Ch 5: Macroeconomic Measurements, Part I

Prices & Unemployment

Del Mar College

John Daly©2003 South-Western Publishing, A Division of Thomson Learning

Measuring Prices

• To Measure Prices, we use the Consumer Price Index.

• The CPI is based on a “market basket” of typical household goods & services.

Consumer Price Index

• We use a base year to calculate the CPI.

• The CPI is equal to the Total dollar expenditure in the current year for the market basket DIVIDED BY the Total dollar expenditure in the base year for the market basket.

• This Result is then multiplied by 100.

Consumer Price Index

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20

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60

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120

140

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1913-1999

CPI

Consumer Price Index

• Percentage difference in the CPI from one year to any other year =

(CPI later year – CPI earlier year) X 100__________________________________________________________________________________

CPI earlier year

• Inflation is an increase in the price level and is usually measured over some time period.

Are You Beating (CPI) Inflation or is Inflation Beating You?

• Nominal Income is the current-dollar amount of a person’s income.

• The Real Income measurement is reached by dividing Nominal Income by the Consumer Price Index, the result multiplied by 100

Real Income = [(Nominal Income)/CPI]x100

How Is The CPI Used?

• The CPI is used as – An economic indicator– To find the real value of an economic variable– To adjust certain income payments

Substitute Bias in Fixed Weight Measures

• A fixed weight price assumes the same items are bought

• A Substitute Bias is when one good is substituted for another: An example is White Bread is Substituted for Rye Bread.

• As a result of the Substitution bias, fixed weight measures can overstate the “cost of living”

Other Measures

• The Chain-Weighted Price Index corrects for the substitution bias found in fixed weight measures.

• The GDP deflator is based on all goods and services within an economy.

Converting Dollars from One Year to Another

• Take your price, income, or salary that you want to compare. Choose the current year and the year to compare to.

• Complete this formula:

(CPI current year / CPI earlier year) x Income

to discover the current level of income in an earlier time’s dollars.

Q & A

• Explain how the CPI is calculated.• If the CPI in one year is 132.5, and is 143.6

the following year, what is the inflation rate?

• What is the difference between a fixed-weighted price index and a chain-weighted price index? Why is that difference important?

UNEMPLOYMENT• The Potentially Employed are defined as: older

than 16 years; not in the armed services; not institutionalized. This is the “civilian non-institutional population”.

• A person is considered Employed if: he did at least one hour of paid work during the survey week; worked in his or her own business or profession; worked at least 15 hours per week as an unpaid worker in a family-owned farm or business; was temporarily absent from work due to illness, vacation, strike, or bad weather.

Unemployment

• A person is unemployed if: he did not work during the survey week, has actively looked for work within the past 4 weeks and is available for work; is waiting to be called back to a job from which he or she has been laid off; is waiting to report to a job within 30 days.

• The Unemployment rate is equal to the number of people unemployed divided by the number of people employed added to the number of people unemployed.

Employment Rate

• The Employment rate is equal to the number of employed persons divided by the Civilian Non-institutionalized Population.

• The labor force participation rate is equal to the Civilian Labor Force divided by the Civilian Non-institutionalized Population.

Classifying the Unemployed

• Job LoserJob Loser: was employed in the civilian labor force, was either fired or laid off.

• Job LeaverJob Leaver: was employed in the civilian labor force, quit his or her job.

• ReentrantReentrant: A person who was employed, hasn’t been for a period of time and is reentering the labor force.

• New EntrantNew Entrant: A person who has never held a full time job for two weeks or longer.

• Unemployed persons = Job Losers+ Job Leavers +Reentrants + New Entrants

Discouraged Workers

• A person who gives up looking for a job, for whatever reason, is no longer considered part of the unemployment rate, because the person has stopped looking for work.

• The unemployed worker gets counted and the discouraged worker does not.

• Does this give us a good count of the “true unemployment problem” today?

Types of Unemployment

• Frictional Unemployment: loss of employment is due to the natural friction of the economy. This includes changing market conditions, and those people who change jobs.

• Structural Unemployment: loss of employment due to elimination of jobs from the economy.

• Natural Unemployment Rate: Adding the Frictional Unemployment Rate and the Structural Unemployment Rate provides you the Natural Unemployment Rate.

Full Employment?

• Full employment exists when the economy is operating at the Natural Unemployment Rate.

• The Difference between the Natural Unemployment Rate and the Current Unemployment Rate (if any) is called the Cyclical Unemployment Rate.

Q & A

• What is the major difference between a person who is frictionally unemployed and one who is structurally unemployed?

• If the Cyclical unemployment rate is positive, what does this imply?

Job Search Theory

• Many job searchers do not accept the first job they are offered because they cannot be sure that a better job is waiting around the corner.

Job Search Theory• The lowest wage a person will accept at any

time in the job search process is called the person’s reservation wage.

Optimal Search Time

• During the period of 1998-1999, the mean duration of unemployment was about 13 weeks.

• During the same time, the median duration of unemployment was about 6 weeks.

• As Optimal Search Time increases, the Unemployment Rate increases.

• As Optimal Search Time decreases, the Unemployment Rate decreases.

Q & A

• Suppose unemployment benefits increase. How will this effect the Optimal Search Time and the Unemployment Rate? Explain your answer.

• A person says” I don’t think of the costs and benefits of searching for a job, I simply search for as long as it takes to get a job.” Comment on this.