PRIN OF ECONOMICS
PRIN OF ECONOMICS ECON 203
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This 18 page Class Notes was uploaded by Mr. Tito Legros on Wednesday October 21, 2015. The Class Notes belongs to ECON 203 at Texas A&M University taught by Michael Nelson in Fall. Since its upload, it has received 28 views. For similar materials see /class/225828/econ-203-texas-a-m-university in Economcs at Texas A&M University.
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Date Created: 10/21/15
1212010 Unemployment and Inflation 39 I h Unemployment Measuring Unemgloyment I Household Survey The Bureau of Labor Statistics BLS surveys 60000 households every month Each adult aged 16 or older into one of three categories I The Labor Force is the number of I Who is not in the labor force 1212010 Learningomecive 81 Employee 1455 millm 348 million Unaanimal FIGURE 81 39 1 Note that some people are available for work but have not looked for ajob during the previous fourweeks because they believe no jobs are available for them These people are called The unemployment rate measures the percentage of the labor force that is unemployed The labor force participation rate measures the percentage of the workingage population in the labor force Numerical example Nelsonville I Population adult 240000 I Employed 180000 I Unemployed 30000 I Size of Labor Force I Unemployment Rate I Labor Force Participation Rate Problems Measurinq Unemployment I Problems causing measured unemployment to understate actual joblessness E Discouraged workers E Parttime workers I Problems causing measured unemployment to overstate actual joblessness 1 People who falsely claim to be actively looking for work 1 People employed in illegal industries often report themselves as unemployed I Next we look at trends in the real world data 1212010 1212010 Learningomecive 81 Trends in Labor Force Participation FIGURE 82 panicipminn rate 100 i i i i i 1943 i960 1970 1950 I990 2000 2006 Leaquotiquot90bquote ve 8quot Unemployment Rates for Demographic Groups FIGURE 88 Unemployment 95 Unemployme Fi39ales in he Un 35 birnemggra so 25 gt 20 15 r Unemployment rate ior the iolai o ulaiiun 45 w p 0 While Hispanic Black White Hispanic Black adulls duils aduils ieenagers ieenagers ieenagers 39 J Another Measure of 39 39 The quot 39 quot 39 Survev aka the payroll survey I Samples 300000 business establishments each month to see number of people on the payrolls of these businesses D Strengths Li Weaknesses Labor market churn I Each year millions of jobs are created and destroyed in our economy I Jobs created I Jobs destroyed I When the BLS announces increasesdecreases in of people employed and unemployed these are net figures E Example April to June 2006 US I Jobs created 7761000 I Jobs eliminated 7295000 I Net jobs created 1212010 1212010 39 J Types of Unemployment 1 Frictional Unemployment Job Search c Shortterm unemployment that arises from the process of matching workers with jobs Note that frictional unemployment can occur even if the of available jobs is C D Would eliminating all frictional unemployment be good forthe economy 39 I 2 Structural Unemployment E arises from a persistent mismatch between the skills and characteristics of workers and 3 Cyclical Unemployment a Unemployment caused by the business cycle Cyclical unemployment rises and falls over the business cycle but structural and frictional unemployment are 1212010 Learningomec ve 82 FIG U R E 84 The Annual Unemployment Plate in the United States 1950 2006 Unemploymenl rat 1 2 1 l E E 4 2 D I950 I960 1970 1930 1990 2000 39 I I The natural rate of unemployment is the normal rate of unemployment and consists of I That is it s the level of unemployment we have when cyclical unemployment I When unemployment is equal to the natural rate of unemployment then the economy is said to be at I The natural rate of unemployment varies over time because frictional and structural unemployment vary over time Estimate Explaining Unemployment I Government policies and unemployment i Unemployment insurance is designed to soften the blow of unemployment What incentive does this provide the unemployed Ci Minimum wage laws If the minimum wage is set above the market wage determined by the demand and supply of labor the quantity of labor supplied will be than the quantity of labor demanded I Labor unions often successfully negotiate for above equilibrium wages Does this cause unemployment to increase 1 Maybe 1 Maybe not 1 Notice that unions do cause wage inequality between similarly skilled workers 1212010 I An efficiency wage is an aboveequilibrium wage paid by firms in order to increase worker productivity Why would a firm voluntarily pay efficiency wages wages above the equilibrium wage a Improve Worker Health a Reduce Worker Turnover a Increase Worker Effort a Attract Higher Quality of Workers I Example Henry Ford and the Generous 5 a day wage Learning Objective 83 kg International Comparisons FIGURE 85 quot 39quotquot quot i A v u neimpio vm ii I heun39 s 16 Japan Unied United Canada Germai39iy Italy France Slates Kingdom Spain 1212010 396 Inflation Measuring Inflation I What is the difference between the price level and the inflation rate One measure inflation is the change of the The most common measure of inflation however is the of the The GDP Deflator contains the prices of GDP The CPI contains the prices of goods that typical people buy How does the BLS know what typical people buy IE Measuring Inflation I The Consumer Price Index FIGU RE 86 Olher goods and seNices The CPlMafkel BaSkeh W December 2006 Education and communicalion Food and beverages 60 1 5 0 a Recreation 56 Medical care i 63 i Housing 427 Transportation 172 Apparel 37 1212010 Inflation calculation I Each month BLS employees collect price information In effect each month they calculate the A base year is chosen The consumer price index CPI in any year is defined as The inflation rate is the change of the CPI from one period to the next For example if the CPI is 120 in 1988 and 130 in 1989 then the inflation rate between 88 and 89 is 39 1 Numerical Example Market Basket 3 footballs and 4 basketbaIIs Assume Base Year 2008 Cost of Basket in 07 Cost of Basket in 08 Cost of Basket in 09 CPI in 07 CPI in 08 CPI in 09 Year Price of Price of Footballs Basketballs 2007 1 0 1 2 2008 1 2 1 5 2009 1 4 1 8 1212010 1212010 I Inflation rate between 07 and 08 is I Inflation rate between 08 and 09 is Problems in 39 cost of livinq chanqes I Substitution bias Law of demand says that we buy less of a good when its price increases Construction of CPI doesn t allow for this change I Increase in quality bias Over time the quality of most goods increases but the CPI construction doesn t account for this change 39 i Newproduct bias New products are not included immediately The prices of new products typically drop quickly but the CPI doesn t capture this effect Outetbias Consumers often shop at stores with cheaper prices than the stores visited in data collection by the BLS All of these biases imply that the CPI measures How much No big deal 1212010 Usinq the CPI to Adiust for the Effects of Inflation Value in 08 dollars Value in Year Xdollars x CPI in 08CPI in X Example Your dad tells you that he earned 335 per hour in 1983 That is just like earning how many 55 per hour in 2008 We need CPI values for both years CPI in 83 996 and CPI in 08 2191 A bit of lingo Your dad s nominal wage in 1983 was Your dad s real wage in 1983 expressed in 2008 dollars is I For some purposes we are interested in tracking changes in an economic variable over time rather than in seeing what its value would be in today s dollars In that case to correct for the effects of inflation we can divide the nominal variable by a price index and multiply by 100 to obtain a real variable Once we ve converted nominal variables to real variables we can directly compare the real variables of different years None of the difference in the real variables will have anything to with Learning Objective 85 Calculating Real Average Hourly Earnings NOMINAL REAL AVERAGE AVERAGE CPI HOURLY EARNINGS HOURLY 19821984 19821984 YEAR EARNINGS 100 DOLLARS 2004 15 69 1889 2006 1794 2016 2008 1862 2191 I Growth rate of real wages 04 to 06 I Growth rate of real wages 06 to 08 I Another measure of price level in the Producer Price Index PPI Producer price index PPI An average of the prices received by producers of goods and services at all stages of the production process Because firms eventually pass on higher costs to consumers in the form of higher prices on products the producer price index is believed to be helpful in predicting 1212010 Real vs Nominal Interest Rates I Real interest rate The nominal interest rate adjusted for inflation Nominal interest rate The stated interest rate on a loan Example A firm borrows 100 at a 10 interest rate when inflation I The firm must pay back I In one year the lender must receive 6 Assume that this is a one year loan in one year to buy the same amount of goods that the 100 would be able to purchase today I The lender actually receives 110 in one year The true gain to i I It is the the lender 5 rate of interest that ultimately matters to lendersborrowers were FIGURE 87 rats 20 7 NOminal and Real Interest39 Rates 1 970 2006 0 m l J 972 4 7 39 52 34 66 ea 3990 92 94 95 95 00 39OZMOS Real 5 inferestlate Learning Objective 86 1212010 Costs of Inflation I Many people believe that the major problem caused by inflation is that inflation lowers the purchasing power of a person s income This is not a true cost of inflation however Why I The above however refers to average nominal wages Some wages will rise by more than inflation some by less and some by the same amount Inflation then causes changes in the The extent to which inflation redistributes income depends in part on whether the inflation is anticipated in which case consumers workers and firms can see it coming and can prepare for it or unanticipated in which case they do not see it coming and do not prepare for it 39 i The Problem with Anticipated Inflation I If workers and firms both anticipate high inflation they will be likely to agree to I What is the problem with anticipated inflation then C There are costs associated with changing prices These are calle 7v Low inflation means u Another problem is that nominal returns are typically taxed instead of real returns thus during high inflation 1212010 1212010 returns concerned with the nominal interest for inflation Another Cost of Anticipated Inflation Taxation of Interest I Typically in the US taxes are paid on nominal interest and nominal I When people buy bonds or othenNise earn interest they are I That is the actual returns to bondholders involve adjusting the I The following example shows that bondholders are hurt by high EAL PFIINCIPAL 1 000 1 000 2 2 INFLATION INTEREST TAX FIATE PA YMENT PAYMENT 4 2 INTEREST FIATE INFLATION FIATE 4 2 AFTERTAX INTEREST PAYMENT FI ADJUSTMENT AFTERTAX O INFLATION Learning Objective 87 NOMINAL IN TEFIES T FIATE EAL INTEREST PAYMENT 1212010 The Problem with Unanticipated Inflation Example Samantha Student takes out a 10000 loan at 7 percent interest nominal In 10 years the loan will come due After her debt has compounded for 10 years at 7 percent Sam will owe the bank 20000 What is the real value of this debt If the economy has extremely high inflation then Samantha If the economy has deflation fall prices then Samantha Thus unanticipated inflation redistributes wealth from
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