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Chapter 7

Chapter 7 . Part 2 . Unemployment (One Result of Economic Downturns). The population is divided into three groups: Those under age 16 : “not potential members of the labor force” Adults not looking for work: not in the labor force.

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Chapter 7

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  1. Chapter 7 Part 2

  2. Unemployment (One Result of Economic Downturns) The population is divided into three groups: Those under age 16: “not potential members of the labor force” Adults not looking for work: not in the labor force. Labor force: includes those in age 16 and over who are willing and able to work, and actively seeking work.

  3. The unemployment rate is defined as the percentage of the labor force (not of population) that is not employed. unemployed Unemployment rate x = 100 labor force

  4. In USA the unemployment rate is calculated by random survey of 60,000 households nationwide. Two factors cause the official unemployment rate to understate actual unemployment: Part‑time workers are counted as “employed.” b. who want a job, but are not actively seeking one, are not counted as being in the labor force, so they are not part of unemployment statistic.

  5. Types of unemployment Frictional unemployment: Workers between jobs. Consists of those searching for jobs or waiting to take jobs soon; it is regarded as somewhat desirable, because it indicates that there is mobility as people change or seek jobs. Types: Voluntarily moving from one job to another Fired and seeking another job Housewives who decided to work New graduates looking for jobs for the first time Note: this type of unemployment is unavoidable

  6. Structural unemployment is due to changes in the structure of demand for labor; e.g., when certain skills become obsolete (out-dated) or geographic distribution of jobs changes. Difference between frictional and structural is that frictional unemployed have salable skills. Structurally unemployed will find it difficult to find a job

  7. Cyclical unemployment is caused by the recession phase of the business cycle, which is sometimes called deficient demand unemployment. When demand for goods and services falls, employment falls and unemployment increases.

  8. Definition of “Full Employment” Frictional and structural unemployment is unavoidable, hence, full employment is something less than 100%. Full employment does not mean zero unemployment. The unemployment rate consistent with full‑employment is equal to the total of frictional and structural unemployment. 3. The “full‑employment” rate of unemployment is also referred to as the natural rate of unemployment NRU.

  9. 4. The natural rate is achieved when labor markets are in balance; the number of job seekers equals the number of job vacancies. Hence at NRU The economy is producing its potential output Note: It is not necessary that the economy will work at NRU. At times of recession unemployment will be greater than NRU.

  10. The natural rate of unemployment is not fixed, but depends on the demographic makeup of the labor force and the laws and customs of the nations. Recently in USA the natural rate has dropped from 6% to 4 or 5%. This is attributed to: a. The aging of the work force as the baby boomers approach retirement. b. Improved job information through the Internet and temporary-help agencies. c. The doubling of the U.S. prison population since 1985.

  11. Economic cost of unemployment Foregone output. Failure to create enough jobs leads to loss of potential output (NRU). This is measured by GDP gap: the difference between potential and actual GDP. GDP gap = Actual GDP - Potential GDP GDP gap and Okun’s Law: Economist Arthur Okun quantified the relationship between unemployment and GDP as follows: For every 1 percent of unemployment above the natural rate, a negative GDP gap of 2 percent occurs. This is known as “Okun’s law.”

  12. Unequal Burdens: Burden of unemployment is unequally distributed. Occupations: workers in lower skilled occupations have higher unemployment rates Age: teenagers have much higher unemployment rates than adults (less skills and less experience). Race and ethnicity: rate is high among African-Americans and Hispanics. Education: rate is higher among less educated.

  13. GLOBAL PERSPECTIVE Unemployment Rates 5 Industrial Nations 1992 - 2002 15 10 5 0 France U.K. Germany U.S. Japan 1992 1997 2002 Source: Economic Report of the President, 2003

  14. Inflation: Defined and Measured Definition: Inflation is continuous rise in the general level of prices. - Acontinuous rise:a one shot rise in the price level is not inflation (price rise). - The general price level: it is not necessary that all prices must increase at the same time. During inflation some prices can go down.

  15. The main index used to measure inflation is the Consumer Price Index (CPI). Measuring Inflation: the percentage change in CPI 2002 CPI = 123 2003 CPI – 127 Inflation = ((127-123)/123)% = 3.25% The “rule of 70” permits quick calculation of the time it takes the price level to double: Divide 70 by the percentage rate of inflation and the result is the approximate number of years for the price level to double. If the inflation rate is 7 percent, then it will take about ten years for prices to double.

  16. GLOBAL PERSPECTIVE Inflation Rates in Five Industrial Nations 1992 - 2002 10 5 0 Italy Germany U.S. France Japan 1992 1997 2002 Source: Bureau of Labor Statistics

  17. Types of inflation Demand‑pull inflation: When resources are already fully employed, businesses cannot respond to excess demand by expanding output. So excess demand bids up the prices of the limited output. Spending increases faster than production.

  18. Cost-Push inflation: Prices rise because of a rise in per-unit production costs. Per unit cost = total input cost/units of output. Rising costs squeeze profits and reduce output firms are willing to produce at current prices. Supply of goods decreases and prices go up

  19. Note Output and employment decline while the price level is rising. b. Supply shocks (due to higher cost of inputs) have been the major source of cost-push inflation. These typically occur with dramatic increases in the price of raw materials or energy.

  20. Redistributive effects of inflation Nominal and real income Nominal income is the number of KDs received as wages, rent, interest and profits Real income is a measure of the amounts of goods and services income can buy. Therefore; Real income = nominal income / price level % change in real income = % change in nominal income – percentage change in price level

  21. surprising inflation has stronger impacts; those expecting inflation may be able to adjust their work or spending activities to avoid or lessen the effects. Who is hurt by inflation? Fixed income receivers: People whose incomes are fixed see their real incomes fall when inflation occurs.

  22. Savers will be hurt by unexpected inflation, because interest rate returns may not cover the cost of inflation. Their savings will lose purchasing power. e.g., A 1000 CD with a 6% interest and inflation 13%, after one year Nominal value = 1060 Real value = (1060/1.13) = 938

  23. Creditors: They can be harmed by unexpected inflation. Interest payments may be less than the inflation rate. Borrowers are paying back money that have less purchasing power for the lender. If inflation is predictable, the effects of inflation may be less severe, since wage and pension contracts may have inflation clauses built in, and interest rates will be high enough to cover the cost of inflation to savers and lenders.

  24. Who is Unaffected by inflation? • Flexible-Income receivers: they can avoid inflation’s harm or even benefit from it. • They benefit more from unexpected inflation. Debtors: they pay back less valuable money whose purchasing power has been eroded by inflation. • Real income is redistributed away from creditors to debtors. • The government, as a debtor, benefits as it pays back its debt with money that has less purchasing power than the original money it borrowed.

  25. expected Inflation Redistribution effects of inflation are less severe if inflation was expected. People can adjust their nominal incomes to reflect the expected rise in the price level. “Inflation premium” is amount that the interest rate is raised to cover effects of expected inflation. “Real interest rate” is defined as nominal rate minus inflation premium.

  26. ANTICIPATED INFLATION 6% 11% 5% = + Inflation Premium Nominal Interest Rate Real Interest Rate

  27. Output Effects of Inflation A. Cost‑push inflation, where resource prices rise unexpectedly, could cause both output and employmentto decline. Real income falls. B. Mild inflation (<3%) has uncertain effects. It may be a healthy by-product of a wealthy economy, or it may have an undesirable impact on real income. C. Danger of creeping inflation turning into hyperinflation, which can cause speculation, out of control spending, and more inflation

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