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EC202 Week 2 Notes

by: Annie Notetaker

EC202 Week 2 Notes Econ 202

Annie Notetaker
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About this Document

These notes cover all of week two: Monday 10/3/16 and Wednesday 10/5/16
Introduction to Macroeconomics
Tim Duy
Class Notes
Economics, Econ, EC, EC202, econ202, Macroeconomics
25 ?




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This 9 page Class Notes was uploaded by Annie Notetaker on Thursday October 6, 2016. The Class Notes belongs to Econ 202 at University of Oregon taught by Tim Duy in Fall 2016. Since its upload, it has received 15 views. For similar materials see Introduction to Macroeconomics in Macro Economics at University of Oregon.


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Date Created: 10/06/16
EC 202- Tim Duy: Week 2, Chapter 5 Mon 10/3/16 Jobs and Inflation Recession Indicators Two quarters of the business cycle of low GDP don’t necessarily imply a recession • Decline in jobs: nonfirm payrolls • Industrial production: decrease in manufacturing • Real personal income (excluding transfer payments) Employment and Unemployment Why do we care about unemployment? Macroeconomists spend a lot of time trying to answer this question: • Lost incomes and lost production • Lost human capital- someone unemployed for a long period of time becomes undesirable to employers. Unemployment feeds upon itself and becomes worse for people who are unemployed for a long period of time • Coming out of school during a recession may lead to taking a job not related to your field, and hurt you when you’re trying to get back into your field Costs that occur during a recession are narrowly felt • Only some people experience the effects of a recession, while others are “free” from it • Low interest rates can harm people (senior citizens) living off retirement on fixed income interest rates (this problem can be solved in fairly obvious ways like increasing social security, which many retirees survive on) Different groups of people are affected more seriously by the economy based on race, education, etc • Some groups of people have a lack of economic opportunity • People of poor/little education are often shut out of the job market • Death rates of these people are increased • Consequences of a lack of jobs are fairly severe How do we determine the current employment rate? Current Population Survey • 60,000 households are in the survey for 6 months, out for 6 months, and back in for 6 months • Participants are asked about their employment status The population is split into two broad groups: 1. Working Age Population: Number of people aged 16+ not in an institution (i.e. jail, hospital, military) 1A. Labor Force: To be defined in this group, you must be employed or unemployed: To be unemployed, you must be available to work and one of the following: i. Without work but have looked in the last four weeks : documented and undocumented workers ii. Waiting to be called back to a job after a layoff (expected to return within 30 days) iii. Waiting to start a new job within 30 days 1B. Not in the labor force 2. Young and Institutionalized U = 100(Number Unemployed/Labor Force) Labor Force = Employed + Unemployed 2 • If the unemployed drop out of the labor force, the unemployment rate will drop • If people come back into the labor force but are still unemployed, the unemployment rate will increase, but that isn’t necessarily a bad thing Ex.: 10 people are unemployed, 90 are employed Labor force: 90 + 10 = 100 Unemployment rate: 100(10/100) = 10% Can we push the unemployment rate down to 4-4.5% without raising prices and inflation? What is a sustainable level of employment? • A “fully employed” economy may still have an unemployment rate • If you could hold the economy and employment close to the level of potential output without something going wrong The Employment to Population Ratio EmpPop Ratio = 100(Number Employed/Working-Age Pop) The Labor Force Participation Rate LFP = 100(Labor Force/Working-Age Pop) Other Definitions of Unemployment • Marginally Attached Workers: Neither working nor looking for work, but are available for work and have looked in the recent past. Workers that may take a job if it comes along, but are not actively searching • Discouraged Workers: Have stopped looking for work because of repeated failure: Become unemployed and are unable to find work again, so they stop looking • Part-Time Workers for Economic Reasons: Can’t find full-time work, even though they want it: Have the skillset and desire to work full - time, but there isn’t enough economic activity to justify full-time employment People who are counted in the unemployment statistic may be: 3 1. Too young to work 2. Institutionalized 3. Don’t want to work (retired) 4. Are employed part-time This drastically raises the actual unemployment rate from around 5% to around 40% Types of Unemployment Frictional Unemployment: Unemployment associated with people entering and leaving the labor force and natural job creation and destruction a. Retirement b. Leaving for childcare reasons c. People leaving because they have the luxury to not work Structural Unemployment: Unemployment that arises because of changes in skills, technology, international competition, or job location a. Your skillset no longer matches your location b. New technological advances outdate your line of work c. International competition forces you to move in order to have work Cyclical Unemployment: The temporary unemployment associated with the business cycle Natural Unemployment: The combination of structural and frictional unemployment, or when cyclical unemployment is zero Full Employment Full Employment: Occurs when the actual unemployment is equal to the natural rate of unemployment Factors that influence the level of full employment: 1. Age distribution of the population Aging workers means less frictional unemployment 2. Scale of Structural Change More/rapid structural change means a higher rate of structural unemployment 4 3. Real Wage Rate Unemployment can be caused by minimum wages or efficiency wages (higher wages for more productive workers) 4. Unemployment Benefits The longer you can survive without a job, the less likely you are to put effort into finding a job (i.e. surviving off social security or unemployment benefits). More benefits raise the natural rate (lower cost to unemployment) 5 EC 202- Tim Duy: Week 2, Chapter 5 Wed 10/5/16 Jobs and Inflation The unemployment rate becomes very important for policy -makers. Keeping the rate close to the Federal Reserve’s estimation for natural unemployment keeps people in jobs. If policy-makers raise it even 1%, thousands-millions of people can become and stay unemployed. Output Gap Actual GDP-Potential GDP When the gap is positive: Unemployment is less than the natural rate (actual > potential) When the gap is negative: Unemployment is more than the natural rate (actual < potential) Inflation Inflation decreases the purchasing power of money Price Level: The average level of prices Mathematically calculated level of prices based on the thousands and millions of goods/services purchase d yearly Inflation: A persistent increase in the price level Deflation: A persistent decrease in the price level, also negative inflation Disinflation: A decrease in the rate of inflation -Inflation has been running around 2% per year 6 Why is Inflation a Problem? Redistributes Income: Unexpected inflation lowers real wages (Real wages are wages adjusted for prices) • If your wage doubles, but the price of everything doubles also, you receive no benefit. We don’t care about wage in nominal terms, only in real terms • Ex.: If I get a 5% raise next year, but inflation unexpectedly rises from 3% to 5%, then in real terms, adjusting for inflation, my raise is 0% instead of 2% Redistributes Wealth: Unexpected inflation means debtors pay back creditors with money that is worth less than what it was originally worth when they borrowed it • Ex.: I borrow $100, expecting to pay back $105 next year. If inflation is 10%, then that $105 next year will purchase the equivalent of $94.5 of this year’s goods/services Lowers Real GDP and Employment: With deflation, firms and households with debt are worse off and consequently cut spending Inflation might create a temporary boom in activity that pushes GDP above potential, but that often ends in a recession Diverts Resources from Production: People and firms spend time forecasting inflation, shoe leather costs, and menu costs • Shoe Leather Costs: ‘Running’ around town, trying to find the lowest prices • Menu Costs: The cost to change prices (i.e. a restaurant purchasing new menus) Consumer Price Index (CPI): A measure of the average prices paid by consumers for a fixed basket of goods The CPI is set to 100 during a period called the reference base period, or base year. It is measured by items evaluated for price, size, and quality 7 The current base year is 1982-1984. The average of those 36 months is set to 100 The CPI for August 2015 is 237.703. Prices for the basket of CPI goods are more than twice the base (138%) The CPI for August 2016 is 240.305. Prices for the basket of CPI goods ar e 1.1% higher than last year Constructing CPI Requires 1. Selecting the CPI basket 2. Conducting a monthly survey of prices 3. Calculating the CPI Not everyone has the same CPI basket. People feel the effects of inflation differently because of how they spend their money, whether or not payments are fixed, etc. Calculating CPI Item Quantity Price Cost of CPI Basket Oranges 10 $1.00 $10 Haircuts 5 $8.00 $40 15 $9 $50 The CPI is calculated using the formula: CPI = 100(Cost of basket at current-period prices/Cost of basket at base- period prices) Simple ex.: CPI in 2013 = 100($70/$50) = 140 The CPI was 40% higher in 2013 than it was in the base period Calculating Inflation • The major purpose of the CPI is to measure inflation • The inflation rate is the percentage change in the price level from one year to the next 8 Inflation is calculated using the formula: Inflation Rate = 100[(CPI this year – CPI last year)/CPI last year] Sources of Bias in the CPI • Are we calculating CPI correctly? • How can we accommodate for changes? New Goods Bias: New goods are often more expensive than the goods they replace (can overstate inflation by putting in a new item that costs more than the old one due to new advances) Quality Change Bias: Part of an increase in price might be for quality adjustment, which may not be fully accounted for and lead to an overestimate of price change (can overstate inflation by not accounting for better quality compared to price changes) Commodity Substitution Bias: Changing prices trigger changes in consumption patterns Outlet Substitution Bias: Higher prices may trigger shifts to lower-priced discount stores Magnitude of bias may be as high as 1.1 percentage points Alternatives to adjust to this • Chained CPI • PCE Deflator • GDP Deflator Calculated differently than CPI to accommodate for mistakes in CPI calculations 9


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