Chapter 7: Unemployment,Inﬂation and Long Run...

UnemploymentInflation

Long Run Growth

Chapter 7: Unemployment,Inflation and Long RunGrowth

Week 3

Presenter:Zheng Zhang

Feb 1, 2013

Zheng Zhang Chapter 7: Unemployment,Inflation and Long Run Growth


Long Run Growth

Table of Contents

1 Unemployment

2 Inflation

3 Long Run Growth



Long Run Growth

Unemployment

Figure 1: No one likes unemployment!



Long Run Growth

Unemployment

Figure 2: A breakdown of population of 16 years or older



Long Run Growth

Questions

Which workers are consider employed? Which areunemployed?(2011Mid1 M10) Additional Reading 3: Q1

What is unemployment(employment) rate? What is labor force?Given the number of unemployed and employed, can youcompute unemployment(employment) rate?(PEQ3 Q1-3; 2012Mid1 M17; 2012Mid1 M21;2011Mid1 M22 )

What is participation rate? (2012Mid1 M22)(2011Mid1 M24)Additional Reading 3: Q2

What are discouraged workers? In a recession,how would theirnumber change? How would change affect unemployment rate?(2012Mid1 M18 2011Mid1 M24 )

What are the three types of unemployment? What do they referto?(2011Mid1 E3)


http://publish.illinois.edu/zzhangecon/files/2013/01/Additional-Reading-3.pdf



Long Run Growth

Unemployment

2012Mid1 M17 Page 19417. If the number of people classified as unemployed is 10,145 andthe number of people classified as employed is 620,000, what is theunemployment rate?

A 0.016%

B 0.15%

C 1.59%

D 1.61%

E 1.64%

Back



Long Run Growth

Unemployment

2012Mid1 M17 Page 19417. If the number of people classified as unemployed is 10,145 andthe number of people classified as employed is 620,000, what is theunemployment rate?

A 0.016%

B 0.15%

C 1.59%

D 1.61%

E 1.64%number of unemployed

number of unemployed +number of employed

= 10,14510,145+620,000=1.61%

Back



Long Run Growth

Unemployment

2012Mid1 M21 Page 194to the information provided in Table 7.1 below to answer the questionthat follows.

Table 1: Information on employment

employed 11,000unemployed 2,500not in the labor force 3,000



Long Run Growth

Unemployment

2012Mid1 M21 Page 194Refer to Table 7.1. The unemployment rate is

A 9.09%

B 18.5%.

C 15.8%

D 16.9%

Back



Long Run Growth

Unemployment

2012Mid1 M21 Page 194Refer to Table 7.1. The unemployment rate is

A 9.09%

B 18.5%.

C 15.8%

D 16.9%number of unemployed

number of unemployed +number of employed = 25002500+11000 = 18.5%

Back



Long Run Growth

Unemployment

2011Mid1 M22 Page 205Carla lost her job and immediately started looking for another job.Asa result the

A labor force increases

B unemployment rate increases

C unemployment rate remains constant

D labor force decreases

Back



Long Run Growth

Unemployment

2011Mid1 M22 Page 205Carla lost her job and immediately started looking for another job.Asa result the

A labor force increases

B unemployment rate increases

C unemployment rate remains constant

D labor force decreases

The labor force remains constant because laborforce=employed(-1)+unemployed(+1). Carla moves from anemployed to an unemployed but she did not leave the labor force.However the unemployment rate increases becauseUnemployment Rate ↑= unemployed↑

labor forceBack



Long Run Growth

Unemployment

2012Mid1 M22 Page 195Refer to the information provided in Table 7.2 below to answer thequestion that follows.

Table 2: Information on employment

Labor Participation Rate 65%Total population 16 years of age and older 210 millionUnemployment Rate 5%



Long Run Growth

Unemployment

2012Mid1 M22 Page 195Refer to Table 7.2. The total number of people employed is

A 129.68 million.

B 128.92 million.

C 126.96 million.

D 131.83 million.

Back



Long Run Growth

Unemployment

2012Mid1 M22 Page 195Refer to Table 7.2. The total number of people employed is

A 129.68 million.

B 128.92 million.

C 126.96 million.

D 131.83 million.

Labor force = Populaion× Participation Rate = 210× 0.65 =136.5(m);number of employed = Labor Force× (1− unemployment rate) =136.5× (1− 5%) = 129.68(m)Back



Long Run Growth

Unemployment

2012Mid1 M18 Page 194During recessions, the number of discouraged workersand this the unemployment rate?

A falls; reduces

B decreases; increases

C increases; reduces

D increases; increases

Back



Long Run Growth

Unemployment

2012Mid1 M18 Page 194In recession,discouraged workers would increase since more peoplemay feel so frustrated about not being able to find a job that they giveup searching, therefore leaving labor force. This would lead to anunderestimation of the unemployed.unemployment rate ↓= unemployed(a)−x

labor force(b)−x Why? this has to do with "saltwater inequality" which says a−x

b−x < ab where x < a < b( You can

think of it as the concentration of a cup of salt water, when you addsome salt, it would taste saltier and vice versa.)Back



Long Run Growth

Unemployment

2011Mid1 M24 Page 205Mike has just graduated from college and is now looking for a job,buthas not yet found one. This causes the unemployment rate to

and the labor force participation rate to .

A increase; stay the same

B increase;decrease

C stay the same;stay the same

D increase; increase

Back



Long Run Growth

Unemployment

2011Mid1 M24 5Mike has just graduated from college and is now looking for a job,buthas not yet found one. This causes the unemployment rate to

and the labor force participation rate to .

A increase; stay the same

B increase;decrease

C stay the same;stay the same

D increase; increase

Recall unemployment rate ↑= unemployed(a)+1labor force(b)+1 . Using "salt water

inequality" a+1b+1 > a

b when a < b, we know that unemployment ratewould increase. For participation rate, because population of 16 yearsor older remains constant and labor force increases by one, soparticipation rate ↑= labor force↑+1

pop.16 years or olderBack



Long Run Growth

Unemployment

2011Mid1 E3 (Part 1) 1For each of the following examples of unemployment please indicateif it can be classified as cyclical,frictional or structural

(a) An entertainer who worked at Disneyland over the summer butwas recently laid off due to recessionary budget cuts.

(b) A lawyer who recently quit her job in New York to move to a newjob in California

(c) A newspaper reporter who was laid-off as printed newspapercirculation fell due to online newspapers.

Back



Long Run Growth

Unemployment

2011Mid1 E3 (Part 1) Page 211For each of the following examples of unemployment please indicateif it can be classified as cyclical,frictional or structural

(a) An entertainer who worked at Disneyland over the summer butwas recently laid off due to recessionary budget cuts.Cyclical

(b) A lawyer who recently quit her job in New York to move to a newjob in California


Back



Long Run Growth

Unemployment



(b) A lawyer who recently quit her job in New York to move to a newjob in CaliforniaFrictional


Back



Long Run Growth

Unemployment



(b) A lawyer who recently quit her job in New York to move to a newjob in CaliforniaFrictional

(c) A newspaper reporter who was laid-off as printed newspapercirculation fell due to online newspapers.Structural

Back



Long Run Growth

Unemployment

Remarks

frictional : involve qualified individuals and have transferrableskills but seeking for a job. e.g. short contract softwareengineers; new college graduates.

structural: due to underlying structural change usuallycharacterized by technological advancement that may eliminatesome old jobs and create new jobs for which unemployed may beunqualified. e.g. laid-off textile workers can’t find a job in ITindustry.

cyclical : due to the downturn(recession) in business cycle.It’scaused by the drop-off of labor demand since many firms havemuch less sales (therefore less profits) during the recession.

Back



Long Run Growth

Unemployment

2011Mid1 E3 (Part 2 Revised) Page 211If unemployment rate in the US is currently 7.8% and the natural rateof unemployment is normally set at 5%, what is the cyclicalunemployment rate?Back



Long Run Growth

Unemployment

2011Mid1 E3 (Part 2 Revised) Page 211If unemployment rate in the US is currently 7.8% and the natural rateof unemployment is normally set at 5%, what is the cyclicalunemployment rate?Answer: cyclical unemployment rate=7.8%-5%=2.8%Back



Long Run Growth

Unemployment

2011Mid1 E3 (Part 2 Revised) Page 211If unemployment rate in the US is currently 7.8% and the natural rateof unemployment is normally set at 5%, what is the cyclicalunemployment rate?Answer: cyclical unemployment rate=7.8%-5%=2.8%Remark: Natural rate of unemployment=Frictional+Structuralunemployment rate. And also, The term "full employment" doesn’tmean everyone in the labor force is employed, instead, it means therate of unemployment equals the natural rate of unemployment.Back



Long Run Growth

Table of Contents

1 Unemployment

2 Inflation

3 Long Run Growth



Long Run Growth

Inflation

Figure 3: Why is inflation bad?



Long Run Growth

Questions

What is the Definition of CPI ? (HW7 Q10)

What’s the difference between CPI , PPI and GDPdeflator?(HW7 Q9) Additional Reading 3: Q5

Do you know how to calculate inflation rate between year X andY given CPI of these two years?2012Mid1 M19

What is cost of inflation?(2012Mid1 E4(b) ) Who benefits frominflation?(Example 1;2012Fin M27)Who loses from inflation? (Example 2;2012Mid1 E4(a)) Whatabout delation?2012Mid1 E4(c)

Do you know the relationship between real interest rate andnominal interest rate?(2012Mid1 M20;)




Long Run Growth

Homework7 Q10

CPI is a fixed weight index. It compares the price of a fixed bundle ofgoods in some year with the price of a fixed bundle of goods in baseyear.

GoodAmounts in Market basket price in 2008 price in 2009 price in 2010

x 100 $2.50 $4.00 $ 4.38y 175 $3.00 $4.50 $ 4.20z 60 $5.00 $5.50 $ 5.00

Back



Long Run Growth

Homework7 Q10

Cost of Market Basket in 2008 equals $1075Using year 2008 price andquantities:$2.50×100 + $3.00×175 + $5.00×60 = $1075Cost of Market Basket in 2009 equals $1517.5Using year 2008 price andquantities:$4.00×100+$4.50×175+$5.50×60 = $1517.15Cost of Market Basket in 2009 equals $ 1473Using year 2008 price andquantities:$4.38×100 + $4.20×175 + $5.00×60 = $1473

Back



Long Run Growth

Homework7 Q10

Formula for CPI in current year: Cost of market basket in current yearCost of market basket in base year × 100

CPI in 2008 10010751075 × 100 = 100CPI in 2009 141.161517.51075 × 100 = 141.16

CPI in 2010 137.0214731075 × 100 = 137.02

Back



Long Run Growth

Homework7 Q10

Inflation is the rate of change in CPI

Rate of inflation between 2008 and 2009 is 41.16%CPI2009−CPI2008

CPI2008× 100% = 41.16%

Rate of inflation between 2008 and 2009 is -2.93%CPI2010−CPI2009

CPI2009× 100% = −2.93%

Back



Long Run Growth

CPI vs PPI vs GDP Deflator

HW7 Question9

(a) A price index that is computed monthly by BLS using a bundle ofgoods and service that represents the "market basket "

(b) A price index for products at all stages in the production processis the

(c) A price index for all newly and domestically produced final goodsand services in an economy is

Back



Long Run Growth


HW7 Question9

(a) A price index that is computed monthly by BLS using a bundle ofgoods and service that represents the "market basket "Consumer Price Index(CPI)

(b) A price index for products at all stages in the production processis the


Back



Long Run Growth


HW7 Question9


(b) A price index for products at all stages in the production processis theProduce Price Index(PPI)


Back



Long Run Growth


HW7 Question9


(b) A price index for products at all stages in the production processis theProduce Price Index(PPI)

(c) A price index for all newly and domestically produced final goodsand services in an economy isGDP deflator

Back



Long Run Growth

CPI PPI vs GDP Deflator

HW7 Question9

Compared to GDP, CPI includes a different range of goods andservices (e.g it doesn’t include investment goods or exportedgoods BUT includes imported consumption goods).Compared to GDP, CPI is based on a fixed basket of goods andservices while the "basket" for GDP deflator is allowed to changewith people’s consumption and investment patterns. This wouldlead to CPI overestimating inflation by ignoring "substitutioneffect".Therefore, substituting for relatively low priced itemwould reduce the value of GDP deflator which CPI fails tocapture.Compared to PPI, CPI may underestimate the inflation withoutaccounting for the rise in the prices of intermediate goods whichPPI include.

BackZheng Zhang Chapter 7: Unemployment,Inflation and Long Run Growth


Long Run Growth

Inflation

2012Mid1 M19 Page 194If the CPI in 2010 was 125.2 and the CPI in 2011 was 142.6, then therate of inflation between 2010 and 2011 was

A 11.1%.

B 12.9%

C 13.9%.

D 14.3%.

Back



Long Run Growth

Inflation

2012Mid1 M19 Page 194If the CPI in 2010 was 125.2 and the CPI in 2011 was 142.6, then therate of inflation between 2010 and 2011 was

A 11.1%.

B 12.9%

C 13.9%.

D 14.3%.

inflation rate is the rate of change in CPI between 2010 and 2011, thus

142.6− 125.2125.2 × 100% = 13.9%

Back



Long Run Growth

Inflation

2012Mid1 M20 Page 194You want to make a 2% real return on a loan that you are planning tomake, and the expected inflation rate during the period of the loan is-1%. You should charge a nominal interest rate of

A 1%.

B 3%.

C -3%.

D 2%.

Back



Long Run Growth

Inflation

2012Mid1 M20 Page 194You want to make a 2% real return on a loan that you are planning tomake, and the expected inflation rate during the period of the loan is-1%. You should charge a nominal interest rate ofA 1%.B 3%.C -3%.D 2%.A: Nominal interest rate incorporates the inflation rate as acompensation to the creditor for the value loss of each unit of moneyin the inflation(this erodes purchasing power),i.e.nominal interest rate=real interest rate(real return) + inflationrate=2%+(-1%)=1%. In this case,deflation,so the creditor gains fromthe change in money value and demand less than interest rate.Back



Long Run Growth

Inflation

Q: Who gains from inflation? A: borrowers on fixed rate debtsEx. Suppose you rent an apartment on Green Street for $100 permonth but you consider buying a house for 100,000 dollars.Busey Bank offers you a 30-years fixed-rate mortgage at 10percent.

100, 000× (1 + .1) = 110, 000$You monthly payment:

110, 00012× 30

= 110, 000360

= 305.6$ > 100$

Also, the projected rent payment path indexed with inflation rate15 percent is like this

year 1 year 2 year 3 year 4 year 5 year 6 year 7 year 8100 115 132 152 175 201 266 306

After 8 years, you’ll be paying less for the house than theapartment you need to rent

Back Zheng Zhang Chapter 7: Unemployment,Inflation and Long Run Growth


Long Run Growth

Inflation

Q: Who loses from inflation? A: Mainly people living on fixedincomes.

Ex. Suppose a person started in 1960 to pay a retirement plan.Every Month, until she retired in 2000, she had to pay 100dollars. The benefits are 1200 dollars each month.

In 1960, the living cost per month was 700 dollars but in 2000, itwas 1500 dollars.

So if retirement benefits are fixed but not indexed to inflationrate, inflation hurts people living on fixed incomes

Back



Long Run Growth

Inflation

2012Fin M27 Page 271What is the impact of inflation that is higher than expected?

A It benefits creditors

B It benefits debtors

C It makes the allocation of resources more efficient

D There is no effect on resource allocation

Back



Long Run Growth

Inflation

2012Fin M27 Page 271What is the impact of inflation that is higher than expected?

A It benefits creditors

B It benefits debtors

C It makes the allocation of resources more efficient

D There is no effect on resource allocation

A: Since Real interest rate = Nominal interest rate - inflation rate. ahigher-than expected inflation would reduce the real interest rate paidfrom debtors to creditors that would have been higher withoutexcessive inflation. Therefore, this implies the real return debtors payto creditors have been lowered which of course would benefit debtorsBack



Long Run Growth

Inflation

2012Fin M27 Page 271Remarks

If inflation is higher than expected, we know thatReal interest rate ↓= Nominal interest rate− inflation rate ↑, soit benefits debtors (borrowers) and hurts creditors (lenders) andvice versa.

In this case, the income is going to be distributed from creditorsto debtors and vice versa.

Keep in mind that this conclusion only applies to lender andborrowers on fixed nominal interest rates.If nominal interest rateis indexed to inflation rate, an adjustment after inflation rate isrealized can lead to real interest rate remaining the same.

Back



Long Run Growth

Inflation

2012Fin M27 Page 271RemarksSimilarly, given that nominal wage is fixed, under a situation whereinflation is higher than expected, the purchasing power is going to beredistributed from wager earners to producers. For more information,go to Additional Reading 3: Question 4 Back




Long Run Growth

Inflation

2012 Mid1 E4aa. Explain how inflation can redistribute income?Back



Long Run Growth

Inflation

2012 Mid1 E4aa. Explain how inflation can redistribute income?A: There is redistribution from creditors to debtors (on fixed nominalinterest rate loan). Debtors pay their loans in future dollars,which areworth less. Creditors earn a real rate of return that declines if it is afixed nominal interest rate loanBack



Long Run Growth

Inflation

2012 Mid1 E4bExplain the administrative costs associated with inflation.Back



Long Run Growth

Inflation

2012 Mid1 E4bExplain the administrative costs associated with inflation.A: When inflation rises rapidly, this reduces the value of money,increasing the opportunity cost of holding cash. To avoid this, peoplekeep less cash in the pocket and go more often to banks to maketransactions. This wastes time, which is one of our main endowments.Back



Long Run Growth

Inflation

2012 Mid1 E4c.If inflation is a bad thing, deflation must be beneficial from amacroeconomic perspective. Is this statement true or false? Explain.Back



Long Run Growth

Inflation

2012 Mid1 E4c.If inflation is a bad thing, deflation must be beneficial from amacroeconomic perspective. Is this statement true or false? Explain.A: This statement is false because of the following reasons.

1 Government cannot lower interest rate to counter recession.2 Consumers wait to purchase so worsen recession.3 Deflation redistributes income form debtor to creditor.

Back



Long Run Growth

Table of Contents

1 Unemployment

2 Inflation

3 Long Run Growth



Long Run Growth

Inflation

2011Mid1 M21 Page 20521.Which of the following is considered capital?

A A tractor produced by John Deere

B The knowledge an individual acquires through education

C A factory a company builds to produce other output.

D all of the above



Long Run Growth

PEQ 3 Page 165

[Calculating Unemployment, Inflation, and Interest Rates] Answerquestions 1 through 5 using the following information. Arboc has apopulation of 2, 000, 000. The labor force participation rate is 90%.Assume that the citizens of Arboc, when trying to determine theinflation rate for the next 12 months, base their calculations solely onthe current inflation rate. The following table provides information onthe consumer price index (CPI) and unemployment rate for Arbocover a five?year period.



Long Run Growth

PEQ 3 Page 165

Information on CPI and Unemployment Rate from Year 1999-2003



Long Run Growth

PEQ 3 Page 165

1 Based on the information, calculate the number of workers in thelabor force.A1

2 Based on the information, calculate the number of workersunemployed in 2000.A2

3 Based on the information, calculate the number of workersemployed in 2002.A3

4 Based on the information, calculate the inflation rate for 2000,2001, 2002, and 2003.A4

5 In 2001, the market interest rate was 12%. Based on theinformation, calculate the real interest rate.A5



Long Run Growth

PEQ 3 Page 165

1. Population = 2,000,000.Labor force participation = 90%.Labor Force = Population× Labor force participation =2, 000, 000× 90% = 1, 800, 000.Back



Long Run Growth

PEQ 3 Page 165

2. Using formulanumber of unemployed = labor force× unemployment rate for 2000,number of unemployed = 1, 800, 000× 4.2% = 75, 600

Figure 4: The Number of Unemployed Workers 1999-2003

Back



Long Run Growth

PEQ 3 Page 165

3. Using formula number of employed =number of labor force− number of unemployed for 2002,number of employed = 1, 800, 000− 176, 400 = 1, 623, 600

Figure 5: The Number of Unemployed Workers 1999-2003

Back



Long Run Growth

PEQ 3 Page 165

Figure 6: CPI and Inflation rate 1999-2003

4. Inflation Rate in 2000 = 0%;Inflation Rate in 2001 = 10%Inflation Rate in 2002 = 5%;Inflation Rate in 2003 = 2%Back



Long Run Growth

PEQ 3 Page 165

5.Taking market interest rate as nominal interest rate(market interestrate is representative of nominal interest rate) and using the formulaReal Interest Rate=Nominal Interest Rate-Inflation Rate.For 2001, 12%-10%=2%.So Real Interest Rate is 2%.Back


Chapter 7: Unemployment,Inﬂation and Long Run...

Documents

Transcript of Chapter 7: Unemployment,Inﬂation and Long Run...