CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

Unemployment, Inflation, and Long-Run Growth

OUTLINE
Economic Goals Unemployment Measuring Unemployment Components of the Unemployment Rate The Costs of Unemployment Inflation The Costs of Inflation Long-Run Growth Output and Productivity Growth Looking Ahead

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Economic Goals
CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

1. Full Employment 2. Stable Price 3. Economic Growth 4. Balanced Budget 5. Balance of Payments

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CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

Unemployment rate (%)

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LABOUR

LAST

DATE

PREVIOUS

HIGHEST

LOWEST

FORECAST

UNIT

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

EMPLOYED PERSONS
JOB VACANCIES

38175.00

2013-09-30

37819.00

38545.00

18567.00

38201.64

THOUSAND PERSONS JOBS

319720.00

2009-06-15

199942.00

319720.00

3036.00

307692.81

UNEMPLOYMENT RATE

7.30

2013-06-30

7.50

13.90

6.30

7.40

PERCENT THOUSAND PERSONS INDEX POINTS INDEX POINTS MILLION

UNEMPLOYED PERSONS WAGES WAGES IN MANUFACTURING POPULATION

3002.00

2013-09-30

3086.00

4989.00

1720.00

2935.54

2613.30

2012-11-15

2509.00

2613.30

870.27

2351.02

1240.20

2012-11-15

1298.00

1391.40

638.86

1020.57

95.80

2012-12-31

94.85

95.80

27.06

95.88

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Unemployment
Measuring Unemployment

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

employed Any person 16 years old or older (1) who works for pay, either for someone else or in his or her own business for 1 or more hours per week, (2) who works without pay for 15 or more hours per week in a family enterprise, or (3) who has a job but has been temporarily absent with or without pay. unemployed A person 16 years old or older who is not working, is available for work, and has made specific efforts to find work during the previous 4 weeks.

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Unemployment
Measuring Unemployment

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

not in the labor force A person who is not looking for work because he or she does not want a job or has given up looking. labor force The number of people employed plus the number of unemployed.

labor force = employed + unemployed

population = labor force + not in labor force

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Unemployment
Measuring Unemployment

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

unemployment rate The ratio of the number of people unemployed to the total number of people in the labor force.

unemployment rate =

unemployed employed + unemployed

labor force participation rate The ratio of the labor force to the total population 16 years old or older.

labor force participation rate =

labor force population

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Unemployment
Components of the Unemployment Rate Unemployment Rates in States and Regions
CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

A Quiet Revolution: Women Join the Labor Force

If you are interested in learning more about the economic history of American women, read the book Understanding the Gender Gap: An Economic History of American Women by Harvard University economist Claudia Goldin.

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Unemployment
Components of the Unemployment Rate Discouraged-Worker Effects
CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

discouraged-worker effect The decline in the measured unemployment rate that results when people who want to work but cannot find jobs grow discouraged and stop looking, thus dropping out of the ranks of the unemployed and the labor force.

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Unemployment

I. Components of the Unemployment Rate

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

The Duration of Unemployment

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Unemployment
2. The Costs of Unemployment Some Unemployment Is Inevitable
CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

When we consider the various costs of unemployment, it is useful to categorize unemployment into three types:

Frictional unemployment Structural unemployment Cyclical unemployment

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Unemployment
The Costs of Unemployment Frictional, Structural, and Cyclical Unemployment
CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

frictional unemployment The portion of unemployment that is due to the normal working of the labor market; used to denote short-run job/skill matching problems. structural unemployment The portion of unemployment that is due to changes in the structure of the economy that result in a significant loss of jobs in certain industries.

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Unemployment
The Costs of Unemployment Frictional, Structural, and Cyclical Unemployment
CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

natural rate of unemployment The unemployment that occurs as a normal part of the functioning of the economy. Sometimes taken as the sum of frictional unemployment and structural unemployment.
cyclical unemployment The increase in unemployment that occurs during recessions and depressions.

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Unemployment
The Costs of Unemployment Social Consequences
CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

In addition to economic hardship, prolonged unemployment may also bring with it social and personal ills: anxiety, depression, deterioration of physical and psychological health, drug abuse (including alcoholism), and suicide.

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ASSUMPTIONS IN ATTAINING ECONOMIC EQUILIBRIUM

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

AE = Y

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Sectoral Flow of Economy and its Criteria

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

2 Sector Flow HH and BF 3 Sectoral Flow HH, BF and Govt 4 Sectoral Flow HH, BF, Govt, Foreign Market

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Criteria
1. 2.
CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

INCOME = SPENDING (SIMPLE ECONOMY) S=I S> I = RECESSION S<I = INFLATION Savings is discourage during recession (Figure of Planned and Savings vs Income) Effect: Increase S, same I, decrease Y, reduce AE, Increase Unemployment Investment is discourage during inflation Read Paradox of Thrift 3. C + S + T = C + I + G (leakages = Injections) with Govt Intervention Y = AE Y = Yd Since Yd = Y T G > T = Budget Deficit Y=C+S G< T = Budget Surplus Y=C+S+T AE = C + I + G Therefore AE = Y C+S+T=C+I+G S+T=I+G

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Policies of Government

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

1. Monetary Policy Contractionary Expansionary Mechanisms 2. Fiscal Policy Contractionary Expansionary Mechanisms

Multiplier effects Any Change in I and G would result to increase in Y while an increase in T will cause a decrease in Y.

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Interaction Between Money and Goods Market Goods Market (effects of Tax and Govt spending) Investment (crowding- out effect) Money market (effects of interest rate). An in crease in Y of consumers and price level change the Money demand. Change in RR, rediscount rate and stocks and bonds activities affects Money supply.

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CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

RELATIONSHIP OF CHANGES IN MONEY AND GOODS MARKET TO UNEMPLOYMENT

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

Change in goods market affects money market, and change in money market affects investment. Change in investment leads to crowding out effect that limits the effects of change in government spending. Any changes of the Y would affect the IS LM model/ IS (investment-saving) and LM model indicates the relationship beetwen interest rate and Y when goods market is at equilibrium. LM shows the relationship between interest rate and Y when money market is at equilibrium. IS and LM model affects Aggregate Demand and Aggregate Supply. Any change in AD and AS affects Price (inflation) Inflation of price change negatively affects unemployment rate (Phillips Curve) This is what we call the natural rate of inflation

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The Classical View of the Labor Market

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

FIGURE 29.1 The Classical Labor Market Classical economists believe that the labor market always clears. If the demand for labor shifts from D0 to D1, the equilibrium wage will fall from W0 to W1. Anyone who wants a job at W1 will have one. 21 of 29

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The Classical View of the Labor Market

The Classical Labor Market and the Aggregate Supply Curve

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

The classical idea that wages adjust to clear the labor market is consistent with the view that wages respond quickly to price changes. This means that the AS curve is vertical. When the AS curve is vertical, monetary and fiscal policy cannot affect the level of output and employment in the economy.

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The Classical View of the Labor Market

The Unemployment Rate and the Classical View

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

The unemployment rate is not necessarily an accurate indicator of whether the labor market is working properly. The measured unemployment rate may sometimes seem high even though the labor market is working well.

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Explaining the Existence of Unemployment

Sticky Wages

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

sticky wages The downward rigidity of wages as an explanation for the existence of unemployment.
FIGURE 29.2 Sticky Wages If wages stick at W0 instead of falling to the new equilibrium wage of W* following a shift of demand from D0 to D1, the result will be unemployment equal to L0 - L1.

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Explaining the Existence of Unemployment

Sticky Wages Social, or Implicit, Contracts
CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

social, or implicit, contracts Unspoken agreements between workers and firms that firms will not cut wages. relative-wage explanation of unemployment An explanation for sticky wages (and therefore unemployment): If workers are concerned about their wages relative to other workers in other firms and industries, they may be unwilling to accept a wage cut unless they know that all other workers are receiving similar cuts.

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Explaining the Existence of Unemployment

Sticky Wages Explicit Contracts
CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

explicit contracts Employment contracts that stipulate workers wages, usually for a period of 1 to 3 years. cost-of-living adjustments (COLAs) Contract provisions that tie wages to changes in the cost of living. The greater the inflation rate, the more wages are raised.

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Explaining the Existence of Unemployment

Efficiency Wage Theory

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

efficiency wage theory An explanation for unemployment that holds that the productivity of workers increases with the wage rate. If this is so, firms may have an incentive to pay wages above the market-clearing rate.

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Explaining the Existence of Unemployment

Imperfect Information

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

Firms may not have enough information at their disposal to know what the market-clearing wage is. In this case, firms are said to have imperfect information.

If firms have imperfect or incomplete information, they may set wages wrongwages that do not clear the labor market.

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Explaining the Existence of Unemployment

Minimum Wage Laws

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

minimum wage laws Laws that set a floor for wage ratesthat is, a minimum hourly rate for any kind of labor.

An Open Question

The aggregate labor market is very complicated, and there are no simple answers to why there is unemployment.

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The Short-Run Relationship Between the Unemployment Rate and Inflation

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

In the short run, the unemployment rate (U) and aggregate output (income) (Y) are negatively related.
FIGURE 29.3 The Aggregate Supply Curve The AS curve shows a positive relationship between the price level (P) and aggregate output (income) (Y).

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The Short-Run Relationship Between the Unemployment Rate and Inflation

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

inflation rate The percentage change in the price level. Phillips Curve A curve showing the relationship between the inflation rate and the unemployment rate.

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The Short-Run Relationship Between the Unemployment Rate and Inflation

CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

FIGURE 29.5 The Phillips Curve The Phillips Curve shows the relationship between the inflation rate and the unemployment rate.

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CHAPTER 22 Unemployment, Inflation, and Long-Run Growth

Keynesians who favored low unemployment targets argued for further government intervention in the form of wage and price controls Keynesian modelsshort run models with various types of market imperfections Long run models of a more classical characterrational expectations, policy neutrality More emphasis on long run issues of government debt, growth, intergenerational issues

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