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1.1 The unemployment rate is calculated monthly from data gathered by the U.S. Bureau of the Census in its household survey. The unemployment rate equals the percentage of the labor force that is unemployed: (Unemployed/Labor Force) x 100. Teenagers and black adults tend to have above average unemployment rates, and white adults tend to have below average unemployment rates.
160 CHAPTER 8 (20) | Unemployment and Inflation 1.2 The labor force participation rate is calculated monthly from data gathered by the U.S. Bureau of the Census in its household survey. The labor force participation rate equals the percentage of the working-age population that is in the labor force: (Labor Force/Working-Age Population) x 100. Since 1950, the labor force participation rate has decreased for men and increased for women. 1.3 The household survey is a sample of 60,000 households chosen to represent the U.S. population and provides information on the employment status of everyone in the household 16 years of age and older. The establishment survey is a sample of 300,000 business establishments and gathers information on the total number of people employed and on a company payroll. The household survey includes information on both employment and unemployment, while the establishment survey only includes information on employment. Many economists prefer the establishment survey because it is based on actual payrolls, rather than on unverified answers as in the household survey.
The number of people unemployed is computed using the definition that the unemployment rate equals the number of unemployed divided by the sum of the number of unemployed and the number of employed. The labor force equals employment plus unemployment. The working-age population is computed using the definition that the labor force participation rate equals the labor force over the working-age population. 1.5 A recession or slowdown in the economy that decreases the demand for the companys products would cause a firm to lay off workers. Technological innovations or international competition that decrease the number of workers required in the domestic industry or decrease the size of the domestic industry could lead to layoffs. The firm falling behind its competition in the industry due to inadequate management or product development would also cause layoffs. 1.6 The slowdown in the increase in the labor force participation rate for women after 1995 may reflect its having reached a new equilibrium level that may persist for some time. Women are still more likely to have greater responsibilities for childcare than are men. As long as this continues to be true, the labor force participation rate for women is likely to be below that for men. 1.7 Including homemakers as employed would decrease the unemployment rate because it increases the size of the labor force, but leaves unchanged the number of unemployed. Including homemakers as employed would increase the labor force participation rate because it increases the labor force, but leaves unchanged the working-age population. 1.8 There are several reasons why job openings and unemployed workers can exist at the same time. One reason is that the unemployed may not know that those jobs are available or may be unwilling to relocate. Another reason is that the unemployed may not have the skills required for those jobs.
CHAPTER 8 (20) | Unemployment and Inflation 161 1.9 This law would persuade more men between the ages of 25 and 54 to stay in the labor force. As more of these men would join the labor force, their measured income and the countrys GDP would rise. This should make society as a whole better off because people can now consume the goods and services that these men would produce. However, these men would not necessarily be better off as a result of the policy. Presumably, many of these men are currently choosing not to be in the labor force, probably because they value their leisure time more highly than they value the income they could earn by working. Forcing them into the labor force may reduce their well-being. Whether such a law would be a good idea is a normative question. 1.10 An increase in the number of discouraged workers who were previously counted as unemployed could cause the number of people counted as unemployed (and the labor force) to fall by enough to decrease the unemployment rate, even though employment declined. 1.11 If the labor force is contracting because some of the unemployed have become discouraged and stopped actively looking for work, labor market conditions are worse than the unemployment rate indicates. 1.12 By the economy rebounds they mean that the expansion phase of the business cycle has begun. As the expansion begins, many discouraged workers begin looking for jobs, which increases the number of unemployed persons counted by the Bureau of Labor Statistics. In calculating the unemployment rate, the numerator of the fraction will have increased by relatively more than the denominator.
Review Questions
2.1 Frictional unemployment arises from the process of matching workers with jobs. Because job search takes time, there are always some workers who are frictionally unemployed because they are in between jobs and in the process of searching for new ones. 2.2 The natural rate of unemployment is not equal to zero because of frictional and structural unemployment, which exist even when the economy is at full employment.
162 CHAPTER 8 (20) | Unemployment and Inflation 2.5 As income increases, the demand for a normal good increases but the demand for an inferior good decreases. During an economic expansion, the income level of the typical worker increases. This means that you would rather be working in an industry that produces a normal good, the demand for which tends to increase. During a recession, household income tends to decline, so the demand for an inferior good would increase. In this case, you would rather be working in an industry that produces an inferior good instead of a normal good. 2.6 Eliminating the unemployment insurance system would raise the opportunity cost of searching for a job by eliminating payments to the unemployed. As a result, many unemployed workers would accept one of the first few job offers they received and the level of frictional unemployment would fall. The level of real GDP would rise as a result of the additional production due to the increased level of employment. Well-being in the economy might well fall, however. Workers who quickly take jobs that they are not well suited for might experience lower productivity and more discontent. In addition, a worker who has trouble finding a job would suffer from not receiving unemployment insurance payments. These workers would have to draw down their savings or rely on loans or charity. They would almost certainly have to cut back on their consumption.
Review Questions
3.1 The payment of government unemployment insurance likely raises the unemployment rate. The unemployment insurance payments lower the opportunity cost (the salary that the unemployed are giving up by not working) of continuing to search for a job, which leads the unemployed to spend more time searching for a job. 3.2 All three push the wage above the market wage, causing some unemployment.
3.6 The efficiency wage argument states that a firm may want to pay a wage higher than the equilibrium wage in order to increase worker productivity, especially where it is difficult to monitor workers. 3.7 If Wal-Mart adopted Costcos compensation policies by paying more to its workers, then it would be likely to reduce the number of workers it hires as their wages rise. The demand curve for workers is downward sloping, just as are the demand curves for other goods and services. An increase in the wage reduces the quantity of workers demanded by Wal-Mart. With fewer and more highly-paid workers, WalMart would be likely to raise the prices it charges and provide somewhat poorer service to its customers
CHAPTER 8 (20) | Unemployment and Inflation 163 by having fewer workers available in the stores to help them. So, Wal-Marts customers are likely to be made worse off by Wal-Marts adopting this policy. It is possible, though, that by paying higher wages Wal-Mart would be able to attract more skilled and more highly motivated workers. If this were true, Wal-Marts customers could conceivably be made better off.
Review Questions
4.1 The GDP deflator is the broadest measure of the price level because it includes the prices of all final goods and services in GDP. The Consumer Price Index measures the prices of goods and services purchased by consumers. The Producer Price Index measures the prices of goods and services at all stages of the production process. The Consumer Price Index is the measure most frequently used. 4.2 The potential biases include the substitution bias, the increase in quality bias, the new product bias, and the outlet bias. The Bureau of Labor Statistics updates the market basket every two years to reduce the substitution bias and the new product bias, uses statistical methods to reduce the quality bias, and conducts point-of-purchase surveys to track where consumers actually make their purchases to reduce the outlet bias.
CPI for 2008 = [($136.50/$130) x 100] = 105; CPI for 2009 = [($140.40/$130) x 100] = 108. So, the inflation rate for 2009 = [((108 105)/105) x 100)] = 2.9% 4.6 City New York Los Angeles Dec-05 184.6 223.9 Dec-06 193.1 226.7 Percentage Increase 4.6% 1.3
164 CHAPTER 8 (20) | Unemployment and Inflation Chicago 153.4 157.1 2.4 Seattle 147.4 159.1 7.9 a. In percentage terms, the prices of luxury homes in Seattle rose the most during that year. b. We cannot determine on the basis of these numbers which city had the most expensive luxury homes because the numbers are not dollar amounts but indexes that measure prices in each city in a given month relative to what they were in that city in the base month.
Review Questions
5.1 A nominal variable is a variable measured in monetary units, while a real variable is a variable measured in physical units. 5.2 The real wage for a given year between 2002 and 2008 can be calculated by using the formula: Real wage = (Nominal Wage/CPI) x 100.
Real GDP for 1929 = (Nominal GDP/GDP price deflator) x 100 = $870.6 billion. Real GDP for 1933 = ($56.4 billion/8.9) x 100 = $633.7 billion. Percentage decline in real GDP between 1929 and 1933 = [($633.7 $870.6)/ $870.6] x 100 = 27.2%.
CHAPTER 8 (20) | Unemployment and Inflation 165 5.6 Rank 1 2 3 4 5 6 7 8 9 10 Film Gone with the Wind Snow White and the Seven Dwarfs Star Wars The Sound of Music One Hundred and One Dalmatians Jaws E.T. the Extra-Terrestrial Titanic Star Wars: Episode IThe Phantom Menace Shrek 2 Spider-Man Pirates of the Caribbean: Dead Mans Chest Lord of the Rings: The Return of the King Spider-Man 2 Star Wars: Episode III Revenge of the Sith Total Box Office Receipts 198,655,278 184,208,842 460,935,655 163,214,286 153,000,000 260,000,000 434,949,459 600,779,824 431,065,444 436,471,036 403,706,375 423,032,628 377,019,252 373,377,893 380,262,555 Year Released 1939 1937 1977 1965 1961 1975 1982 1997 1999 2004 2002 2006 2003 2004 2005 CPI 14 14 61 32 30 54 97 161 167 189 180 202 184 189 195 Real Receipts (2006 Dollars) $2,866,311,868.29 2,657,870,434.57 1,526,377,087.05 1,030,290,180.38 1,030,200,000.00 972,592,592.59 905,771,038.33 753,773,443.78 521,408,501.13 466,492,853.29 453,048,265.28 423,032,628.00 413,901,570.13 399,059,970.30 393,913,005.69
The real receipts in 2006 dollars for each film are listed in the last column. The first column shows the rankings of the top 10 firms based on their earnings in 2006 dollars.
Review Questions
6.1 The nominal interest rate is the stated interest rate on a loan, while the real interest rate is the nominal interest rate minus the inflation rate. 6.2 Because the nominal interest rate is the real interest rate plus the inflation rate, an increase in expected inflation raises the nominal interest rate by the expected rate of inflation, assuming that the real interest rate remains constant.
6.5 If the monthly inflation rate is 4 percent, the annual inflation rate is about 60 percent. To see this, notice that at a 4 percent inflation rate, the price level is rising four percent per month. If the price level starts at 100, after two months it would have increased to 100 x 1.04 x 1.04 = 108.2; after three months it would have increased to 100 x 1.04 x 1.04 x 1.04 = 122.5; and after twelve months to 100 x (1.04) 12 = 160.1, or by 60.1 percent. So, the real interest rate would be 4% 60% = 56%. 6.6 We can answer by using the method of calculating the real interest rate explained in the example of DVDs on page 680 in the textbook. With $1,000 you can purchase 500 hamburgers at the beginning of the year. If you lend $1,000 out for one year at an interest rate of 5 percent, you will receive $1,050 at the end of the year. With the higher price of hamburgers, at the end of the year you can buy $1,050/$2.08 = 504.8 hamburgers. So, you can purchase [(504.8 500)/500] x 100 = 0.96%] more hamburgers. Therefore, the real interest rate you receive on the loan is 0.96%. Notice that this is very close to the real interest rate on the loan calculated by subtracting the 4 percent inflation in hamburger prices from the 5 percent nominal interest rate on the loan.
Review Questions
7.1 Inflation affects the purchasing power of money. People with incomes rising faster than the rate of inflation enjoy an increasing purchasing power, while people with incomes rising slower than the rate of inflation are hurt by a decreasing purchasing power. In general, inflation particularly hurts people on fixed incomes, such as retired persons who may be receiving a pension of a fixed number of dollars each year. (As we noted, though, the Social Security payments received by retired workers are increased every year by an amount equal to the change in the CPI.) 7.2 Unanticipated inflation is the greater problem. Anticipated inflation can be incorporated into nominal interest rates and nominal wage contracts. Unanticipated inflation causes the actual real interest rate and actual real wage rate received to differ from the expected real interest rate and the expected real wage rate.
CHAPTER 8 (20) | Unemployment and Inflation 167 b. If Jamess pension increases each year by the same percentage of the inflation rate, then it is likely that 10 years from now he will have a higher real income than Frank, whose interest income is $200 less than Jamess. 7.7 The real interest rate is the cost to Alcatel-Lucent of borrowing funds from investors. Therefore, a low real interest rate is good for Alcatel-Lucent and bad for investors, much like a low price is usually good for consumers, but bad for producers. Inflation was expected to be 2 percent, but turned out to be 6 percent. This causes the expected and actual real interest rates to differ. The expected real interest rate equals the nominal interest rate minus the expected inflation rate. The actual real interest rate equals the nominal interest rate minus the actual inflation rate. In this question the expected real interest rate is 4 percent but the actual real interest rate equals 0 percent (6 percent nominal interest rate minus the 6 percent actual inflation rate). Because the actual real interest rate is less than the expected real interest rate, Alcatel-Lucent pays less than it thought it would to borrow and it gains. Because the investors are receiving a smaller payment than expected for letting Alcatel-Lucent borrow funds, the investors lose.