inflation on the distribution of income are likely to be fairly small, since people and institutions will adjust to the anticipated inflation. Unanticipated inflation, on the other hand, may have large effects, depending, among other things, on how much indexing to inflation there is. real interest rateThe difference between the interest rate on a loan and the inflation rate.

22. Administrative Costs and Inefficiencies There may be costs associated even with anticipated inflation, such as the administrative cost associated with simply keeping up. Interest rates tend to rise with anticipated inflation. When interest rates are high, the opportunity costs of holding cash outside of banks is high. Public Enemy Number One? Economists have debated the seriousness of the costs of inflation for decades. No matter what its real economic cost, it makes us uneasy and unhappy. In 1974, President Ford verbalized some of this discomfort when he said, “Our inflation, our public enemy number one, will unless whipped destroy our country, our homes, our liberties, our property, and finally our national pride, as surely as any well-armed wartime enemy.” In this belief, our elected leaders have vigorously pursued policies designed to stop inflation.

23. Long-Run Growth output growthThe growth rate of the output of the entire economy. per-capita output growthThe growth rate of output per person in the economy. productivity growthThe growth rate of output per worker.

24. Output and Productivity Growth ▲ FIGURE 7.2 Output per Worker Hour (Productivity), 1952 I–2012 IV Productivity grew much faster in the 1950s and 1960s than it has since.

25. ▲ FIGURE 7.3 Capital per Worker, 1952 I–2012 IV Capital per worker grew until about 1980 and then leveled off somewhat.

26. Looking Ahead This ends our introduction to the basic concepts and problems of macroeconomics. The first chapter of this part introduced the field; the second chapter discussed the measurement of national product and national income; and this chapter discussed unemployment, inflation, and long-run growth. We are now ready to begin the analysis of how the macroeconomy works.

27. productivity growth real interest rate structural unemployment unemployed unemployment rate Equations: labor force = employed + unemployed population = labor force + not in labor force R E V I E W T E R M S A N D C O N C E P T S consumer price index (CPI) cyclical unemployment discouraged-worker effect employed frictional unemployment labor force labor force participation rate natural rate of unemployment not in the labor force output growth per-capita output growth producer price indexes (PPIs)