Chapter 22

Unemployment and Inflation

2009 South-Western/ Cengage Learning
INTRODUCTION
examines the macroeconomic problems of unemployment
and inflation.
The idea is to show what can go wrong with the economy,
thereby providing the rationale for studying
macroeconomics.
Four types of unemployment are discussed:
frictional,
structural,
seasonal,
and cyclical.
The composition and duration of unemployment, along
with unemployment insurance, are also examined.
Inflation, deflation, disinflation (a reduction in inflation),
and changes in relative prices.
The cost of unemployment and inflation,.
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Unemployment
Measuring unemployment
Categories: employed, unemployed, not
in the labor force
Labor Force = Employed + Unemployed
Unemployment Rate =
Unemployed/Labor Force
Participation Rate = Labor Force/Adult
Population
Employment Ratio = Employed/Adult
Population
Unemployment
Unemployment
Long stretch of unemployment affect the
jobless and their families
Personal cost
lose self-esteem and part of identity Alfred
Marshall wrote: your job is often the main
object of your thoughts and intellectual
development.
loss in steady paychecks
Unemployment linked to incidence of crime;
and other afflictions e.g. heart disease,
suicide and clinical depression .
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Unemployment
Cost on the economy
Fewer goods and services are produced
Those who want to work cant find jobs, their
labor are loss forever.
President Harry Truman remarked, Its
recession when you neighbor loses his
job, its depression when you lose your
own.
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Unemployment
Measuring unemployment
Civilian (exclude those in the military)
non-institutional adult population which
consist of all civilians 16 year old except those in prison or mental
hospitals.
Labor force adult population who are either working or
looking for work.
Employed + Unemployed ( Bureau of Labor
statistics people look for a job at least once during the
preceding four weeks.)

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Unemployment
Unemployment rate
Percentage of unemployed in the labor force
i.e (number of unemployed) / (number of
labour force).
Unemployment rate are normally
reported monthly.
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Unemployment
Adult population
Employed
Working full time or part time
Not working
Unemployed (looking for work)
Not in labor force
Retired; Students; Dont want to work
Discouraged workers
Unable to work due to long-term illness or
disability.

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Exhibit 1
The adult population sums: employed, unemployed,
and those not in labor force, June 2007 (in millions)
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LABOR FORCE
(153.1)
Employed
(146.2)
NOT WORKING
(85.5)
Not in labor force
(78.6)
Unemployed
(6.9)
Labor force= employed + unemployed
Not working = not in the labor force + unemployed
Adult population = employed + unemployed + not in the labor force
Unemployment
Labor force participation rate or
proportions of adults in the labor force:
Adult population = those in the labor force + those not in the
labor force = 231.7 million
Number in labor force / Adult population
(from Exhibit 1: labor force participation rate =
153.1million / 231.7 million) or 66.1% .
On the average about 2 out of 3 adults are in the labor
force.
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Unemployment
Unemployment over time
Rise during contractions
Fall during expansions
most striking is the jump during the great depression in 1930s
when unemployment rate was 25%.
Overall downward trend (1980s to 2000)
Growing economy
Fewer teenagers in workforce cut the
overall unemployment rate.

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Exhibit 2
The US unemployment rate since 1900
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Unemployment
Unemployment rate among young
workers are much higher than among
older workers:
They enter job market with little training
Took up unskilled jobs and the first to be
fired
Move in and out of the job market
juggling school demand.
Those who left school often shop around
in search for a better job.
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Unemployment
Unemployment in various groups
Age
Higher unemployment among teenagers
Race
Gender
Geography
Occupation

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Exhibit 3 (a)
Unemployment rates for 20 years of age and older
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Exhibit 3 (b)
Unemployment rates for 16 to 19 years of age
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High school dropouts, labor market dropouts
High unemployment rates
Poorly educated young black males
2000, 65% of high-school dropouts
Not working
Unemployed
Not looking for jobs
In prison
2004, 72% of high-school dropouts
Not working
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High school dropouts, labor market dropouts
Possible causes
Failing schools
Absent parents
Racial discrimination
Fewer blue collar jobs
Growing competition
Stricter child-support enforcement
Rising incarceration rate (kadar masuk
penjara)
Subculture: downplay the value of work
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Unemployment
Varies by occupation
Blue-collar workers
Higher unemployment relative to
professional and technical workers.
Varies across regions
Certain occupations
Dominate certain regions Pressure on
blue-collar jobs in auto and steel
(smokestack) industries in 2007 the state of
Illinois, Michigan and Ohio faces high
unemployment.
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Exhibit 4
Unemployment rates differ: US metropolitan areas
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Sources of Unemployment
People become unemployed due to
various reasons;
Four sources of unemployment:
Frictional
Seasonal
Structural
cyclical
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Sources of Unemployment
Frictional unemployment
The time required to Bring together
employers and job seekers
Doesnt last long
Better match workers and jobs, so that
the economy works more efficiently
Policy makers and economists are less
concern about frictional unemployment
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Sources of Unemployment
Seasonal unemployment
Seasonal changes in labor demand
during the year.
Examples:
Winter season; demand for farm hands, life-
guards, landscapers and construction
worker reduce.
Christmas and festival seasons there may
increase in demand for sales clerks, ect.

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Sources of Unemployment
Structural unemployment
Mismatch of skills or geographic location -
Such unemployment occurs because changing in tastes, technology,
taxes, and competition reduce the demand for certain skills and
decrease in demand for other skills.
Problem - workers must either develop the skills demanded in
the local job market or look elsewhere.
Married couples with one spouse still employed may not want to give
up one good job.
Jobs may be in regions where cost of living is much higher.
Structural may take a long time before lifting
off
Some retraining programs aim at reducing
structural unemployment will have to be set
up.

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Sources of Unemployment
Cyclical unemployment economy is
operating inside its production possibility
frontier.
Increases during recessions
Decreases during expansions
Output declines during recessions and
firms reduce resources including labor.
Government policies that stimulate
aggregate demand aim to reduce
cyclical unemployment.
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Full Employment
Full employment if there is
No cyclical unemployment
Some unemployment
Frictional
Structural
Seasonal
Full employment does not mean zero
unemployment.
Estimates ranging : 4 - 6%
unemployment.

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Unemployment Compensation
Unemployment often imposes and economic
and psychological hardship.
Unemployment benefits Half of the
unemployed received because of restrictions
Criteria
Lost job
Looking for work
Time limit: 6 months
40% of wages
May reduce the incentive to find work

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International Comparisons
Unemployment trends
US: down
Japan: up
Low unemployment : Job security for life
Bankruptcy in the 1990s unemployment
increase.
Western Europe: remained high
Higher unemployment benefits
Last longer
Government regulations workers are not
easily laid-off.

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Exhibit 5
Since 1980, the US unemployment rate fell, Europes
remained high, and Japans rose
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Europe
U.S.
Japan
Problems with Unemployment Figures
Understate unemployment
Discouraged workers
Not counted
Underemployed
Only part-time (want full-time)
Overqualified
Overstate unemployment
Looking for work
Qualify for unemployment benefits
Only full-time (want part-time)
Underground economy
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Inflation
Inflation
Sustained increase in price level
Annual inflation rate
Percentage increase in price level
Hyperinflation
Extremely high inflation
Deflation
Sustained decrease in price level
Disinflation
Decrease in inflation

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Hyperinflation in Brazil
Price level in 1994
3.6 million times higher than in 1988
People dont want to hold cruzeiro
Workers
Paid daily; purchases
Exchanges for a stable currency
Real Cruzeiro: larger denominations
Facilitate purchase
Reduce productivity
Dropped since 1994
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Two Sources of Inflation
Increase in AD
Demand-pull inflation
Increased government spending
Social programs
Decrease in AS
Cost-push inflation
Increase cost of production
Push up the price level
Stagflation
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Exhibit 6
Inflation caused by shifts of AD and AS curves
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Aggregate output 0
Price
level
P
P
AS
AD
AD
(a) Demand-pull inflation: inflation
caused by an increase of
aggregate demand
An outward shift of the aggregate
demand to AD pulls the price
level up from P to P.
Aggregate output 0
Price
level
P
P
AS
AD
(b) Cost-push inflation: inflation caused
by a decrease of aggregate supply
A decrease of aggregate supply to
AS pushes the price level up
from P to P.
AS
A Historical Look: Inflation; Price Level
Price level, US, since 1913
Steady increase
Inflation or deflation, US, since 1913
Before 1950s
High inflation war related
Followed by deflation
Since 1950s
Inflation: 3.8% per year
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Exhibit 7 (a)
Consumer price index since 1913
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Exhibit 7 (b)
Inflation since 1913
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Anticipated vs. Unanticipated Inflation
Anticipated inflation
Expected inflation
If inflation > expected
Sellers lose
Buyers gain
If inflation < expected
Sellers gain
Buyers lose
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Inflation
Unpopular
Imposes transaction costs
Obscures relative price changes
Differ across metropolitan areas
Housing prices
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Exhibit 8
Average annual inflation between 2002 and 2006
differed across US metropolitan areas
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International Comparisons of Inflation
First half of 1980s
Declining inflation
Mid-1980s to early 1990s
Rising inflation
Mid-1990s
Lower trend
Similar trend
Overall: lower inflation
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Exhibit 9
Inflation rates in major economies have trended lower
over the last quarter century
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Europe
U.S.
Japan
Inflation and Interest Rates
Interest
Dollar amount
Paid by borrowers to lenders
Interest rate
As percentage
Supply of loanable funds
Upward sloping
Demand of loanable funds
Downward sloping
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Inflation and Interest Rates
Nominal interest rate
Current dollars
Real interest rate
=Nominal interest rate Inflation rate
Expected real interest rate
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Exhibit 10
The market for loanable funds
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Loanable funds per period 0
N
o
m
i
n
a
l

i
n
t
e
r
e
s
t

r
a
t
e

i
D
S
The upward sloping supply
curve, S, shows that more
loanable funds are supplied at
higher interest rates.
The downward-sloping
demand curve, D, shows that
the quantity of loanable funds
demanded is greater at lower
interest rates.
The two curves intersect to
determine the market interest
rate, i.
Why is Inflation Unpopular?
Pay higher prices
Inflation = Penalty
Receive higher receipts
Higher income
well-deserved reward
Fixed nominal income
Unadjusted for inflation
Social Security
Adjusted for inflation (COLA)
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