Chapter 5 Monitoring Jobs and Inflation

5
MONITORING JOBS
AND INFLATION
After studying this chapter, you will be able to:
 Explain why unemployment is a problem and how we
measure the unemployment rate and other labor
market indicators
 Explain why unemployment occurs and why it is
present even at full employment
 Explain why inflation is a problem and how we
measure the inflation rate
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Employment and Unemployment
Why Unemployment Is a Problem

Unemployment results in
Lost incomes and production
Lost human capital
The loss of income is devastating for those who bear it.
Employment benefits create a safety net but don’t fully
replace lost wages, and not everyone receives benefits.
Prolonged unemployment permanently damages a
person’s job prospects by destroying human capital.

Current Population Survey

The U.S. Census Bureau conducts a monthly population
survey to determine the status of the U.S. labor force.
The population is divided into two groups:
1. The working-age population—the number of people
aged 16 years and older who are not in jail, hospital, or
some other institution
2. People too young to work (under 16 years of age) or in
institutional care

The working-age population is divided into two groups:

1. People in the labor force
2. People not in the labor force
The labor force is the sum of employed and unemployed
workers.

To be counted as unemployed, a person must be in one of

the following three categories:
1. Without work but has made specific efforts to find a job
within the previous four weeks
2. Waiting to be called back to a job from which he or she
has been laid off
3. Waiting to start a new job within 30 days

Figure 22.1 shows the

labor force categories.
In June 2017:
Population: 325 million
Working-age population:
255 million
Labor force: 160 million
Employed: 153 million
Unemployed: 7 million

Three Labor Market Indicators

The unemployment rate
The employment-to-population ratio
The labor force participation rate

The Unemployment Rate

The unemployment rate is the percentage of the labor
force that is unemployed.
The unemployment rate is
(Number of people unemployed ÷ labor force)  100.
In June 2017, the labor force was 160 million and
7 million were unemployed, so the unemployment rate was
4.4 percent.
The unemployment rate increases in a recession and
reaches its peak value after the recession ends.

Figure 22.2 shows the unemployment rate: 1980–2017.

The unemployment rate increases in a recession.

The Employment-to-Population Ratio

The employment-to-population ratio is the percentage
of the working-age population who have jobs.
The employment-to-population ratio is
(Employment ÷ Working-age population)  100.
In June 2017, the employment was 153 million and the
working-age population was 255 million.
The employment-to-population ratio was 60 percent.

The Labor Force Participation Rate

The labor force participation rate is the percentage of
the working-age population who are members of the
labor force.
The labor force participation rate is
(Labor force ÷ Working-age population)  100.
In June 2017, the labor force was 160 million and the
working-age population was 255 million.
The labor force participation rate was 62.7 percent.

Figure 22.3 shows that the labor force participation rate

and the employment-to-population ratio both trended
upward before 2000 and downward after 2000.

Other Definitions of Unemployment

The purpose of the unemployment rate is to measure the
underutilization of labor resources.
The BLS believes that the unemployment rate gives a
correct measure.
But the official measure is an imperfect measure because
it excludes
Marginally attached workers
Part-time workers who want full-time jobs

Marginally Attached Workers

A marginally attached worker is a person who currently
is neither working nor looking for work but has indicated
that he or she wants and is available for a job and has
looked for work sometime in the recent past.
A discouraged worker is a marginally attached worker
who has stopped looking for a job because of repeated
failure to find one.

Part-Time Workers Who Want Full-Time Jobs

Many part-time workers want to work part-time, but some
part-time workers would like full-time jobs and can’t find
them.
In the official statistics, these workers are called economic
part-time workers and they are partly unemployed.
Most Costly Unemployment
All unemployment is costly, but the most costly is long-
term unemployment that results from job loss.

Alternative Measures of Unemployment

The BLS reports six alternative measures of the
unemployment rate: two narrower than the official
measure and three broader ones.
The narrower measures, U-1 and U-2, focus on the
personal cost of unemployment.
The broader measures, U-4, U-5, and U-6, focus on
assessing the full amount of unused labor resources.

Figure 22.4 shows six

alternative measures.
U-1: Those
unemployed for
15 weeks or
longer
U-2: Unemployed job
losers
U-3: The official
unemployment
rate

Broader measures are

U-4: U-3 + Discouraged
workers
U-5: U-4 + Other
marginally
attached workers
U-6: U-4 + Part-time
workers who want
full-time jobs
All measures increase
together in recession.
Unemployment and Full Employment
Unemployment can be classified into three types:

Frictional unemployment
Structural unemployment
Cyclical unemployment

Frictional Unemployment
Frictional unemployment is unemployment that arises
from normal labor market turnover.
The creation and destruction of jobs requires that
unemployed workers search for new jobs.
Increases in the number of people entering and reentering
the labor force and increases in unemployment benefits
raise frictional unemployment.
Frictional unemployment is a permanent and healthy
phenomenon of a growing economy.

Structural Unemployment
Structural unemployment is unemployment created by
changes in technology and foreign competition that
change the skills needed to perform jobs or the locations
of jobs.
Structural unemployment lasts longer than frictional
unemployment.

Cyclical Unemployment
Cyclical unemployment is the higher than normal
unemployment at a business cycle trough and lower than
normal unemployment at a business cycle peak.
A worker who is laid off because the economy is in a
recession and is then rehired when the expansion begins
experiences cyclical unemployment.

“Natural” Unemployment
Natural unemployment is the unemployment that arises
from frictions and structural change when there is no
cyclical unemployment.
Natural unemployment is all frictional and structural
unemployment.
The natural unemployment rate is natural unemployment
as a percentage of the labor force.

Full employment is defined as the situation in which the

unemployment rate equals the natural unemployment rate.
When the economy is at full employment, there is no
cyclical unemployment or, equivalently, all unemployment
is frictional and structural.

The natural unemployment rate changes over time and is

influenced by many factors.
Key factors are
The age distribution of the population
The scale of structural change
The real wage rate
Unemployment benefits

Real GDP and Unemployment Over the Cycle

Potential GDP is the quantity of real GDP produced at full
employment.
Potential GDP corresponds to the capacity of the economy
to produce output on a sustained basis.
Real GDP minus potential GDP is the output gap.
Over the business cycle, the output gap fluctuates and the
unemployment rate fluctuates around the natural
unemployment rate.

Figure 22.5 shows the output

gap and …
the fluctuations of
unemployment around the
natural rate.
When the output gap is
negative, ...
the unemployment rate exceeds
the natural unemployment rate.

Price Level, Inflation, and Deflation
The price level is the average level of prices and the

value of money.
A persistently rising price level is called inflation.
A persistently falling price level is called deflation.
We are interested in the price level because we want to
1. Measure the inflation rate or the deflation rate
2. Distinguish between money values and real values of
economic variables.

Why Inflation and Deflation Are Problems

Low, steady, and anticipated inflation or deflation is not a
problem.
Unpredictable inflation or deflation is a problem because it
Redistributes income
Redistributes wealth
Lowers real GDP and employment
Diverts resources from production

Unpredictable changes in the inflation rate redistribute

income in arbitrary ways between employers and workers
and between borrowers and lenders.
A high inflation rate is a problem because it diverts
resources from productive activities to inflation forecasting.
From a social perspective, this waste of resources is a
cost of inflation.
At its worst, inflation becomes hyperinflation—an inflation
rate that is so rapid that workers are paid twice a day
because money loses its value so quickly.

The Consumer Price Index

The Consumer Price Index, or CPI, measures the
average of the prices paid by urban consumers for a
“fixed” basket of consumer goods and services.

Reading the CPI Numbers

The CPI is defined to equal 100 for the reference base
period.
Currently, the reference base period is 19821984.
That is, for the average of the 36 months from January
1982 through December 1984, the CPI equals 100.
In June 2017, the CPI was 245.
This number tells us that the average of the prices paid by
urban consumers for a fixed basket of goods was 145
percent higher in June 2017 than it was during
19821984.
Constructing the CPI

Constructing the CPI involves three stages:
Selecting the CPI basket
Conducting a monthly price survey
Calculating the CPI

The CPI Basket

The CPI basket is based on a Consumer Expenditure
Survey, which is undertaken infrequently.
The CPI basket today is based on data collected in the
Consumer Expenditure Survey of 2016.

Figure 22.6 illustrates the

CPI basket.
Housing is the largest
component.
Transportation and food
and beverages are the
next largest components.
All other components
account for 27.4 percent
of the basket.

The Monthly Price Survey

Every month, BLS employees check the prices of the
80,000 goods in the CPI basket in 30 metropolitan areas.
Calculating the CPI
1. Find the cost of the CPI basket at base-period prices.
2. Find the cost of the CPI basket at current-period prices.
3. Calculate the CPI for the current period.

Let’s work an example of

the CPI calculation.
In a simple economy,
people consume only
oranges and haircuts.
The CPI basket is
10 oranges and 5 haircuts.
The table also shows the
prices in the base period.
The cost of the CPI basket
in the base period was $50.
Table 22.1(b) shows the

fixed CPI basket of goods.
It also shows the prices in
the current period.
The cost of the CPI basket
at current-period prices is
$70.

The CPI is calculated using the formula:

CPI = (Cost of basket at current-period prices ÷ Cost of
basket at base-period prices) x 100.
Using the numbers for the simple example,
CPI = ($70 ÷ $50) x 100 = 140.
The CPI is 40 percent higher in the current period than it
was in the base period.

Measuring the Inflation Rate

The major purpose of the CPI is to measure inflation.
The inflation rate is the percentage change in the price
level from one year to the next.
The inflation formula is:
Inflation rate = [(CPI this year – CPI last year) ÷ CPI last
year]  100.

The Biased CPI

The CPI might overstate the true inflation rate for four
reasons:
New goods bias
Quality change bias
Commodity substitution bias
Outlet substitution bias

New Goods Bias

New goods that were not available in the base year
appear and, if they are more expensive than the goods
they replace, they put an upward bias into the CPI.
Quality Change Bias
Quality improvements occur every year. Part of the rise in
the price is payment for improved quality and is not
inflation.
The CPI counts all the price rise as inflation.

Commodity Substitution Bias

The market basket of goods used in calculating the CPI is
fixed and does not take into account consumers’
substitutions away from goods whose relative prices
increase.
Outlet Substitution Bias
As the structure of retailing changes, people switch to
buying from cheaper sources, but the CPI, as measured,
does not take account of this outlet substitution.

The Magnitude of the Bias

An estimate made in 1996 says that the CPI overstates
inflation by 1.1 percentage points a year.
Some Consequences of the Bias
 Distorts private contracts.
 Increases government outlays (close to a third of
federal government outlays are linked to the CPI).
The BLS has now corrected much of the bias, but some
still remains.

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5

© 2019 Pearson Education Ltd.

Why Unemployment Is a Problem

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Current Population Survey

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The working-age population is divided into two groups:

© 2019 Pearson Education Ltd.

To be counted as unemployed, a person must be in one of

© 2019 Pearson Education Ltd.

Figure 22.1 shows the

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Three Labor Market Indicators

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The Unemployment Rate

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Figure 22.2 shows the unemployment rate: 1980–2017.

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The Employment-to-Population Ratio

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The Labor Force Participation Rate

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Figure 22.3 shows that the labor force participation rate

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Other Definitions of Unemployment

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Marginally Attached Workers

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Part-Time Workers Who Want Full-Time Jobs

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Alternative Measures of Unemployment

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Figure 22.4 shows six

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Broader measures are

Unemployment can be classified into three types:

© 2019 Pearson Education Ltd.

© 2019 Pearson Education Ltd.

© 2019 Pearson Education Ltd.

© 2019 Pearson Education Ltd.

© 2019 Pearson Education Ltd.

Full employment is defined as the situation in which the

© 2019 Pearson Education Ltd.

The natural unemployment rate changes over time and is

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Real GDP and Unemployment Over the Cycle

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Figure 22.5 shows the output

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The price level is the average level of prices and the

© 2019 Pearson Education Ltd.

Why Inflation and Deflation Are Problems

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Unpredictable changes in the inflation rate redistribute

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The Consumer Price Index

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Reading the CPI Numbers

Constructing the CPI

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