Econ 1012 3 Week of In Class and Textbook Notes Chapter 9
Econ 1012 3 Week of In Class and Textbook Notes Chapter 9 Econ 1012
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This 11 page Class Notes was uploaded by Caroline Jok on Tuesday February 2, 2016. The Class Notes belongs to Econ 1012 at George Washington University taught by Dr. John Volpe in Spring 2016. Since its upload, it has received 36 views. For similar materials see Principles of Economics II in Economcs at George Washington University.
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Date Created: 02/02/16
WEEK 3 NOTES Introduction to Macroeconomics Professor JECON 1012 Caroline E. Jok The George Washington University Class 5 Notes ~ Chapter 8 Continued • Firms buy from households and pay households wages/profits/rents o Income payment • Firms & individuals pay taxes to gov. • Households save money • Firms borrow money from the financial system • Banks act as financial medicines • Consumption of demand is around 75% of a ggregate demand o If consumption demand is week, PPI/machines inactive • Can measure GDP by looking at value adding in production process • Interested in GDP because we want to know how much Goods/Services each person has (but measuring GDP per person is impreci se way to measure wealth • Issues: o Household production -> Work in the house is not a part of GDP because it doesn't have a dollar value and contains no purchase or sale. • Doesn't get counted because there is no money attached to it o Underground economy (abo ut 15-18% now) • Work off the books or pay in cash so you don't have to declare it as income • Selling pirated CDs/DVDs, drugs gambling, etc. • When there is unreported income, governments with poorer countries don't try looking for the main cause because they want other government organizations to give money to the countries that appear poorer (lower GDP) than it actually is. • Distribution of income is unequal o Marginal theory productivity of wages: you earn what you're worth • Calculating real GDP (because normal GDP has inflation ) o Only interested in real GDP o P*Q • GDP deflation o Another way at looking at prices in the economy o (Normal GDP/real GDP)*100 • Likely to be somewhat different than inflation from consumer price index because it only counts consumers and doesn't take into account producers buying. But it counts prices of imports, while GDP doesn't count imports • % average increase o Most recent - previous/previous * 100 Class 6 ~ Chapter 9 Chapter 9: Unemployment and inflation • Who's working? Who's in the la bor force and not working? Who's not working period? • Household survey (Current Population Survey) o Issue: • People are self reporting • Establishment survey/payroll survey o Represent ~ 45% of non agricultural work force o Done by mail or phone o Issue: • Doesn't do a good job of surveying small businesses • Doesn't survey agricultural workers • inaccurate • Unemployed: o In the last four weeks you have actively sought work • Exempt: o In prison o People in the Armed Services o Retired o Student o Mentally/Physically disable d o Homemaker • 16 years of age or older, no more official retirement age • Vs. Italy - 14; *Not uniform & difficult to compare unemployment rates between countries and participation rates o Countries have different interpretations, and collect data differently Things that increase unemployment: • Unemployment compensation • Minimum Wage • Government regulation Labor force: Figure 9.1 • Labor Force o Employed o Unemployed • Not in Labor Force o Not Available for work o Available for work but not currently working • Discouraged workers • Not currently looking because of childcare responsibilities or transportation or other problems • Labor Force Participation Rate: o Rate of people in the Labor Force: Labor force/Working age population • Unemployment Rate: o Number of unemployed/labor force What's important in terms of unemployment • Frictional unemployment • Structural unemployment o Kind of important o People who are out of work because there has been a significant increase in imports and the companies are having a hard time compet ing, o Don't have the skill set necessary to get better/comparable jobs • Skill shortage in the United States? (i.e. doctors etc.) • Surplus of unemployed bc they don't have the skills the workforce needs (structurally unemployed) • People are not moving to where the jobs are • Cyclical unemployment o Most important o Occurs because of business cycle/fluctuations o Economy turns down = recession = put out of work o Short run = employment/unemployment o Long run = economic growth Reading Notes ~ Hubbard and O ’Brien Chapter 9: Unemployment and Inflation • Unemployment and Inflation are mos t often discussed in the media and during political campaigns • Misery index: adds together the inflation rate and unemployment rate 9.1 Measuring the Unemployment Rate, The labor Force Participation Rate and the Employment Population Ratio • If unemployment rate is higher or lower than expected, investors are likely to change their views on health of economy • Good News: Stock rises • Bad news: stock falls • The incumbent president is reelected if the unemployment rate is falling early in the election year, but is defeated if unemployment is rising. Household Survey • Each month: U.S. Bureau of the Census • Current Population Survey o Collect data needed to compute the unemployment rate o Sample of 60,000 houses represents the population o Everyone 16 and older o Employed = worked during the week prior to the survey o Unemployed = did not work in the previous week, but were available for work and had actively looked for work during the past 4 weeks • Labor Force: sum of the employed and the unemployed • Unemployment rate: percentage of the labor force that is unemployed. • Not in the labor force: people who do not have a job and are not actively looking for a job o Retirees o Homemakers o Full-time students o Active military o In prison o Mental hospital • Discouraged workers: available for work, but have not looked for jobs during the past 4 weeks because they believe no jobs are available for them. Problems with Measuring the Unemployment Rate • Distinguishing between the unemployed and people who are not in the labor force • Counts people as employed if they hold a part -time jobs • In a recession this makes unemployment situation seem better than it actually is. Overstate the extent of joblessness: • o Household survey doesn't verify the responses o Does not account for the black market Trends in Labor Force Participation Determines the amount of labor that will be available to the economy from a given population • • Higher, the more labor will be available a nd the higher a country's levels of GDP and GDP per person • 2 important trends since 1948 o Rising rates of women Changing social attitudes due in part to the women's movement, federal legislation • outlawing discrimination, increasing wages for women, family having fewer children o Falling rates of men • Older men retiring earlier and younger men remaining in school longer Unemployment Rates for Different Groups • Different ethnic groups have very different unemployment rates How long are people typically unemplo yed? • The longer one is unemployed, the greater the hardship • U.S.: relatively brief period of time • 4 - 6 months How Unusual Was the Unemployment Situation Following the 2007 - 2009 • Great Depression: high unemployment for long periods of time • 1981 - 82 unemployment rate was high, but people found jobs quickly • 07 - 09 Unemployment rate was high for a long period of time (2 years) o Workers who drop out of the labor market are no longer counted by the BLS as unemployed o Focus on the employment - population ratio The Establishment Survey: Another Measure of Employment • Establishment Survey a.k.a. Payroll survey o Measures total employment in the economy • Monthly • Samples about 300,000 businesses • Small company: 1 establishment • Large company: multiple establi shment • Provides: o Total number of people employed and on a company payroll • Draw backs: o Does not provide information on the number of self -employed people because they aren't on a company payroll o Survey fails to count some people employed at newly opened fi rms that are not included in the survey o Survey provides no information on unemployment o Initial employment values for the establishment survey can be significantly revised as data from additional establishments become available. • Advantage: o Determined by actual payrolls • Household survey includes self -employment and will likely provide a greater employment rate Revisions in the Establishment Survey Employment Data: How Bad was the 2007 - 2009 Recession? • to avoid long waits in data supplies to policy makers and the general public, government agencies typically issue the preliminary estimates that they revise as additional information comes in. • Recession of 2007 - 09 was much more severe than people realized at the time Job Creation and Job Destruction over Time • The U.S. economy creates and destroys millions of jobs every year The creation and destruction pf job results from changes in consumer tastes, technological progress, • and the successes and failures of entrepreneurs in responding to the o pportunities and the challenges of shifting consumer tastes and technological change • Large volume of job creation and destruction explains why the unemployment timespan is brief • When the BLS announces each month the increase/decrease in the number of perso ns employed and unemployed, these are net figures • Change in the number of persons employed is equal to the total number of jobs created minus the number of jobs eliminated. • Net change doesn't fully represent how dynamic the U.S. job market really is. 9.2 Types of unemployment Frictional Unemployment and Job Search • Workers have different skills, interests and abilities • Jobs have different requirements, working conditions and pay levels • New worker entering the labor force or a worker who has lost a job pr obably will not find an acceptable job right away • Most workers spend time job searching • Frictional unemployment: Short term unemployment that arises from the process of matching workers with jobs o Due to weather o Fluctuation in demand • Time of year • Tourism • Holidays • Aka: Seasonal Unemployment • Makes unemployment seem artificially high or low • Can be seasonally adjusted • Would eliminating frictional unemployment be good for the economy? o Some frictional unemployment actually increases economic efficiency o Frictional unemployment occurs because workers and firms take the time necessary to ensure a good match between the attributes of workers and the characteristics of jobs o Workers end up with jobs they find satisfying and in which they can be productive Structural Unemployment • Unemployment that arises from a persistent mismatch between the skills or attributes of workers and the requirements of jobs. • Some workers lack basic skills or have addictions that make it difficult for them to perform adequately Cyclical Unemployment • Unemployment caused by a business cycle recession • As production falls, firms start laying off workers Full Employment • Cyclical unemployment eventually drops to zero • Due to frictional and structural unemployment, the unemployment rate will not be zero • When the only remaining unemployment is structural and frictional unemployment = full employment Normal level of unemployment = sum of frictional and structural unemployment = natural rate of • unemployment • The natural rate of unemployment i s also called full-employment rate of unemployment How Should we Categorize Unemployment at Caterpillar? • Decline in the demand for the mining machinery • Falling prices and slow growth • Therefore Structural unemployment • Had the layoffs been due to competition it would have been frictional 9.3 Explaining Unemployment Government Policies and Unemployment rates • Government policies can aid private efforts to fill and find jobs • Governments pursue policies that help speed up the process of matching unempl oyment workers with unfilled job will help reduce frictional unemployment • Structural unemployment can be reduced by implementing policies that aid workers in retraining • Policies can also add to the level of frictional and structural unemployment o Increasing the time workers devote to searching for jobs by providing disincentives for firms to hire workers or by keeping wages above the market level Unemployment Insurance and Other Payments to the Unemployed • Someone in the labor force for a few years that los es their job could find a low -wage job immediately if needed (wal-mart) o May choose to look for a better job o Opportunity cost plays a role • In this case - the salary at wal-mart that you could have taken • The longer you search, the greater chance you have of finding a better job but the more salary you have given up o Unemployed are eligible for unemployment insurance payments • Vary state by state, generally equal to about half of the average wage • Only for six months, extended during recession o Other countries ha ve social insurance programs that allow them to receive government payments after their eligibility for unemployment insurance has ended Minimum Wage Laws • 1938 enacted national minimum wage from federal government • Higher minimum wage = higher unemployment • Discrepancy between living wage and minimum wage • But what about teen employment? Labor Unions • Organizations of workers that bargain with employers for higher wages and better working conditions for their members • Unionize industries: the wage is usually above what otherwise would be the market wage • Above market wage results in employers in unionized industries hiring fewer workers o Does it significantly increase the overall unemployment? • No because most workers who can't find jobs in unionized industries because the wage is above its market level can find jobs in other industries Efficiency wages: Paying above-market wages • • Believe doing so will increase their profits • Largest cost for many employers is monitoring workers • Motivation/incentivizing • Above market wage: it results in the quantity of labor supplied being greater than the quantity of labor demanded 9.4 Measuring Inflation • Prices of most goods rise over time • Cost of living is increasing • Price level: measure of the average prices of goods/services in the economy • Inflation rate: percentage increase in the price level from one year to the next • GDP deflator: measure of the price level o Broadest measure because it includes the price of every final good and service o Too broad in some cases o May be misleading because it includes prices of large products such as generators and machines that are included in the investment component but are not purchased by a typical household • Consumer price index: measuring the inflation rate by changes in this o Closest to measuring changes in the cost of living as experienced by a typical household • Producer price index Consumer Price Index • Uses the results of the BLS survey of 14,000 households to construct a market basket of 211 types of goods/services purchased by a typical urban family of four • Consumer price index: a measure of the average change over time in the prices a typical urban famiy of four pays for the goods and services they purchase • CPI = ratio of the dollar amount necessary to buy the market basket of goods in that year divided by the dollar amount necessary in the base year * 100 • Aka: cost of living index • Inaccuracies: we are assuming that households buy the same market basket of products each month • The CPI is intended to measure changes in the price level over time • Can't use CPI to tell us in an absolute sense how high the price level is Is the CPI accurate • Most widely used measure of inflation • Use CPI to track the state of the economy • Businesses use it to help set the pr ices of their products and the salaries of their employees • Social Security is increased each year by an amount equal to the percentage in the CPI increase • Same with setting alimony and child support payments in divorce cases. • Four biases: o Substitution bias: • CPI assumes each month consumers purchase the same amount of each product in the market basket • Consumers are likely to buy fewer of products that increase in price and more of products that decrease in price o Increase in quality bias: Most products included in the CPI improve in quality increases in the prices of these • products partly reflect their improved quality o New product bias • Formerly only updated every 10 years • New products introduced between updates were not included in the mark et basket • Can result in price decreases to make room for newer products o Outlet Bias • Internet has begun to account for a significant fraction of sales of some products • Cheaper than outlet stores • CPI doesn't necessarily reflect the prices that consumers wer e actually paying • Bias causes changes in the CPI to overstate the true inflation rate by 0.5- 1 % Producer Price Index: • Producer Price index: an average of the prices received by producers of goods/services at all stages of the production process • Tracks the prices of a market basket of goods • CPI tracks prices for a typical household • PPI tracks prices firms receive for goods and services at all stages of production • Includes the prices of intermediate goods • If the prices of these goods rise the cost to fi rms of producing final goods and services will rise - may lead firms to increase the prices of goods and services purchased by consumers • Changes in PPI give early warning of future movements in the CPI 9.5 Using the Price Indexes to Adjust for the Effects of Inflation • The purchasing power of a dollar was much higher in the past than it is now because the prices of most goods/services were lower • Price indexes give us a way of adjusting for the effects of inf lation so we can compare dollar values • Nominal Variables: economic variables that are calculated in current year prices • Real variable: measured in dollars of the base year for the price index 9.6 Nominal Interest Rates versus Real Interest rates • Difference between nominal and real values is important when money is being borrowed and lent • Interest rate: cost of borrowing funds o Percentage of the amount borrowed o Nominal interest rate: stated interest rate on a lone o Real interest rate: nominal interest rate minus the inflation rate • Corrects the nominal interest rate for the effect of inflation on purchasing power • The higher the inflation rate, the lower the real interest rate • For the economy as a whole; measure the nominal interest rate as the interest rate o n three month U.S. Treasury bills o Short term loans investors make to federal government • The real interest rate provides a better measure of the true cost of borrowing and the true return from lending than nominal interest rate does. • It is possible for nominal interest rate to be less than real interest rate o Inflation rate is negative o Deflation: decline in price level 9.7 Does Inflation Impose Costs on the Economy Nominal incomes generally increase with inflation • Inflation Affects the Distribution of Income • If inflation doesn't reduce affordability of goods/services why do people dislike it? o Because it applies to the average person but not to every person o Some people find their incomes rising faster than the rate o f inflation • Purchasing power will rise o Others find their incomes rising slower than the rate of inflation o If a retiree receives a fixed pension, their purchasing power is significantly reduced. • The extent to which inflation redistributes income depends in part on whether the inflation is anticipated or unanticipated Problem with Anticipated Inflation • Inflation is easier to manage if you see it coming • Inevitably brings o Redistribution of income o Firms and consumers have to hold some paper money o Anyone holding paper money will find its purchasing power decreasing each year by the rate of inflation • Try to hold as little paper money as possible • Menu costs: the costs to firms of changing prices o Moderate rates of anticipated inflation: menu costs are relativ ely small o High rates of inflation: menu costs can be substantial • Even anticipated inflation acts to raise the taxes paid by investors and raise the cost of capital for business investment o Investors are taxed on the nominal payments they receive from buying stocks and bonds or from making loans rather than on the real payments. The Problem with unanticipated Inflation • High income economy: firms routinely enter into contracts that commit them to make or receive certain payments for years in the future o Ex: mortgage loans o Making long term commitments requires forecast in the rate of inflation • Depending on the inflation determines whether the firm loses or gains process • Inflation rate needs to be forecasted so that they can calculate the real rate of interest o Actual inflation turns out to be different from the anticipated inflation: some gain and some lose • This is why people dislike unanticipated inflation What's so bad about falling prices: • Falling prices are deflatio n • Should encourage consumers to increase their spending , but in reality it has the opposite effect on consumers • Declining prices sometimes causes consumers to withhold their spending in anticipation of continuation of the trend
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