CHAPTER 5

Macroeconomic Measurements,Part I: Prices and Unemployment

ECONOMICS, 5eRoger Arnold

ECONOMICS, 5eRoger Arnold

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Exhibit 1 Three Major Economic Goals

MACROECONOMIC MACROECONOMIC VARIABLESVARIABLES

Price LevelsPrice Levels– The economy's The economy's price levelprice level refers to a weighted refers to a weighted

average of the prices of its goods and servicesaverage of the prices of its goods and services

PRICE STABILITYPRICE STABILITY

INFLATION is an increase in the general INFLATION is an increase in the general price level over timeprice level over time

DEFLATION is a decrease in the general DEFLATION is a decrease in the general price level over timeprice level over time

INFLATION AND INFLATION AND PURCHASING POWERPURCHASING POWER

If prices on average riseIf prices on average rise a given income buys fewer goods and a given income buys fewer goods and

services.services. inflation decreases the purchasing power of inflation decreases the purchasing power of

the dollar.the dollar.

MEASURING THE PRICE LEVELMEASURING THE PRICE LEVEL

Measures of the Price LevelMeasures of the Price Level– The The consumer price indexconsumer price index measures the average measures the average

nominal prices of goods and services that a nominal prices of goods and services that a typical family living in an urban area buystypical family living in an urban area buys

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Consumer Price IndexConsumer Price Index

The CPI is calculated by the Bureau of Labor The CPI is calculated by the Bureau of Labor Statistics (BLS, http://www.bls.gov).Statistics (BLS, http://www.bls.gov).

The representative group of goods chosen is called The representative group of goods chosen is called the Market Basket.the Market Basket.

To calculate the CPI we need the total dollar To calculate the CPI we need the total dollar expenditure in the current year and the base year.expenditure in the current year and the base year.

The base year is a benchmark year that serves as The base year is a benchmark year that serves as that basis of comparison for prices in other years.that basis of comparison for prices in other years.

CPI’s BasketCPI’s Basket

CHAPTER 2CHAPTER 2 The Data of MacroeconomicsThe Data of Macroeconomics slide 44

The composition of the CPI’s “basket”The composition of the CPI’s “basket”

16.2%

40.0%

4.5%

17.6%5.8% 5.9%

2.8%

2.5%

4.8%

Food and bev.

Housing

Apparel

Transportation

M edical care

Recreation

Education

Communication

Other goods andservices

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Calculating the CPICalculating the CPI

CPI = (current expenditure/base CPI = (current expenditure/base expenditure) X 100expenditure) X 100

Current expenditure = the total dollar Current expenditure = the total dollar expenditure on market basket in current expenditure on market basket in current yearyear

Base expenditure = the total dollar Base expenditure = the total dollar expenditure on market basket in base yearexpenditure on market basket in base year

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Exhibit 2 Computing the Consumer Price Index

THE INFLATION RATETHE INFLATION RATE

Inflation rate = Inflation rate =

{CPI (t) - CPI (t-1) } x 100{CPI (t) - CPI (t-1) } x 100

CPI (t-1)CPI (t-1)

US InflationUS Inflation

0

2

4

6

8

10

12

14

16

1960 1965 1970 1975 1980 1985 1990 1995 2000

% p

er

ye

ar

inflation rate

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COMPUTE THE INFLATION COMPUTE THE INFLATION RATE USING THE RATE USING THE

FOLLOWING:FOLLOWING:

CPI 1997 = 159.1CPI 1997 = 159.1 CPI 1996 = 156.9CPI 1996 = 156.9 formula ({CPI 97 - CPI 96} / CPI 96) X 100formula ({CPI 97 - CPI 96} / CPI 96) X 100 159.1-156.9 / 156.9 = 2.2/156.9 = .014159.1-156.9 / 156.9 = 2.2/156.9 = .014 .014 X 100 = 1.4%.014 X 100 = 1.4%

USING THE CPI:USING THE CPI:REAL vs. NOMINAL INCOMEREAL vs. NOMINAL INCOME

NOMINAL INCOME - money income NOMINAL INCOME - money income measured in current period dollarsmeasured in current period dollars

USING THE CPI:USING THE CPI:REAL vs. NOMINAL INCOMEREAL vs. NOMINAL INCOME

REAL INCOME - money income adjusted REAL INCOME - money income adjusted for changes in the price levelfor changes in the price level

real Y = real Y = nominal Ynominal Y x 100 x 100 CPI (t)CPI (t)

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Are you keeping up with Are you keeping up with inflation?inflation?

Income in 2000 = $40,000Income in 2000 = $40,000 Income in 1999 = $35,000Income in 1999 = $35,000 CPI in 2000 = 120CPI in 2000 = 120 CPI in 1999 = 100CPI in 1999 = 100 Real income 1999 = 35,000/100 x 100 = $35,000Real income 1999 = 35,000/100 x 100 = $35,000 Real income 2000 = 40,000/120 x 100 = $33,334Real income 2000 = 40,000/120 x 100 = $33,334 Real income is falling $33,334 < $35,000Real income is falling $33,334 < $35,000

MEASURING THE PRICE LEVELMEASURING THE PRICE LEVEL

Other Measures of the Price LevelOther Measures of the Price Level– The The producer price indexproducer price index is a weighted average is a weighted average

of the prices of inputs that producers buy to of the prices of inputs that producers buy to make final goodsmake final goods

MEASURING THE PRICE LEVELMEASURING THE PRICE LEVEL

MACROECONOMIC MACROECONOMIC VARIABLESVARIABLES

Price LevelsPrice Levels– The The GDP price deflatorGDP price deflator equals nominal GDP equals nominal GDP

divided by real GDPdivided by real GDP– Nominal GDP measures the current dollar value Nominal GDP measures the current dollar value

of the economyof the economy– Real GDP measures output valued at constant Real GDP measures output valued at constant

pricesprices– Nominal GDP = Real GDP X GDP price deflatorNominal GDP = Real GDP X GDP price deflator– Real GDP = Nominal GDP / GDP price deflatorReal GDP = Nominal GDP / GDP price deflator

MEASURING THE PRICE LEVELMEASURING THE PRICE LEVEL

Limitations of Price IndexesLimitations of Price Indexes– Index and other measures are imperfect and Index and other measures are imperfect and

have limitationshave limitations» Ignores such things as changes in quality, Ignores such things as changes in quality,

technological advances, and other factors that alter technological advances, and other factors that alter resultsresults

» People substitute other goods when prices risePeople substitute other goods when prices rise

SUBSTITUTION BIASSUBSTITUTION BIAS

To avoid a potential bias created by To avoid a potential bias created by ignoring consumer substitutions the ignoring consumer substitutions the US moved to a CHAIN-WEIGHTED US moved to a CHAIN-WEIGHTED

index in Dec. 1995index in Dec. 1995

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Exhibit 5 Breakdown of the U.S. Population and the Labor Force

SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.

EMPLOYEDEMPLOYED

Worked at least 1 hour in a wage/salary Worked at least 1 hour in a wage/salary paying positionpaying position

Owned his/her own businessOwned his/her own business Worked 15 hrs. per week in family business Worked 15 hrs. per week in family business

or farm as “unpaid” workeror farm as “unpaid” worker absent due to illness, strike, or vacationabsent due to illness, strike, or vacation

UNDEREMPLOYMENTUNDEREMPLOYMENT

Workers are classified as employedWorkers are classified as employed If they worked as little as one hour for pay If they worked as little as one hour for pay

during the survey week andduring the survey week and Even if they are Even if they are overover qualified for the work qualified for the work The reported rate of unemployment may be The reported rate of unemployment may be understatedunderstated due to underemployment due to underemployment

UNEMPLOYEDUNEMPLOYED

Did not work in the survey week but willing Did not work in the survey week but willing and able to work and actively looked within and able to work and actively looked within the last 4 weeks.the last 4 weeks.

Laid off and waiting to be called backLaid off and waiting to be called back Waiting to report to a job within 30 daysWaiting to report to a job within 30 days

DISCOURAGED WORKERSDISCOURAGED WORKERS

people who have given up on the job search people who have given up on the job search processprocess

not considered unemployed because they not considered unemployed because they are not actively searching for a jobare not actively searching for a job

Cause the reported unemployment rate to Cause the reported unemployment rate to understateunderstate the true unemployment problem the true unemployment problem because they are not included in the labor because they are not included in the labor forceforce

Phantom UnemployedPhantom Unemployed

Those who claim to be unemployment, Those who claim to be unemployment, when in fact they are notwhen in fact they are not

May be due to qualify for unemployment May be due to qualify for unemployment benefitsbenefits

Cause the reported unemployment rate to Cause the reported unemployment rate to overstateoverstate the true unemployment problem the true unemployment problem because they are not actively seeking workbecause they are not actively seeking work

THE UNEMPLOYMENT RATETHE UNEMPLOYMENT RATE

# people unemployed # people unemployed x 100 x 100

# people in labor force # people in labor force

FIND THE UNEMPLOYMENT FIND THE UNEMPLOYMENT RATERATE

population is 100 millionpopulation is 100 million labor force is 50 millionlabor force is 50 million 45 million are employed45 million are employed

UNEMPLOYMENT RATEUNEMPLOYMENT RATE

U = 5m./50m. x 100 = 10%U = 5m./50m. x 100 = 10%

Types of UnemploymentTypes of Unemployment FrictionalFrictional

FRICTIONAL FRICTIONAL UNEMPLOYMENTUNEMPLOYMENT

people moving between jobs or into people moving between jobs or into the labor force.the labor force.

Types of UnemploymentTypes of Unemployment FrictionalFrictional StructuralStructural

STRUCTURAL STRUCTURAL UNEMPLOYMENTUNEMPLOYMENT

skills and/or location of workers does skills and/or location of workers does not match available jobsnot match available jobs

Types of UnemploymentTypes of Unemployment FrictionalFrictional StructuralStructural NaturalNatural

NATURAL UNEMPLOYMENTNATURAL UNEMPLOYMENT

a certain level of frictional and a certain level of frictional and structural unemployment that is structural unemployment that is considered natural in a changing considered natural in a changing

economy (usually 4-6.5%)economy (usually 4-6.5%)

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U.S. Unemployment, U.S. Unemployment, 1958-20021958-2002

2

3

4

5

6

7

8

9

10

11

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

Per

cen

t o

f la

bo

r fo

rce

Unemployment rate Natural rate of unemployment

FULL EMPLOYMENTFULL EMPLOYMENT

The full employment rate is when The full employment rate is when unemployment is at its natural rate unemployment is at its natural rate

(not zero).(not zero).

Types of UnemploymentTypes of Unemployment FrictionalFrictional StructuralStructural NaturalNatural CyclicalCyclical

CYCLICAL CYCLICAL UNEMPLOYMENTUNEMPLOYMENT

unemployment due to downturns in unemployment due to downturns in overall economic activity (recessions)overall economic activity (recessions)

The difference between the The difference between the existing unemployment rate and the existing unemployment rate and the

natural unemployment ratenatural unemployment rate

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U.S. Unemployment, U.S. Unemployment, 1958-20021958-2002

2

3

4

5

6

7

8

9

10

11

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

Per

cen

t o

f la

bo

r fo

rce

Unemployment rate Natural rate of unemployment