Summary
Defining Unemployment
- 1. Employed people currently hold a part-time or full-time job; unemployed people do not hold a job but are actively looking for work. Their sum is equal to the labor force, and the labor force participation rate is the percentage of the population age 16 or older that is in the labor force.
- 2. The unemployment rate, the percentage of the labor force that is unemployed and actively looking for work, can overstate or understate the true level of unemployment. It can overstate because it counts as unemployed those who are continuing to search for a job despite having been offered one (that is, workers who are frictionally unemployed). It can understate because it ignores frustrated workers, such as discouraged workers, marginally attached workers, and the underemployed. In addition, the unemployment rate varies greatly among different groups in the population; it is typically higher for younger workers and for workers near retirement age than for workers in their prime working years.
- 3. The unemployment rate is affected by the business cycle. The unemployment rate generally falls when the growth rate of real GDP is above average and generally rises when the growth rate of real GDP is below average. In a jobless recovery the GDP growth rate is positive but the unemployment rate is still rising.
Categories of Unemployment
- 4. Job creation and destruction, as well as voluntary job separations, lead to job search and frictional unemployment. In addition, a variety of factors such as minimum wages, unions, efficiency wages, and government policies designed to help laid-off workers result in a situation in which there is a surplus of labor at the market wage rate, creating structural unemployment. As a result, the natural rate of unemployment, the sum of frictional and structural unemployment, is well above zero, even when jobs are plentiful.
- 5. The actual unemployment rate is equal to the natural rate of unemployment, the share of unemployment that is independent of the business cycle, plus cyclical unemployment, the share of unemployment that depends on fluctuations in the business cycle.
- 6. The natural rate of unemployment changes over time, largely in response to changes in labor force characteristics, labor market institutions, and government policies.
The Costs of Inflation
- 7. Inflation does not, as many assume, make everyone poorer by raising the level of prices. That’s because if wages and incomes are adjusted to take into account a rising price level, real wages and real income remain unchanged. However, a high inflation rate imposes overall costs on the economy: shoe-leather costs, menu costs, and unit-of-account costs.
- 8. Inflation can produce winners and losers within the economy, because long-term contracts are generally written in dollar terms. Loans typically specify a nominal interest rate, which differs from the real interest rate due to inflation. A higher-than-expected inflation rate is good for borrowers and bad for lenders. A lower-than-expected inflation rate is good for lenders and bad for borrowers.
- 9. It is very costly to create disinflation, so policy makers try to prevent inflation from becoming excessive in the first place.
Measuring Inflation
- 10. To measure the aggregate price level, economists calculate the cost of purchasing a market basket. A price index is the ratio of the current cost of that market basket to the cost in a selected base year, multiplied by 100.
- 11. The inflation rate is the yearly percent change in a price index, typically based on the consumer price index, or CPI, the most common measure of the aggregate price level. A similar index for goods and services purchased by firms is the producer price index, or PPI. Finally, economists also use the GDP deflator, which measures the price level by calculating the ratio of nominal to real GDP times 100.