Chapter 8 Unemployment and
Inflation
A. Unemployment has obvious
costs:
1. Personal- loss of paycheck,
loss of personal identity, linked to crime, suicide, heart disease, and mental
illness.
2. Costs to society- less
goods/services produced.
B. Measuring Unemployment:
Adult population – civilian (non-military), non-institutional
(not in mental hospital or prison), adult (16 or over) population.
Labor
Force – Those
in the adult population either working or looking for work.
-You
are counted as unemployed if you have no job but have looked for work at
least once during the preceding four weeks.
Unemployment
Rate –
percentage of those in the labor force who are unemployed.
= Number of people without jobs,
looking for work/ # in labor force.
Productive
Capacity
depends on the proportion of adults in the labor force.
Labor
Force Participation Rate – Ratio of adult population in the labor force to total adult population.
Not
counted:
1. retired
2. chose to stay home, care for
children
3. full-time students
4. do not want to work
5. unable to work
6. discouraged worker – A person who has dropped
out of the labor force because of lack of success in finding a job.
7. Part-time workers – counted
as employed even if they would like to work full-time.
1. Because the unemployment
rate does not count 6,7 à it may underestimate the true extent of unemployment.
Official
data also ignores the problem of Underemployment – A situation in which
workers are overqualified for their jobs or work fewer hours than they would
prefer.
2. On the other hand, because
benefits require that people look for work, some people may be pretending to
search. Their inclusion tends to overstate the official unemployment
figures.
**Most
experts tend to believe that unemployment figures underestimate the level of
unemployment.
B. What the unemployment rate
does not tell us.
1. Unemployment Rate does not
tell us who is unemployed.
-Unemployment rates higher among African Americans
than whites.
-Unemployment rates higher among teenagers than
those over 20.
-First dismissed in recession (less training), move in
and out of job market because of school, etc.
2. Unemployment Rate does not
tell us how long people remain unemployed.
1998- average duration 14.5
weeks.
Typically, a rise in unemployment rate reflects both
a larger number of unemployed and a longer duration of unemployment.
3. Unemployment Rate does not
show the differences in unemployment across the country.
1. Frictional Unemployment – Unemployment that arises
because of the time needed to match qualified job seekers with available job
openings.
Workers do not always accept the first job they get.
Employers do not always hire the first applicant. The time required for labor
suppliers and labor demanders
together results in frictional unemployment. Usually
short-term, voluntary.
2. Structural Unemployment – Unemployment that arises
because
1. The skills demanded by
employers do not match the skills of the unemployed, or
2. The unemployed do not live where the jobs are
located.
This type of unemployment arises from a mismatch of
skills or geographic location.
Structural unemployment occurs because changes in
tastes, technology, taxes, or competition reduce the demand for certain skills
and increase the demand for other skills. Workers may be stuck with skills that
are no longer demanded. Workers must seek jobs elsewhere or develop skills that
are in demand. This is not easily done. Costs of moving may be so high that
unemployed remain where they are, and remain structurally unemployed.
3. Seasonal Unemployment – Unemployment caused by
seasonal shifts in labor supply and demand.
During winter, what happens to the demand for
lifeguards, golf instructors, etc..?
4. Cyclical Unemployment – Unemployment that
fluctuates with the business cycle, increasing during recessions and decreasing
during expansions.
Government policies to stimulate Aggregate Demand during recessions are
aimed at reducing cyclical unemployment.
Even
in what would be considered a healthy economy, there will always be some
unemployment (frictional, structural, and seasonal).
The
economy is considered to be in FULL EMPLOYMENT if there is no
cyclical unemployment. Estimates range from 4 to 6%.
More
than ½ of those people unemployed have quit their last job or are new entrants
or reentrants into the labor force.
1. More homes have two people
working, so if one is unemployed, the other is still likely to have a job.
(That job will likely provide health insurance, benefits.)
2. Unemployment Benefits – Cash transfers provided
to unemployed workers who actively seek employment and who meet other
qualifications.
Congress passed the Social Security Act of 1935 that provided
unemployment insurance financed by a tax on employers.
- Benefits
generally available for 6 months, does not cover those reentering the labor
force or new entrants, does not cover those who quit or were fired from their
last job for excessive absenteeism or theft.
-
Usually pays ½ of a person’s take-home pay.
(about 50% of unemployed
workers receive benefits)
Advantages of Unemployment insurance – allows for a higher-quality
search. An unemployed worker need not take the first job he or she is offered.
A better search leads to a better match, promoting economic efficiency.
Disadvantages of Unemployment insurance – People
tend to search “less actively” if they have benefits. This leads to longer
duration of unemployment.
1. Unemployment rates tend to
be higher in the U.K.- ratio of unemployment benefits
to average pay are higher. Unemployment benefits extend longer than 6 months.
2. Difficult to make
comparisons between countries because of different definitions of unemployment
and different methods for collecting data. Some countries also have laws
limiting layoffs and other policies/laws that could affect the unemployment rate.
A. What is inflation?
1. Inflation – A sustained increase in
the average level of prices.
2. Hyperinflation –A very high rate of
inflation
What
are the problems associated with the hyperinflation?
3. Deflation - A sustained decrease in the price level
Example:
A deflation occurred during the Great Depression.
4. Disinflation – A reduction in the rate of
inflation
The
annual inflation rate is the percentage increase in the price level between one
year and the next.
1. Demand-pull inflation – A sustained rise in the
price level caused by increases in aggregate demand.
Rising
inflation in the 1960s resulted from demand-pull inflation.
2. Cost-push inflation – A sustained rise in the
price level caused by reductions in aggregate supply.
1974,
1975 crop failure and decreases in the supply of oil reduced AS.
C.
Problems with Inflation
1. Anticipated v. Unanticipated
Inflation
Unanticipated
inflation creates more problems for the economy than does anticipated
inflation.
Inflation
higher than expected à Winners are those who
contracted to pay a price that doesn’t reflect the higher inflation. Losers are
those who agreed to sell at that price.
Inflation lower than expected à Winners are those who
contracted to sell at a given price that anticipates higher inflation. Losers are those who agreed
to buy at that price.
Example: -Inflation next year is expected to be 3%.
-You agree to work next year for a nominal wage 3% higher
than your wage this year. (Expect real wage to be unchanged)
What
if inflation is 5%? Your real wage will
fall. Your employer is the winner, and you are the loser.
What
if inflation is 2%? Your real wage will increase. You are the winner, and your
employer is the loser.
These
arbitrary gains and losses associated with unanticipated inflation are one of
the reasons inflation is not good.
2. Transaction Costs of
Variable Inflation:
Inflation
creates uncertainty about the purchasing power of the dollar. Planning becomes
difficult. Managers must shift attention from production to anticipating the
effects of inflation. The transaction costs of drawing up contracts
increases as inflation becomes more unpredictable.
Even
with no inflation, the prices of some goods go up while the prices
of other goods goes down. Their relative prices change. These relative
price changes are important for allocating resources efficiently.
If
all prices moved together, producers could link the selling price to the
overall inflation rate. But prices do not move together.
Example: Suppose an employer agrees to raise wages in
accordance with the inflation rate. But the price of this employer’s product
grows more slowly than the inflation rate.
It will be difficult for this employer to pay the cost-of-living
increase.
Interest – The dollar amount paid by
borrowers to lenders to forgo present consumption.
Interest
Rate –
Interest per year as a percentage of the amount loaned.
Interest
Rate = 5% à interest = $5 per year on a
$100 loan.
The
greater the interest rate à the greater the reward for
lending money
The
higher the interest rate à the greater the opportunity
cost of borrowing
The
Market for Loanable Funds
Nominal Interest Rate – The interest rate
expressed in current dollars as a percentage of the amount loaned; the interest
rate on a loan agreement.
Real Interest Rate – The interest rate expressed in dollars of
constant purchasing power as a percentage of the amount loaned; the nominal
rate of interest minus the inflation rate.
Real Interest Rate = Nominal Interest
Rate – Inflation Rate
No
inflation à Real interest rate =
nominal interest rate
The
real interest rate is known only after the fact. So lenders and borrowers make their decisions
based on the expected real interest rate.
**
Why do we care about the real interest rate?
Suppose
I borrow $1000 at a rate of 5% for 1 year. At the end of the year, I pay back
$1050.
The
average cost of a meal this year is $10.
With
no inflation, I’m giving up 5 meals next year to borrow this money.
If
inflation is 3%, the average cost of a meal is now $10.30. So I’m giving up
only 4 meals next year to borrow this money. The $50 I owe has lost value.
From
the lender’s point of view, the return on that money is only 5%-3% = 2% (the
real interest rate.) Because the money they earn in interest has less
purchasing power.