Hubbard Macro8e PPT Ch09

Macroeconomics
Eighth Edition
Chapter 9
Unemployment and Inflation
Copyright © 2021, 2019, 2017 Pearson Education, Inc. All Rights Reserved
Chapter Outline
9.1 Measuring the Unemployment Rate, the Labor Force
Participation Rate, and the Employment-Population Ratio
9.2 Types of Unemployment
9.3 Explaining Unemployment
9.4 Measuring Inflation
9.5 Using Price Indexes to Adjust for the Effects of Inflation
9.6 Nominal Interest Rates versus Real Interest Rates
9.7 Does Inflation Imposes Costs on the Economy?
Former Inmates and Stoughton Trailers
Meet in a High-Pressure Economy
In the spring of 2019, the
unemployment rate was at
its lowest level since 1969.
Companies like Wisconsin’s
Stoughton Trailers were
struggling to find workers.
They decided to hire people
they wouldn’t have
considered before: former
prison inmates, and even
current inmates through a
work-release program.
Measuring Unemployment and Inflation
Last chapter, we learned about how to measure total
output—a critical first step in understanding the economy.
In this chapter, we continue along these lines, learning
about how to measure unemployment and inflation.
These are very important and commonly used
macroeconomic concepts; we want to solidify our
understanding of what they mean, so that we can talk
intelligently about them.
9.1 Measuring the Unemployment Rate, the Labor
Force Participation Rate, and the Employment-
Population Ratio
Define the unemployment rate, the labor force participation rate, and the
employment–population ratio and understand how they are computed.
There are more than 300 million people in the United States and
monitoring and reporting on their activities regularly would be
very difficult and costly.
Instead, the U.S. Department of Labor reports estimates of
employment, unemployment, and other statistics related to the
labor force each month.
Labor force: The sum of employed and unemployed workers in
the economy.
Of these statistics, the most watched is known as the
unemployment rate: the percentage of the labor force that is
unemployed.
The Household Survey
Each month, the U.S. Census Bureau conducts the Current Population
Survey (a.k.a. the household survey).
• ~60,000 households selected to be “representative”
• Household members of “working age” (16+ years old)
• Asked about employment during “reference week”
• Also asked about recent job search activities
People are then classified as:
• Employed: In government statistics, someone who currently has a job
or who is temporarily away from his or her job.
• Unemployed: In government statistics, someone who is not currently
at work but who is available for work and who has actively looked for
work during the previous month.
• Not in the labor force, if neither of the above apply
Figure 9.1 The Employment Status of the Civilian
Working-Age Population, April 2019 (1 of 3)
Discouraged
workers:
People who are
available for
work but have
not looked for a
job during the
previous four
weeks because
they believe no
jobs are
available for
them.
Based on the CPS estimates,
we calculate several important
macroeconomic indicators.
• The most watched is the
unemployment rate:
 Number of unemployed 
  × 100 =
Unemployment rate
 Labor Force 
 5.8 million 
 162.5 million  × 100 =
3.6%
 
This most common measure of unemployment is known formally as

BLS series U-3.
Also important are the labor-
force participation rate: the
percentage of the working-age
population in the labor force…
 Labor force 
  × 100 =LFPR
 Working − age population 
 162.5 million 
 258.7 million  × 100 =62.8%
 
… and the employment-
population ratio: the
percentage of the working-age
population that is employed:
 Employed 
 = × 100 Employment − population ratio
 Working − age population 
 156.6 million 
 258.7 million  × 100 =
60.5%
 
Problems with Measuring the
Unemployment Rate
The unemployment rate measured by the BLS is not a perfect
measure of joblessness. Why?
• It may understate unemployment:
– Distinguishing between people who are unemployed and not
in the labor force requires judgment (should we exclude
“discouraged workers?’)
– Only measures employment, not intensity of employment (full-
time v s part-time; some people are underemployed)
ersu
• It may overstate unemployment:

– People might claim falsely to be actively looking for work
– May claim not to be working to evade taxes or keep criminal
activity unnoticed
Figure 9.2 The Official Unemployment Rate and a
Broad Measure of the Unemployment Rate, 2000-
2019
Some people suggest that we should include discouraged workers and

underemployed workers in the unemployment statistics, to create a
broader measure of unemployment.
• The BLS measures this, calling it BLS series U-6.
Figure 9.3 Unemployment Rates in the
United States, April 2019
Unemployment rates vary by ethnic group…

… and by education level.
• These two observations are statistically related.
Figure 9.4 Trends in the Labor Force: Participation
Rates of Adult Men and Women Since 1948
The labor force participation rate of adult men has declined gradually
since 1948…
… but it has increased significantly for adult women, making the overall
rate higher today than it was then.
• Recently, the rate for women has declined also.
Apply the Concept: How Large Is the
Potential U.S. Labor Force?
While the unemployment rate returned to “normal” after the 2007-2009

recession, the employment-population ratio did not. Why?
• Aging population (baby boomers reaching retirement)
• Long-term unemployment leading to skill deterioration
• Affordable Care Act making access to health care easier

How Long Are People Typically
Unemployed?
Long periods of unemployment are bad for workers, as their
skills decay and they risk becoming discouraged and
depressed.
• During the Great Depression of the 1930s, some people
were unemployed for years at a time.
Since World War II, average lengths of unemployment have
been relatively low, but that changed dramatically with the
2007-2009 recession.
• The average length of unemployment more than doubled,
from 4 months to 10 months.
The Establishment Survey
In addition to the household survey, the BLS also uses the
establishment survey, (a.k.a. the payroll survey).
This survey samples ~300,000 establishments, or places of
employment, about their employees. Disadvantages include:
• Self-employed people not surveyed (not on a company payroll)
• Newly opened firms often omitted
• Information on employment only, not unemployment
• Numbers fluctuate depending on establishments included, often
requiring large revisions
However, a big advantage is that the data are determined by real

payrolls, not self-reporting like the household survey.
Table 9.1 Household and Establishment
Survey Data for March and April 2019
Household Establishment
Household Household Survey Establishment Establishment Survey
Blank Survey March Survey April Change Survey March Survey April Change
Employed 156,748,000 156,645,000 −103,000 150,832,000 151,095,000 263,000
Unemployed 6,211,000 5,824,000 −387,000 Blank Blank Blank
Labor force 162,960,000 162,470,000 −490,000 Blank Blank Blank
Unemployment 3.8% 3.6% −0.2% Blank Blank Blank

rate
Source: U.S. Department of Labor, Bureau of Labor Statistics, The Employment Situation—April 2019, May 3, 2019.
Even if all surveys are truthfully and accurately answered, we do not expect the
numbers to be identical between the two surveys:
• Different groups are measured
• All surveys have measurement errors

But we get a more complete picture by considering both surveys.
Figure 9.5 Revisions to Employment Changes, as
Reported in the Establishment Survey, 2007-2010
Over time, the BLS adjusts its estimates of employment and

unemployment for previous months. Revisions sometimes take place
years later.
• The large negative revisions were because the BLS underestimated
the severity of the 2007-2009 recession.
Job Creation and Job Destruction Over
Time
Jobs are continually being created and destroyed in the U.S.
economy.
• In 2018, about 30.2 million jobs were created, while about
28.2 million jobs were destroyed.
• This is a natural and normal process for the economy.
The BLS reports net changes in the number of people
employed and unemployed; this does not fully represent how
dynamic the U.S. job market really is.
9.2 Types of Unemployment
Identify the three types of unemployment.
The three types of unemployment are:

• Frictional unemployment: Short-term unemployment that
arises from the process of matching workers with jobs.
• Structural unemployment: Unemployment that arises
from a persistent mismatch between the skills or attributes
of workers and the requirements of jobs.
• Cyclical unemployment: Unemployment causes by a
business cycle recession.
We will examine each in turn over the coming slides.
Figure 9.6 The Annual Unemployment
Rate in the United States, 1950-2018
Unemployment rates rise when the economy is faltering and fall

when the economy is doing well. But they never fall to zero.
• The types of unemployment can help us to understand why.
Frictional Unemployment
Frictional unemployment: Short-term unemployment that
arises from the process of matching workers with jobs.
Frictional unemployment occurs mostly because of job
search: entering or re-entering the labor force or being
between jobs.
It also occurs because of seasonal unemployment: some
jobs fluctuate in availability due to seasonal demand, like ski
instructor or farm work.
• To control for this, the BLS releases raw and seasonally-
adjusted employment figures.
Some frictional unemployment actually increases economic
efficiency by allowing for better job matches.
Structural Unemployment
Structural unemployment: Unemployment that arises from a
persistent mismatch between the skills or attributes of workers
and the requirements of jobs.
Structural unemployment is associated with longer
unemployment spells.
Workers who are structurally unemployed may require retraining
in order to obtain “modern” jobs.
Example: In the film and TV animation industry, jobs in
hand-drawn 2-D illustration have fallen, and jobs in
computer-assisted 3-D animation have risen. Even workers
with the best hand-drawing skills may find themselves
structurally unemployed.
Cyclical Unemployment and the Natural
Rate of Unemployment
Cyclical unemployment: Unemployment caused by a business
cycle recession.
In normal recoveries after a recession, unemployment due to
cyclical factors will fall.
When all unemployment is due to frictional and structural factors,
we say that the economy is at full employment. This means
there will always be some unemployment in the economy.
• Economists call this the natural rate of unemployment: The
normal rate of unemployment, consisting of frictional
unemployment and structural unemployment.
• The general consensus of economists is that the U.S. natural
rate of unemployment is somewhere between 4.0 percent and
5.0 percent.
Apply the Concept: Will Advances in Information
Technology Increase Structural Unemployment?
Progress in robotics, automation,
and AI are changing the way
goods and services are produced
and sold.
Similar disruption has happened
for a long time; but some
economists and policymakers
believe these changes will be
more disruptive to the labor force
than previously.
• The “technologically
unemployed” are finding it
harder to find comparable jobs
than ever before.
9.3 Explaining Unemployment
Explain what factors determine the unemployment rate.
Governments often attempt to directly influence unemployment.

Example: The federal government’s Trade Adjustment
Assistance program offers training to workers whose firms
laid them off as a result of competition from foreign firms.
This would reduce structural unemployment.
Other policies try to reduce frictional unemployment, for example
by subsidizing new hires.
However some other government policies probably increase
unemployment, such as
• Unemployment insurance
• Minimum wage laws
Unemployment Insurance
Suppose you have just lost your job. You want to find another
and have two main options:
• Take a new low-paying job immediately or
• Search for a better job
If unemployment insurance payments are available to you,
you will probably be more likely to choose the second option.
In the U.S., unemployment insurance payments are typically not
very generous, compared with other high-income countries; and
there are relatively short time limits.
• Unemployment benefits are more generous, and
unemployment rates higher, in western European countries.
• Do you think these facts are related?
Minimum Wage Laws
Federal minimum wage law was introduced in 1938: $0.25/hour.
In 2017, the federal minimum wage was $7.25/hour.
• Many states and cities have higher minimum wages.
• Example: In 2019, California’s minimum wage was
$12.00/hour, and San Francisco’s minimum wage was
$15.59/hour.
Studies suggest a 10 percent increase in the minimum wage
reduces teenage employment by about 2 percent.
• Overall effect on unemployment rate is probably small at
current levels, since relatively few people earn minimum
wage.
Labor Unions
Labor unions are organizations of workers that bargain with
employers for higher wages and better working conditions.
Unions are probably not a significant cause of
unemployment in the United States. While they raise the
wage, only about 6.4 percent of private sector workers are
unionized, limiting the effect that unions have on the wider
economy.
Efficiency Wages
Efficiency wage: An above-market wage that a firm pays to
increase workers’ productivity.
Firms want to get the best performance they can out of their
workers.
• Sometimes monitoring workers is difficult or costly; an
alternative is to pay them a relatively high wage, making
them motivated to perform well in order to keep their job.
• These above-market wages are probably another reason
why unemployment exists even when cyclical
unemployment is zero.
9.4 Measuring Inflation
Define the price level and the inflation rate and understand how they are computed.
In the previous chapter we introduced the idea of the price level:

a measure of the average prices of goods and services in the
economy.
We refer to the percentage increase in the price level from one
year to the next as the inflation rate.
Last chapter, we used the GDP deflator to measure changes in
the price level. By measuring changes in the prices of different
baskets of goods, we would come up with different measures.
Two commonly-used measures are:
• The consumer price index (CPI)
• The producer price index (PPI)
Figure 9.7 The CPI Market Basket,
December 2018
The consumer price
index (CPI) is a measure
of the average of the
prices a typical urban
family of four pays for the
goods and services they
purchase.
The chart shows the
composition of the basket
of goods used to create
the CPI. This basket of
goods derives from a
survey of 14,000
households by the BLS.
Calculating the CPI
To calculate the CPI in a given year, we need:
• A basket of goods
• The cost to purchase the basket of goods in a base year
• The prices in the current year
The CPI in the current year is the cost to purchase the

basket of goods this year, divided by the cost in the base
year. By convention, we multiply this by 100, so that the CPI
in the base year is 100.
A Simple CPI Calculation (1 of 2)
Base 2020 2021
Year Base Year Base Year Expenditures Expenditures
(2010) (2010) (2010) 2020 (on base-year 2021 (on base-year
Product Quantity Price Expenditures Price quantities) Price quantities)
Eye
1 $50 $50 $100 $100 $85 $85
examinations
Pizzas 20 10 200 15 300 14.00 280
Books 20 25 500 25 500 27.50 550
Total Blank Blank $750 Blank $900 Blank $915
The table above gives the information we need to create the CPI
in 2020 and 2021, using the basket of goods from 2021.
Formula Applied to 2020 Applied to 2021
Expenditures in the current year  $900  750 dollars 915  $915

dollars over 750 dollars
CCPI × 100
P I equals expenditures in the current year over expenditures ×
in the 900 dollars over100 =120  $750by ×
 $750by100 equals 120. multiplied 100
100 =
dollars122
Expenditures
base year in the 100.
all times base year 
multiplied  
equals 122. 
A Simple CPI Calculation (2 of 2)
Formula Applied to 2020 Applied to 2021
Expenditures
expenditures in thein the year
current  $900
year in the 900  750 dollars 915
 $915
dollars over 750 dollars
CCPI
P I equals current ×
over expenditures
100  $750by100 equals 120.  $750by ×
×
dollars over
100 =120 multiplied 100
100 =
dollars122
base year in
Expenditures all times 100.
the base year 
multiplied
  122.
equals
Based on these data, the inflation rate from 2020 to 2021 is

the percentage change in the CPI:
 122 − 120 
 120  × 100 =
1.7%
 
Since the CPI measures consumer prices, it is often

referred to as the cost of living index. CPI-inflation is
sometimes used to generate “fair” increases in wages for
workers and government benefits.
Is the CPI an Accurate Measure of
Inflation?
Some potential problems with the CPI include:
• Substitution bias: Consumers may change their purchasing
habits away from goods that have increased in price.
• Increase in quality bias: Difficult to separate improvement in
quality from increase in price, say in cars or computers.
• New product bias: The basket of goods used to change only
every 10 years. (Now it updates every 2 years.) There is a delay
to including new goods like cell phones.
• Outlet bias: CPI used to only survey prices at traditional retail
outlets. Now it tries to minimize this bias by surveying people
about where they actually buy products.
Economists believe the CPI overstates true inflation by 0.5 to 1

percentage point (an improvement over previous methods).
Producer Price Index
The producer price index (PPI) is an average of the prices
received by producers of goods and services at all stages of
the production process.
• It is conceptually similar to the CPI, in that it uses a basket
of goods, but the goods are those used by producers.
• Includes raw materials like coal and crude petroleum, and
intermediate goods like flour, yarn, steel, and lumber.
The PPI can give early warning of future movements in
consumer prices.
• Can you suggest why this is true?
9.5 Using Price Indexes to Adjust for
the Effects of Inflation
Use price indexes to adjust for the effects of inflation.
Suppose your mother received a salary of $25,000 in 1993. This

would have bought much more than a salary of $25,000 in 2018.
We can use the CPI to estimate the purchasing power of that
$25,000 in 2018 dollars:
 CPI in 2018 
=
Value in 2018 dollars Value in 1993 dollars ×  
 CPI in 1993 
 251 
= $25,000 ×  = $43,576
 144 
So $25,000 in 1993 would have bought about as much as
$44,000 in 2018.
Nominal and Real Variables
The current standard base “year” for the CPI is an average
of 1982-1984 prices.
Values like wages in current-year dollars are called
nominal variables. When we adjust them for inflation, by
dividing by the current year’s price index and multiplying by
100, we convert them to real variables.
• This is useful for comparing variables across time.
9.6 Nominal Interest Rates Versus Real
Interest Rates
Distinguish between the nominal interest rate and the real interest rate.
When you lend money to someone, they typically agree to pay you back
with interest. If the interest rate is 4 percent, for example, then a $1,000
loan paid back in a year will be paid back with $1,040.
4 percent is the nominal interest rate: the stated interest rate on a loan.
We can adjust for inflation by calculating the real interest rate, equal to
the nominal interest rate minus the inflation rate.
• This is an approximation, but it is quite accurate for low interest and
inflation rates.
If prices rise by 2 percent from this year to next, then your real interest
rate on the loan is only 2 percent. This more accurately reflects the cost
of borrowing and lending money.
Figure 9.8 Nominal and Real Interest
Rates, 1970-2017
The chart shows the interest rate on three-month treasury bills, a good measure
of the nominal interest rate.
• The real interest rate adjusts them for changes in the CPI.
In 2009, the real interest rate was above the nominal interest rate. The change
in the CPI was negative then, indicating a rare deflation, or decline in the price
level.
9.7 Does Inflation Impose Costs on the
Economy?
Discuss the problems that inflation causes.
Sometimes inflation seems unimportant.

• If all prices doubled overnight, it seems like nothing much
would change: the prices of goods and services would have
doubled, but so would your wage.
• So you could afford exactly as much as before.
But not all prices and wages rise at the same rate.
• So some people will see their real wage increase due to
inflation, while others will see it decrease.
• Particularly for people on fixed incomes (e.g. retirees), inflation
can seem unfair, as the purchasing power of their income falls.
The Problem with Anticipated Inflation
Even if inflation is anticipated, it still causes problems:
• Because some prices and incomes will remain fixed,
some redistribution of income will occur.
• People and firms have increased real costs of holding
cash. (The cash that they hold will decrease in value.)
• Firms have menu costs: the cost to firms of changing
prices. Frequently changing prices are inconvenient for
firms (and consumers too!) to deal with.
• Investors are taxed on nominal returns, rather than real
returns; so this can increase the tax due.
The Problem with Unanticipated
Inflation
When people cannot predict the rate of inflation, they find it
hard to make good borrowing and lending decisions.
• For example, in 1980 banks were charging 18 percent or
more on home loans because the rate of inflation was
very high. People who bought homes were locked into
high rates even when inflation subsided.
On the other hand, if banks lend money at a low rate and
then high inflation takes place, the real interest rate they
receive may be zero or negative; thus the risk of inflation
makes banks wary of lending.
Unpredictable inflation makes borrowing and lending
risky.
Apply the Concept: What’s So Bad
about Falling Prices? (1 of 2)
Deflation is much more dangerous for an economy than inflation.

Why? Suppose you are considering buying a car. You know the car will
be cheaper next year, so you delay purchasing. But if everyone does the
same, then many purchases are postponed, firms stop producing, people
become unemployed, etc.
Apply the Concept: What’s So Bad
about Falling Prices? (2 of 2)
This can create a dangerous downward-spiral, delaying economic

recovery. Economists believe this occurred after the Great Depression of
the 1930s and also in Japan in the 1990s.
There were concerns that significant periods of deflation might have
followed the recession of 2007-2009, but fortunately that did not occur.
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Macroeconomics

This most common measure of unemployment is known formally as

• It may overstate unemployment:

Some people suggest that we should include discouraged workers and

Unemployment rates vary by ethnic group…

While the unemployment rate returned to “normal” after the 2007-2009

• Aging population (baby boomers reaching retirement)

• Long-term unemployment leading to skill deterioration

• Affordable Care Act making access to health care easier

However, a big advantage is that the data are determined by real

Employed 156,748,000 156,645,000 −103,000 150,832,000 151,095,000 263,000

Unemployed 6,211,000 5,824,000 −387,000 Blank Blank Blank

Labor force 162,960,000 162,470,000 −490,000 Blank Blank Blank

Unemployment 3.8% 3.6% −0.2% Blank Blank Blank

• Different groups are measured

• All surveys have measurement errors

Over time, the BLS adjusts its estimates of employment and

The three types of unemployment are:

We will examine each in turn over the coming slides.

Unemployment rates rise when the economy is faltering and fall

Governments often attempt to directly influence unemployment.

In the previous chapter we introduced the idea of the price level:

The CPI in the current year is the cost to purchase the

Pizzas 20 10 200 15 300 14.00 280

Books 20 25 500 25 500 27.50 550

Total Blank Blank $750 Blank $900 Blank $915

Formula Applied to 2020 Applied to 2021

Expenditures in the current year  $900  750 dollars 915  $915

Based on these data, the inflation rate from 2020 to 2021 is

Since the CPI measures consumer prices, it is often

Economists believe the CPI overstates true inflation by 0.5 to 1

Suppose your mother received a salary of $25,000 in 1993. This

Sometimes inflation seems unimportant.

Deflation is much more dangerous for an economy than inflation.

This can create a dangerous downward-spiral, delaying economic

This work is protected by United States copyright laws and is

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