ECON 1220 Principles of Macroeconomics

Semester 2, 2011/12

Measuring Inflation and Unemployment

1. Measuring Unemployment The unemployment rate is the statistic that measures the percentage of those people willing and able to work who do not have jobs. The entire non-institutionalized (for example, in metal hospital) population aged 15 (in HK) and over (adult population), working population, falls into one of the four categories: o Labor force: Employed Unemployed had not have a job during the last 7days have been available for work during the last 7 days have sought work during the last 30 days o Not in the labor force

The labor force, employment, and unemployment in HK, 2009

Unemployed ('000), 196.7

Labor Force (000), 3676.6

Employed ('000), 3479.9

Working population (000), 6057

Not in Labor Force ('000), 2380.4

Unemployment rate is defined as:

unemployme rate nt number of unemployed Labor force

Example: Calculation of unemployment rate In 2009, the unemployment rate in HK is:

Unemployme rate(for 2009) nt

Labor force participation rate is defined as:
Labor forceparticipat rate io

196.7 100% 5.35% 3676.6

Labor force T otalworkingpopulation

ECON 1220 Principles of Macroeconomics

Semester 2, 2011/12

Underemployment Rate in HK, 1983 - 2009

4

3.5

Unemployment rate (%)

2.5

1.5

0.5

Limitation of Unemployment Measures o Involuntary part-time workers Many part-time workers intended to work full-time but fail to find a full-time job, yet part-time workers are classified as employed in official statistics. Underestimation of true unemployment problem. Discouraged workers Many workers had been unemployed for a long time. After seeking jobs for some time unsuccessfully, become discouraged and stopped searching. These people were dropped out from the labor force. Underestimation of true unemployment problem. Note: The statistical unit of HK government attempt to identify discouraged workers and include them into unemployed.

2. Types of Unemployment Frictional unemployment Occurs in normal process of job turnover o Search unemployment Short-term unemployment at the individual level. In some sense, frictional unemployment is desirable as it may results in better allocation of labor resources. Structural unemployment Occurs when there is a mismatch between the skill or location requirements of job vacancies and the present skills or location of members of labor force. Long-term unemployment at the individual level.

19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09

ECON 1220 Principles of Macroeconomics

Semester 2, 2011/12

As the frictional and structural unemployment cannot be entirely eliminated, an economys unemployment rate is never zero, regardless of the overall level of production in the economy. o These types of long-run unemployment are called the natural rate of unemployment.

Unemployment rates (by country), 1999 - 2009.

10.000

9.000

8.000

7.000
Unemployment rate (%)

6.000

5.000

EU US Japan China HK

4.000

3.000

2.000

1.000

0.000 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

What can be done to reduce the natural-rate of unemployment? o Job training o Labor market flexibility o Unemployment insurance reform Cyclical unemployment o The unemployment which is tied to the fluctuations of output over the business cycle. Increase during the recession (why?) o The difference between actual unemployment and the natural rate of unemployment. o Macroeconomists usually refer full employment to as zero cyclical unemployment. But the overall unemployment rate at full employment is positive, i.e. the natural rate of unemployment.

3. The Costs of Unemployment Lost output o The potential GDP is the output level when the economy is operating at full employment, i.e. the natural rate of unemployment prevails. o Cyclical unemployment results in actual GDP to be lower than the long-run trend, i.e. the potential GDP. o GDP Gap = actual GDP potential GDP o The negative relationship between output gap and unemployment rate is first addressed and quantified by Arthur Okun in the 1960s.

ECON 1220 Principles of Macroeconomics

Semester 2, 2011/12

Okuns Law: Every 1% by which actual unemployment rate exceeds the natural rate is associated with a negative GDP gap of about 2%.

Lost Skills due to idleness Social Consequences: o Social unrest Especially when the burden of unemployment cost is unequally distributed. o Other human costs

Unemployment rate (by age group) in HK, 2009 25.0

20.0
Unemployment rate (%)

15.0

10.0

5.0

0.0 15 - 19 20 - 29 30 - 39 40 - 49 50 - 59 60 and over 15 and over

ECON 1220 Principles of Macroeconomics

Semester 2, 2011/12

Unemployment rate (by previous industry) in HK, 2009

All industries Other industries Public administration, social and personal services Financing, insurance, real estate, professional and business services Transportation, storage, postal and courier services, information and communications Retail, accommodation and food services Import/export trade and wholesale Construction Manufacturing 0.0 2.0 4.0 6.0 8.0 10.0 12.0

Unemployment rate (%)

Unemployment rate (by gender) in HK, 1982 - 2009.

10

7
Unemployment rate (%)

6 Male Female both

0
19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09

4. Measuring Inflation Consumer Price Index (CPI) is the most commonly used measure of the level of prices. o The current price of a basket of goods and services purchased by a typical consumer relative to the price of the same basket in the base year.
CPI pricesof thestandardconsumptio basket in a particularyear n 100 pricesof thestandardconsumptio basket in thebase year n

Example: Calculation of CPI Suppose the consumption basket of goods consists of 10 apples and 20 oranges, and the prices in 2009 and 2010 are as follows:

ECON 1220 Principles of Macroeconomics

Semester 2, 2011/12

Apple Orange

2009 Price $2.00 $1.00

2010 Price $2.50 $1.50

Using 2009 as the base year, the 2010 CPI is:

CPI $2.5 10 $1.5 20 100 137.5 $2 10 $1 20

It means the 2010 price level is 37.5% higher than the 2009 price level. CPI Basket Components in China and U.S. in 2010 China U.S. Food and beverages 34% 14.80% Housing and Utilities 13% 41.96% Entertainment, Sports and Services 14% 6.44% Transportation & Communication 10% 23.12% Healthcare 10% 6.51% Household Durables 6% Apparel 9% 3.70% Other Goods and Services 4% 3.48% Inflation rate: the percentage change in price index. o Negative inflation: deflation.

Example: Calculation of inflation rate Using 2005 as the base year, the CPI of 2008 and 2009 in HK are 108.9 and 109.5 respectively, the annual inflation rate for 2009 is:
Inflation (for 2009) rate 109.5 108.9 100% 0.55% 108.9

Another widely used price index is the GDP Deflator, which have been discussed in the last topic. o The main difference between the CPI and GDP Deflator are in the types of goods and services covered in each index. CPI tracks the prices of goods bought by households, including used goods and imported goods. GDP deflator measures the prices of all goods and services included in measuring of GDP, including goods bought by government, firms and foreigners.

ECON 1220 Principles of Macroeconomics

Semester 2, 2011/12

Inflation rate based on CPI and GDP Deflator in HK, 1982 - 2009.
+15.0

+10.0

inflation rate (%)

+5.0 Inflation rate (CPI) Inflation rate (GDP deflator) 0.0

19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08

-5.0

-10.0

5. Real and Nominal Variables Nominal variables: variables expressed in dollar terms (measured at the current price level). Real variables: nominalvariable real variable 100 priceindex o variables expressed in terms of its purchasing power.

Movie Box Office Receipts in HK, 2002 2009. Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Movie Title Avatar Toy Story 3 Kung Fu Hustle The Dark Knight Inception Spider-Man 3 Mou gaan dou (Infernal Affairs) Cheung Gong 7 hou (CJ7) Harry Potter and the Order of the Phoenix 2012 Si jie (Lust, Caution) Transformers: Revenge of the Fallen Harry Potter and the Goblet of Fire Harry Potter and the Half Blood Prince Harry Potter and the Deathly Hallows (Part One) Alice in Wonderland (2010) Yip Man 2: Chung si chuen kei The Day After Tomorrow Pirates of the Caribbean: At World's End Transformers Box Office Receipts $22,923,033 $11,502,322 $8,100,201 $7,549,781 $7,529,950 $7,202,197 $7,035,649 $6,881,184 $6,650,517 $6,323,434 $6,249,342 $6,202,442 $5,966,462 $5,873,659 $5,721,429 $5,678,519 $5,558,704 $5,447,484 $5,353,051 $5,182,819 Year 2009 2010 2004 2008 2010 2007 2002 2008 2007 2009 2007 2009 2005 2009 2010 2010 2010 2004 2007 2007 CPI (base year = 04 05) 109.5 112.1 99.4 108.9 112.1 104.4 102.8 108.9 104.4 109.5 104.4 109.5 100.3 109.5 112.1 112.1 112.1 99.4 104.4 104.4

ECON 1220 Principles of Macroeconomics

Semester 2, 2011/12

6. The Costs of Inflation Redistribution of income and wealth among different groups o The impact of inflation depends on whether the inflation is anticipated or unanticipated. o Effect on fixed-income receivers E.g. retired people living on private pensions, landlords who receive fixed payments. hurt by inflation How about those whose incomes are indexed to CPI or contracts include cost of living adjustments? As their incomes are automatically adjusted for inflation, these people will not suffer from inflation. Effect on Debtors and Creditors Unanticipated inflation results in Debtors benefiting at the expense of creditors. Suppose a debtor and a creditor agrees a loan of $1000 with an interest rate of 10%. What happens if there is an inflation of 5%? The real interest rate, which is the percentage increase of goods and services that the debtor pays the lender, decreases.
realinterestrate nominal interestrate inflationrate

How about anticipated inflation? The redistribution effect can be eliminated if the inflation is fully anticipated. The lender can add an expected inflation rate (inflation premium) to the real interest rate by the time the loan is agreed.
nominal interestrate realinterestrate expected inflationrate

Other costs of inflation (resource costs): the resources and time people must spend coping with inflation. o Distortions in relative prices (resource costs for consumers). o Menu costs (resource costs for producers) E.g. Administrative costs involved in updating prices. o Shoe-leather costs (resource costs for wealth management): E.g. more frequent banking transaction.

7. Limitations of CPI as a measure of true cost of living The major problem of CPI is that it assumes the households consume a fixed basket of goods and services (fixed in the base year), which leads to the following problems: Substitution bias o When prices do not change proportionally, some goods become relatively expensive. Computing CPI by assuming the fixed consumption baskets ignores the possibility that households would substitute the relatively cheaper goods for more expensive ones. o It overstates the true cost of living.

ECON 1220 Principles of Macroeconomics

Semester 2, 2011/12

Introduction of new goods o As new goods are introduced, their prices often dropped rapidly after their introduction, helping to balance out price rises in other goods. o New technologies often offer consumers a lower cost alternative for obtaining the same service. o Excluding these newly introduced products overstates the true cost of living. Quality change o An improvement in quality of goods results in the consumers getting more by paying the same price. Computing CPI by assuming the fixed consumption baskets ignores the increase in value of the price paid. o It overstates the true cost of living

Readings: Chapter 18 (p.553 564); Chapter 19