[ECON 202] Chapter 9: Inflation and Unemployment

Q: How can we measure the overall increase of all the goods and services bought by a typical consumer during a period of 1 year?

A: Using the Consumer Price Index (CPI). The Bureau of Labor Statistics reports the CPI each mont

real interest rate=

(nominal interest rate)-(level of inflation)

CPI Equation

(price of basket of goods and services)/(price of basket in one year) * 100

The BLS uses the establishment survey to collect information on employment in the economy. Indicate one drawback of the establishment survey compared to the current population survey and indicate one advantage.

- It does not include information about​ self-employed people. - It is based on company payroll and not on unverifiable answers.

Labor force

-Employed Working at a paid job either full time or part time -Unemployed Not employed but actively looking for a job

What was the all time low level of inflation in the United States during the period 1914 to 2015?

16 percent?

5. What was the all time high level of inflation in the United States during the period 1914 to 2015?

24 percent

Natural Rate of Unemployment

5%

Which of the following causes changes in the CPI to overstate the true inflation​ rate?

A. Substitution bias B. Increase in quality bias C. New product bias

Suppose the fixed interest rate on a loan is​ 5.75% and the rate of inflation is expected to be​ 4.25%. The real interest rate is​ 1.5%. Suppose now that instead of​ 4.25%, the inflation rate unexpectedly reaches​ 5.5%. Who gains and who loses from this unanticipated​ inflation?

Borrowers gain from a lower real interest rate. Lenders lose from a lower real interest rate.

Inflation Rate in Year 2

CPI in year 2-CPI in year 1/CPI in year 1 * 100

What can cause the changes natural rate of unemployment?

Changes in the labor force characteristics (e.g. demographics) Changes in the labor market institutions (e.g. labor unions) Changes in government policies (e.g. minimum wage, unemployment benefits)

Unemployment =

Frictional + Structural + Cyclical

Why do we care about inflation?

It affects our purchasing power as consumers A: Our purchase capacity decreased by 60 percent in the previous example

Wages

Marginal Product of Labor (MPL)* Prices

GDP Deflator

Nominal GDP/Real GDP*100

Not in the Labor force

Not in the labor force Not employed, not looking for work

How does the U.S. economy create and destroy millions of jobs each​ year? ​

Some businesses are​ expanding, while others are contracting. Your answer is correct.B. In the market​ system, new firms are constantly entering and exiting various industries.

Labor force participation rate

The fraction of the adult population that "participates" in the labor force. The labor force participation rate is the percentage of the population aged 16 or older that is in the labor force.

Real wage

The real wage is the wage rate divided by the price level. The real wage measures the purchasing power of a consumer's wage! Income / Price Index

When the price index is decreasing

There is deflation(the market basket costs less!)

When the price index is increasing

There is inflation(the market basket costs more!)

Recessionary gap

Unemployment is higher than at Y*

(Expansionary gap)

Unemployment is lower than at Y*

Output gap

Y (actual) - Y* (potential)

Bureau of Labor Statistics (BLS)

considers a person an adult if: He or she is over 16 years old. A person is considered employed if: He or she has spent some of the previous week working at a paid job. A person is unemployed if: He or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job

The inflation rate

is the percentage change in the price level from the previous period.

Substitution bias

---The basket does not change to reflect consumer reactions to change in relative prices. ---Consumers substitute toward goods that have become relatively less expensive. The CPI overstates the increase in cost of living by not considering consumer substitution.

Why is the unemployment​ rate, as measured by the Bureau of Labor​ Statistics, an imperfect measure of the extent of joblessness in the​ economy?

-It fails to account for illegal activities. -Underemployed people are considered employed. -Discouraged workers are not considered unemployed. -It does not account for inaccurate responses to the Current Population Survey.

What does CPI measure

-The CPI measures the cost of a standard basket of goods and services in a given year relative to the cost of the same basket of goods and services in the base year. -The CPI is used to monitor changes in the cost of living over time.

When the economy is at full​ employment,

-all remaining unemployment is either frictional or structural. -the natural rate of unemployment prevails. -the unemployment rate is greater than zero.

GDP Deflator

-reflects the prices of all goods and services currently -produced to the price of the same goods and services in the base year.

Even perfectly anticipated inflation imposes costs.​ Why?

Paper money loses its purchasing power by the rate of inflation. Some wages will fail to keep up with anticipated inflation. Menu costs.

Why should we care about output gaps?

Policymakers pay attention to output gaps because of the impact it has on our standard of living.

Which of the following can give an early warning of future increases in the price​ level?

Producer price index

Unemployment rate

Unemployment rate = Unemployed Labor force Labor + Not in the labor force Employed + Unemployed

Disinflation

When the inflation is decreasing (but still positive): This is called disinflation and the price index is still increasing (but at a lower rate)

​"Paying good wages and keeping your people working for you is good business...Imagine that you have​ 120,000 loyal ambassadors out there who are constantly saying good things about Costco. It has to be a significant advantage for​ you."

efficiency wages

Okun's Law

is an empirically observed relationship between unemployment and losses in a country's production. The Okun's law relates cyclic unemployment changes to changes in the Q gap. A 1% increase in the unemployment decreases GDP by 2%!!!!!!!

Structural unemployment

is long-term, chronic unemployment in a well- functioning economy Structural shifts in production create a long-term mismatch between workers and market needs. Lack of skills, language barriers, or discrimination. Barriers to employment such as minimum wages, unions, and unemployment insurance.

The nominal interest rate

is the annual percentage increase in the dollar value of an asset

The real interest rate

is the annual percentage increase in the purchasing power of financial assets

Y* (potential output)

is the maximum sustainable amount of real GDP that an economy can produce Y* is also called full-employment GDP Y* grows over time Weather conditions Capital formation Technical innovation, etc.

Real average hourly wage year

nominal average hourly wage year/CPI YEAR*100

real interest rate​

nominal interest rate and subtract the inflation rate.

Inflation

refers to a situation in which the economy's overall price level is rising.

Cyclical unemployment

refers to fluctuations in unemployment around its natural rate. i.e. increase in unemployment during economic slow-downs. It is associated with short-term ups and downs of the business cycle Economic cost is the decline in real GDP

Frictional unemployment

refers to the short term process of matching workers with jobs (workers are between jobs).