The non-comprehensive part of the final will be over the unemployment chapter and the inflation chapter

I. who should be unemployed

On the surface this seems easy—those that do not work

But what about stay at home moms—individuals what are not willing to work for low wages at available jobs       

Unemployment can be divided into two categories.

A.   The economy’s natural rate of unemployment refers to the amount of unemployment that the economy normally experiences.

B.   Cyclical unemployment refers to the year-to-year fluctuations in unemployment around its natural rate.

II.   Identifying Unemployment

A.   How Is Unemployment Measured?

1.   The Bureau of Labor Statistics (BLS) surveys 60,000 households every month.

2.   The BLS places each adult (age 16 or older) into one of three categories: employed, unemployed, or not in the labor force.

3.   Definition of labor force:....

4.   Definition of unemployment rate:.....

5.   Definition of labor-force participation rate: the percentage of the adult population that is in the labor force.

a.   Women ages 20 and older have lower labor-force participation rates than men, but have similar rates of unemployment.

b.   Blacks ages 20 and older have similar labor-force participation rates to whites, but have higher rates of unemployment.

c.    Teenagers have lower labor-force participation rates than adults, but have higher unemployment rates.

B.   Definition of the natural rate of unemployment:........

C.   Definition of cyclical unemployment:........... 

F.   Does the Unemployment Rate Measure What We Want It To?

1.   Measuring the unemployment rate is not as straightforward as it may seem.

2.   There is a tremendous amount of movement into and out of the labor force.

a.   Many of the unemployed are new entrants or reentrants looking for work.

b.   Many unemployment spells end with a person leaving the labor force as opposed to actually finding a job.

3.   There may be individuals who are calling themselves unemployed to qualify for government assistance, yet they are not trying hard to find work. These individuals are more likely not a part of the true labor force, but they will be counted as unemployed.

4.   Definition of discouraged workers:...........

a.   These individuals will not be counted as part of the labor force.

b.   Thus, while they are likely a part of the unemployed, they will not show up in the unemployment statistics.

H.   Why Are There Always Some People Unemployed?

1.   In an ideal labor market, wages would adjust so that the quantity of labor supplied and the quantity of labor demanded would be equal.

2.   However, there is always unemployment even when the economy is doing well. The unemployment rate is never zero; it fluctuates around the natural rate.

a.   Definition of frictional unemployment:......

b.   Definition of structural unemployment:.....

c.    Three possible reasons for structural unemployment are minimum-wage laws, unions, and efficiency wages.

III. Job Search

A.   Definition of job search: the process by which workers find appropriate jobs given their tastes and skills.

B.   Because workers differ from one another in terms of their skills and tastes and jobs differ in their attributes, it is often difficult for workers to match with the appropriate job.

C.   Why Some Frictional Unemployment Is Inevitable

1.   Frictional unemployment often occurs because of a change in the demand for labor among different firms.

a.   When consumers decide to stop buying a good produced by Firm A and instead start buying a good produced by Firm B, some workers at Firm A will likely lose their jobs.

b.   New jobs will be created at Firm B, but it will take some time to move the displaced workers from Firm A to Firm B.

c.    The result of this transition is temporary unemployment.

d.   The same situation can occur across industries and regions as well.

2.   This implies that, because the economy is always changing, frictional unemployment is inevitable. Workers in declining industries will find themselves looking for new jobs, and firms in growing industries will be seeking new workers.

D.   Public Policy and Job Search

1.   The faster information spreads about job openings and worker availability, the more rapidly the economy can match workers and firms.

2.   Government programs can help to reduce the amount of frictional unemployment.

a.   Government-run employment agencies give out information on job vacancies.

b.   Public training programs can ease the transition of workers from declining to growing industries and help disadvantaged groups escape poverty.

3.   Critics of these programs argue that the private labor market will do a better job of matching workers with employers and therefore the government should not be involved in the process of job search.

E.   Unemployment Insurance

1.   Definition of unemployment insurance:.....

2.   Because unemployment insurance reduces the hardship of unemployment, it also increases the amount of unemployment that exists.

IV.  Minimum-Wage Laws

A.   Unemployment can also occur because of minimum-wage laws.

B.   The minimum wage is a price floor.

1.   If the minimum wage is set above the equilibrium wage in the labor market, a surplus of labor will occur.

2.   However, this is a binding constraint only when the minimum wage is set above the equilibrium wage.

a.   Most workers in the economy earn a wage above the minimum wage.

b.   Minimum-wage laws therefore have the largest affect on workers with low skill and little experience (such as teenagers).

C.   FYI: Who Earns the Minimum Wage?

1.   In 2006, the Department of Labor released a study concerning workers who reported earnings at or below the minimum wage.

a.   Of all workers paid an hourly rate in the United States, about 2% of men and 3% of women reported wages at or below the minimum wage.

b.   Minimum-wage workers tend to be young, with about half under the age of 25.

c.    Minimum-wage workers tend to be less educated. Of those workers ages 16 and over with a high school education, only 2% earned the minimum wage.

d.   The industry with the highest proportion of workers with reported wages at or below the minimum wage was leisure and hospitality.

e.   The proportion of workers earning the prevailing minimum wage has trended downward since 1979.

D.   Anytime a wage is kept above the equilibrium level for any reason, the result is unemployment.

1.   Other causes of this situation include unions and efficiency wages.

2.   This situation is different from frictional unemployment where the search for the right job is the reason for unemployment.

V.   Unions and Collective Bargaining

A.   Definition of union:......

B.   Unions play a smaller role in the U.S. economy today than they did in the past. However, unions continue to be prevalent in many European countries.

D.   Are Unions Good or Bad for the Economy?

1.   Critics of unions argue that unions are a cartel, which causes inefficiency because fewer workers end up being hired at the higher union wage.

2.   Advocates of unions argue that unions are an answer to the problems that occur when a firm has too much power in the labor market (for example, if it is the only major employer in town). In addition, by representing workers’ views, unions help firms provide the right mix of job attributes.

VI.  The Theory of Efficiency Wages

A.   Definition of efficiency wages:......

B.   Efficiency wages raise the wage above the market equilibrium wage, resulting in unemployment.

C.   There are several reasons why a firm may pay efficiency wages.

1.   Worker Health

a.   Better-paid workers can afford to eat better and can afford good medical care.

b.   This is more applicable in developing countries where inadequate nutrition can be a significant problem.

2.   Worker Turnover

a.   A firm can reduce turnover by paying a wage greater than its workers could receive elsewhere.

b.   This is especially helpful for firms that face high hiring and training costs.

3.   Worker Quality

a.   Offering higher wages attracts a better pool of applicants.

b.   This is especially helpful for firms that are not able to perfectly gauge the quality of job applicants.

4.   Worker Effort

a.   Again, if a firm pays a worker more than he or she can receive elsewhere, the worker will be more likely to try to protect his or her job by working harder.

b.   This is especially helpful for firms that have difficulty monitoring their workers.

INFlATION

I.    The inflation rate is measured as the percentage change in the Consumer Price Index, the GDP deflator, or some other index of the overall price level.

A.   Over the past 100 years, prices have risen an average of about 4% per year in the United States.  The last 20 years have been far below that average.

II.   The Classical Theory of Inflation

A.   The Level of Prices and the Value of Money

1.   When the price level rises, people have to pay more for the goods and services that they purchase.

2.   A rise in the price level also means that the value of money is now lower because each dollar now buys a smaller quantity of goods and services.

3.   If P is the price level, then the quantity of goods and services that can be purchased with $1 is equal to 1/P.

B.   Money Supply, Money Demand, and Monetary Equilibrium

1.   The value of money is determined by the supply and demand for money.

2.   For the most part, the supply of money is determined by the Fed.

a.   This implies that the quantity of money supplied is fixed (until the Fed decides to change it).

b.   Thus, the supply of money will be vertical (perfectly inelastic).

3.   The demand for money reflects how much wealth people want to hold in liquid form.

a.   One variable that is very important in determining the demand for money is the price level.

b.   The higher prices are, the more money that is needed to perform transactions.

c.    Thus, a higher price level (and a lower value of money) leads to a higher quantity of money demanded.

4.   In the long run, the overall price level adjusts to the level at which the demand for money equals the supply of money.

a.   If the price level is above the equilibrium level, people will want to hold more money than is available and prices will have to decline.

b.   If the price level is below equilibrium, people will want to hold less money than that available and the price level will rise.

5.   We can show the supply and demand for money using a graph.

a.   The left-hand vertical axis is the value of money, measured by 1/P.

b.   The right-hand vertical axis is the price level (P ). Note that it is inverted—a high value of money means a low price level and vice versa.

c.    At the equilibrium, the quantity of money demanded is equal to the quantity of money supplied.

C.   The Effects of a Monetary Injection

1.   Assume that the economy is currently in equilibrium and the Fed suddenly increases the supply of money.

2.   The supply of money shifts to the right.

3.   The equilibrium value of money falls and the price level rises.

4.   When an increase in the money supply makes dollars more plentiful, the result is an increase in the price level that makes each dollar less valuable.

5.   Definition of quantity theory of money: a theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate.

D.   A Brief Look at the Adjustment Process

1.   The immediate effect of an increase in the money supply is to create an excess supply of money.

2.   People try to get rid of this excess supply in a variety of ways.

a.   They may buy goods and services with the excess funds.

b.   They may use these excess funds to make loans to others by buying bonds or depositing the money in a bank account. These loans will then be used to buy goods and services.

c.    In either case, the increase in the money supply leads to an increase in the demand for goods and services.

d.   Because the supply of goods and services has not changed, the result of an increase in the demand for goods and services will be higher prices.

F.   Velocity and the Quantity Equation

1.   Definition of velocity of money:.....

3.   If P is the price level (the GDP deflator), Y is real GDP, and M is the quantity of money

5.   Definition of quantity equation: the equation M × V = P × Y, which relates the quantity of money, the velocity of money, and the dollar value of the economy’s output of goods and services.

a.   The quantity equation shows that an increase in the quantity of money must be reflected in one of the other three variables.

b.   Specifically, the price level must rise, output must rise, or velocity must fall.

c.    Figured in the text shows nominal GDP, the quantity of money (as measured by M2) and the velocity of money for the United States since 1960. It appears that velocity is fairly stable, while GDP and the money supply have grown dramatically.

6.   We can now explain how an increase in the quantity of money affects the price level using the quantity equation.

a.   The velocity of money is relatively stable over time.

b.   When the central bank changes the quantity of money (M ), it will proportionately change the nominal value of output (P × Y ).

c.    The economy’s output of goods and services (Y ) is determined primarily by available resources and technology.

d.   This must mean that P increases proportionately with the change in M.

e.   Thus, when the central bank increases the money supply rapidly, the result is a high level of inflation.

Do prices adjust as in the quantity equations or are they sticky?

The previous unemployment chapter indicates they are sticky and here are some more thoughts.  They are old and have old-fasion names, but I ask you can they be updated?

   Shoeleather Costs

1.   Because inflation erodes the value of money that you carry in your pocket, you can avoid this drop in value by holding less money.

2.   However, holding less money generally means more trips to the bank.

3.   Definition of shoeleather costs: the resources wasted when inflation encourages people to reduce their money holdings.

4.   This cost can be considerable in countries experiencing hyperinflation.

C.   Menu Costs

1.   Definition of menu costs: the costs of changing prices.

2.   During periods of inflation, firms must change their prices more often.

D.   Relative-Price Variability and the Misallocation of Resources

1.   Because prices of most goods change only once in a while (instead of constantly), inflation causes relative prices to vary more than they would otherwise.

2.   When inflation distorts relative prices, consumer decisions are distorted and markets are less able to allocate resources to their best use.

F.   Confusion and Inconvenience

1.   Money is the yardstick that we use to measure economic transactions.

2.   When inflation occurs, the value of money falls. This alters the yardstick that we use to measure important variables like incomes and profit.

I.    The Consumer Price Index

A.   Definition of consumer price index (CPI):.......

B.   How the Consumer Price Index Is Calculated

1.   Fix the basket.

a.   The Bureau of Labor Statistics uses surveys to determine a representative bundle of goods and services purchased by a typical consumer.

2.   Find the prices.

a.   Prices for each of the goods and services in the basket must be determined for each time period.

b.   Example:

3.   Compute the basket’s cost.

a.   By keeping the basket the same, only prices are being allowed to change. This allows us to isolate the effects of price changes over time.

b.   Example:

Cost in 2008 = ($1 × 4) + ($2 × 2) = $8.

Cost in 2009 = ($2 × 4) + ($3 × 2) = $14.

Cost in 2010 = ($3 × 4) + ($4 × 2) = $20. 

4.   Choose a base year and compute the index.

a.   The base year is the benchmark against which other years are compared.

b.   The formula for calculating the price index is:

c.    Example (using 2008 as the base year):

CPI for 2008 = ($8)/($8) × 100 = 100.

CPI for 2009 = ($14)/($8) × 100 = 175.
CPI for 2010 = ($20)/($8) × 100 = 250.

5.   Compute the inflation rate.

a.   Definition of inflation rate: the percentage change in the price index from the preceding period.

b.   The formula used to calculate the inflation rate is:

c.    Example:

Inflation Rate for 2009 = (175 – 100)/100 × 100% = 75%.

Inflation Rate for 2010 = (250 – 175)/175 × 100% = 43%.

D.   FYI: What Is in the CPI’s Basket?

   The largest category is housing, which makes up 43% of a typical consumer’s budget.t improvements into account when computing the CPI.

F.   Problems in Measuring the Cost of Living

1.   Substitution Bias

a.   When the price of one good changes, consumers often respond by substituting another good in its place.

b.   The CPI does not allow for this substitution; it is calculated using a fixed basket of goods and services.

c.    This implies that the CPI overstates the increase in the cost of living over time.

2.   Introduction of New Goods

a.   When a new good is introduced, consumers have a wider variety of goods and services to choose from.

b.   This makes every dollar more valuable, which lowers the cost of maintaining the same level of economic well-being.

c.    Because the market basket is not revised often enough, these new goods are left out of the bundle of goods and services included in the basket.

3.   Unmeasured Quality Change

a.   If the quality of a good falls from one year to the next, the value of a dollar falls; if quality rises, the value of the dollar rises.

b.   Attempts are made to correct prices for changes in quality, but it is often difficult to do so because quality is hard to measure.

4.   The size of these problems is also difficult to measure.

5.   Most studies indicate that the CPI overstates the rate of inflation by approximately one percentage point per year.

6.   The issue is important because many government transfer programs (such as Social Security) are tied to increases in the CPI.