3. Measuring Unemployment and Inflation PDF

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ECON 1 006 Principles of Economics II (Macroeconomics) Semester 2, 2020/Measuring Unemployment and Inflation1. Measuring Unemployment The unemployment rate is the statistic that measures the percentage of those people willing and able to work who do not have jobs. The entire non-institutionalized ...

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ECON 1006 Principles of Economics II (Macroeconomics)

Semester 2, 2020/21

Measuring Unemployment and Inflation 1. Measuring Unemployment 

The unemployment rate is the statistic that measures the percentage of those people willing and able to work who do not have jobs.

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The entire non-institutionalized (for example, people in metal hospital, jail, homes for aged, and so on are institutionalized) population aged 15 (in HK) and over (adult population), i.e. working population, falls into one of the four categories: o Labor force:  Employed  Unemployed  had not have a job during the last 7days  have been available for work during the last 7 days  have sought work during the last 30 days o Not in the labor force

Labor Force: 3888.2 Working Population: 6532.8



Unemployment rate is defined as: unemployment rate (UR) =

number of unempolyed labor force

In 2020, UR = 226.6/3888.2 x 100% = 5.8% 

Labor force participation rate is defined as: labor force participation rate (LFPR) = In 2020, the LFPR = 3888.2/6523.8 x 100% = 59.6%

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labor force total working population

ECON 1006 Principles of Economics II (Macroeconomics)

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Semester 2, 2020/21

Limitation of Unemployment Measures o

Involuntary part-time workers  Many part-time workers intended to work full-time but fail to find a full-time job, yet part-time workers are classified as employed in official statistics.  Underestimation of true unemployment problem.  Underemployment: involuntary work less than 35 hours in the past 7 days.

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o Discouraged workers Many workers had been unemployed for a long time. After seeking jobs for some time unsuccessfully, become discouraged and stopped searching. These people were dropped out from the labor force. Underestimation of true unemployment problem. Note: The statistical unit of HK government attempt to identify discouraged workers and include them into unemployed.

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ECON 1006 Principles of Economics II (Macroeconomics)

Semester 2, 2020/21

2. Types of Unemployment 

Frictional unemployment  Occurs in normal process of job turnover o Search unemployment  Short-term unemployment at the individual level.  In some sense, frictional unemployment is desirable as it may results in better allocation of labor resources.

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Structural unemployment  Occurs when there is a mismatch between the skill or location requirements of job vacancies and the present skills or location of members of labor force.  Long-term unemployment at the individual level.

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As the frictional and structural unemployment cannot be entirely eliminated1, an economy’s unemployment rate is never zero, regardless of the overall level of production in the economy. o These types of long-run unemployment are called the natural rate of unemployment.

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Why is the long-run unemployment rate in European countries so high?

1 In the textbook, it includes the seasonal unemployment, which is the unemployment related to changes in weather, tourist patterns, or other seasonal factors. Because most countries adjust the data to remove the effects (seasonal adjustment), it is not emphasized in most macroeconomics textbooks.

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ECON 1006 Principles of Economics II (Macroeconomics)

Semester 2, 2020/21

o

Government policies that interfere with the adjustment of the labor market, such as high legal minimum wages, generous welfare and unemployment benefits.

o

Labor unions: When a union negotiates a labor contract with a firm, it seeks the highest wage possible without causing the firm to cut employment (maximizes the benefits of the currently employed workers, or insiders). If the union succeeds in getting this wage, the wage will be too high for the firm to employ additional labors, or outsiders.

o

What can be done to reduce the natural-rate of unemployment?  Job training  Unemployment insurance or benefit reform  Job market flexibility

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ECON 1006 Principles of Economics II (Macroeconomics)

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Semester 2, 2020/21

Cyclical unemployment o The unemployment which is tied to the fluctuations of output over the business cycle.  Increase during the recession (why?) o

Actual unemployment minus the natural rate of unemployment

o

Macroeconomists usually refer full employment to as zero cyclical unemployment.  But the overall unemployment rate at full employment is positive, i.e. the natural rate of unemployment.  The natural rate of unemployment is the typical unemployment rate that occurs when the economy is growing normally.

3. The Costs of Unemployment 

Lost output o The potential GDP is the output level when the economy is operating at “full employment”, i.e. the natural rate of unemployment prevails. o Cyclical unemployment results in actual GDP to be lower than the long-run trend, i.e. below the potential GDP. o GDP Gap = actual GDP – potential GDP

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Lost Skills due to idleness

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Social Consequences: o Social unrest  Especially when the burden of unemployment cost is unequally distributed. o Other human costs2

4. Measuring Price Level and Inflation 

Consumer Price Index (CPI) is the most commonly used measure of the level of prices. o The current price of a basket of goods and services purchased by a typical household relative to the price of the same basket in the base year.

CPI =

prices of the standard consumption basket in a particular year prices of the standard consumption basket in the base year

× 100

2 Researchers have found that with every 1% increase in the U.S. unemployment rate, 920 more people commit suicide, 650 commit homicide, 500 die from heart and kidney diseases and cirrhosis of liver, 4000 are admitted to state mental hospitals, and 3300 are sent to state prisons. In total, a 1% increase in unemployment is associated statistically with 37,000 more deaths, including 20,000 heart attacks.

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ECON 1006 Principles of Economics II (Macroeconomics)

Semester 2, 2020/21

Example: Calculation of CPI Suppose the consumption basket of goods consists of 10 apples and 20 oranges, and the prices in 2020 and 2021 are as follows:

Apple Orange

2020 Price $2.00 $1.00

2021 Price $2.50 $1.50

Using 2020 as the base year, the 2021 CPI is:

CPI =

$2.5 × 10 + $1.5 × 20 $2 × 10 + $1 × 20

× 100 = 137.5

It means the 2021 price level is 37.5% higher than the base year (2020) price level. Inflation rate: the percentage change in price index. o Negative inflation: deflation. Example: Calculation of inflation rate Using (Oct 2014 – Sept 2015) as the base year, the (Composite) CPI of 2018 and 2019 in HK are 107.0 and 110.1 respectively, the annual inflation rate for 2019 is:

2019 Inflation rate = 

110.1 − 107.0 107.0

× 100% = 2.9%

Another widely used price index is the GDP Deflator (discussed in the last topic)

GDP Deflator = o

nominal GDP × 100 real GDP

The main difference between the CPI and GDP deflator are in the types of goods and services covered in each index. 

CPI tracks the prices of goods bought by households, including used goods and imported goods.



GDP deflator measures the prices of all goods and services included in measuring of GDP, including goods bought by government, firms and foreigners.

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ECON 1006 Principles of Economics II (Macroeconomics)

Semester 2, 2020/21

5. The Application of CPI: Real and Nominal Variables  

Nominal variables: variables expressed in dollar terms (measured at the current price level). Real variables:

real variable = o o

nominal variable × 100 price index

variables expressed in terms of its purchasing power. Practically, using the CPI, the real variable can be interpreted as the variables measured in the base-year dollar3.

Example: Calculation of real wage Average monthly nominal wages of selected occupations in HK Accounting supervisor Dishwasher CPI (Oct 2014 – Sep 2015 = 100) March 2011 $21,335 $7,803 85.2 March 2021 $26,220 $13,632 111.9 Source: Census and Statistics Department, HK SAR Government.

Using the base year (2014 – 2015) prices, the average real wages of an accounting supervisor in March 2011 and 2021 are: 21,335 2011 real wage = × 100 = $25,041.08 85.2 26,220 × 100 = $23,431.64 2021 real wage = 111.9 The real wage in 2011 is $25,041; it means that the worker could purchase $25,041 worth of goods and services in the base year (Oct 2014 – Sep 2015) with his wage in 2011. On the other hand, he could purchase $23,432 worth of goods and services in the base year with his wage in 2021. While the nominal wage had increased by 22.9% in a decade, the real wage had decreased by 6.4%. How about the real wage of dishwasher? 6. The Costs of Inflation 

A common fallacy: Inflation erodes the purchasing power of incomes and hurts everyone. o As every transaction involves two parties, a buyer and a seller, inflation does not directly change the average purchasing power in the economy.

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Redistribution of income and wealth among different groups o

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Effect on fixed-income receivers  E.g. retired people living on private pensions, landlords who receive fixed payments.  hurt by inflation

Alternately, for comparison purpose, we can also convert all prices to “prices in current-year dollars”: price in current year's dollars = price in earlier year =

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𝐶𝑃𝐼𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟 𝐶𝑃𝐼𝑒𝑎𝑟𝑙𝑖𝑒𝑟 𝑦𝑒𝑎𝑟

ECON 1006 Principles of Economics II (Macroeconomics)

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Semester 2, 2020/21

How about those whose incomes are indexed to CPI or contracts include cost of living adjustments?  As their incomes are automatically adjusted for inflation, these people will not suffer from inflation.

Effect on Debtors and Creditors  The impact of inflation depends on whether the inflation is anticipated or unanticipated. 

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Unanticipated inflation results in debtors benefiting at the expense of creditors.  Suppose a debtor and a creditor agrees a loan of $1000 with an interest rate of 10%. What happens if there is an inflation of 5%? 

The real interest rate, which is the percentage increase of goods and services that the debtor pays the lender, decreases.

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After the loan is agreed: real interest rate = nominal interest rate – inflation rate4

How about anticipated inflation?  The redistribution effect can be eliminated if the inflation is fully anticipated.  The lender can add an expected inflation rate (inflation premium) to the real interest rate to determine the nominal interest rate by the time the loan is agreed. 

By the time the loan is agreed, nominal interest rate = real interest rate + expected inflation rate

Example: Suppose, at the beginning of a year, a lender wants to receive a 10% return (real interest) on a one-year loan and he expects inflation rate to be 5%. What nominal interest rate should he charge? The actual inflation rate for the year turns out to be 3%, what is the real interest rate of the loan? Who gains? Who loses? 

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Other costs/problems of inflation: the resources and time people must spend coping with inflation. o Distortions in relative prices (or money illusion). o Menu costs The derivation of the real interest rate equation (formally, Fisher equation):

Given the nominal interest rate is 𝑖 and inflation rate is 𝜋, then 1+𝑟 =

1 +𝑖 1+𝜋

1 + 𝑖 = (1 + 𝑟)(1 + 𝜋) 𝑖 = 𝑟 + 𝜋 + 𝜋𝑟 ≈ 𝑟 + 𝜋 (because 𝜋𝑟 is very small) So, approximately, 𝑟 ≈ 𝑖 − 𝜋. Formally, we are actually applying the Taylor expansion to perform this linear approximation.

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ECON 1006 Principles of Economics II (Macroeconomics)

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Semester 2, 2020/21

 E.g. Administrative costs involved in updating prices. Shoe-leather costs  E.g. more frequent banking transaction and wealth management.

Limitations of CPI as a measure of true cost of living

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The major problem of CPI is that it assumes the households consume a fixed basket of goods and services (fixed in the base year), which leads to the following problems:

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Substitution bias o When prices do not change proportionally, some goods become relatively expensive. Computing CPI by assuming the fixed consumption baskets ignores the possibility that households would substitute the relatively cheaper goods for more expensive ones. 5 o It overstates the true cost of living.

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Introduction of new goods o As new goods are introduced, their prices often dropped rapidly after their introduction. But the new goods are usually included in the consumption basket after a time lag. o Also, new technologies often offer consumers a lower cost alternative for obtaining the same service. o Excluding these newly introduced products overstates the true cost of living.

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Quality change o An improvement in quality of goods results in the consumers getting more by paying the same price. Computing CPI by assuming the fixed consumption baskets ignores the increase in value of the price paid. o It overstates the true cost of living

Readings:  Chapter 18 (p.553 – 564); Chapter 19

5 A related issue is the growth in discount chains in many countries. When these stores first enter the market, people suddenly can buy the same good from these discounters for less. The CPI systematically misses the price drop from the shift to these discounters.

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Source: The Economist Finance & economics Jan 2nd 2021 edition

Speed limits How quickly will America’s labour market recover? Long-term unemployment is high, but pent-up demand could help bring it down

Jan 2nd 2021

One of the biggest questions facing the world economy in 2021 is how fast America’s labour market will recover. Optimists point to the rapid decline in the unemployment rate after the first wave of the pandemic—from nearly 15% in April to 6.7% in November—as a reason for a speedy recovery. Pessimists’ go-to statistic is the high and rising rate of the long-term unemployed, those who have been out of work for more than six months. It has risen from 0.7% of the labour force in February to 2.5% today. The last time the figure was that high was in December 2013, when the labour market was recovering from the global financial crisis of 2007-09. On average, the longer someone is unemployed, the harder it is for them to find work. In part that may be because the least productive workers, for whom the labour market is always an unwelcoming place, are more likely to experience long spells of unemployment during downturns. But spending months on the sofa also causes people’s skills to atrophy. As a result, recessions inflict lasting scars on both workers and the economy. How deep are the scars likely to be this time? Unemployment fell rapidly in 2020—and much more quickly than after the financial crisis—because millions of laid-off workers were recalled to their jobs in the summer and autumn. This was particularly true of jobs requiring face-to-face contact. Analysis by The Economist suggests that service occupations accounted for about a third of the jobs lost in the spring and about a third of the subsequent rebound. Employment among those aged 20-24, who might often work as waiters and bar staff, has recovered nearly 80% of its losses (see chart).

Spee

The picture for the long-term unemployed is less rosy, though. Nearly 30% of them say they are only temporarily laid off, but with each passing month it seems less likely that their jobs will return. The long-term unemployed are also more evenly spread across the economy. Service workers make up just over a quarter of the rise in long-term unemployment since February. Remarkably, though, they are outnumbered by professionals and managers. These account for a third of the recent rise in long-term unemployment, even though they are often said to have been immune to the downturn. Nor are the newly long-term unemployed

especially young. More than half are over 45. Most are men. They look like a group that has suffered a normal recession rather than a service-sector hiatus. Things appear gloomier still when you consider those who left the workforce altogether in the spring, meaning they stopped working and did not look for new jobs. Such “inactive” workers are not counted as unemployed. Jason Furman and Wilson Powell III of Harvard University reckon that a “realistic” unemployment rate, which adds many of them back in, is 8.5%. A study of the long-term unemployed by Alan Krueger of Princeton University, Judd Cramer of Harvard University and David Cho of the Federal Reserve in 2014 found that, counterintuitively, the long-term unemployed leave the workforce more readily during recoveries than in downturns; they seem to discover they are missing out on the rebound, and give up looking for work. If the same holds in 2021, labour-force participation could fall further. The pessimists therefore have plenty of ammunition. Yet the optimists can fire back. Some 3.9m of the 5.7m people who have left the labour force since January cite the pandemic as the reason they are not looking for work, calculates Joseph Briggs of Goldman Sachs, a bank. Once it ends, they may return. In the years after Messrs Krueger, Cramer and Cho published their study, America’s labour market heated up so much that employers searched far and wide for willing workers, hiring even ex-convicts, and the labour-force participation rate for 16- to 64-year-olds went up. If the economy recovers quickly enough, then its scars will probably heal. Some economists predict a spending spree in 2021 as the economy reopens fully and pent-up demand is unleashed. But what must come first, the consumer-spending rebound, or labour-market healing? Lawmakers may have solved the chicken-and-egg problem. On December 27th President Donald Trump signed a bill that will inject $900bn (4.3% of gdp) in stimulus, sending cheques to households and extending benefits for the long-term unemployed (see article). The replacement of lost incomes could allow the unemployed to spend even as they search for work. And a rapid rise in consumption in 2021 should bring the labour market back to the boil—even, eventually, for the long-term unemployed. ■

Editor’s note: Some of our covid-19 coverage is free for readers of The Economist Today, our daily newsletter. For more stories and our pandemic tracker, see our hub This article appeared in the Finance & economics section of the print edition under the headline "Speed limits"

2015/1/7

Minimum wages: The logical floor | The Economist

2015/1/7

Minimum wages: The logical floor | The Economist

Scepticism about the merits of minimum wages remains this newspaper’s starting-point. But as income inequality widens and workers’ share of national income shrinks, the case for action to help the low-paid grows. Addressing the problem through subsidies for the working poor is harder in an era of austerity, when there are many other pressing claim...