Unemployment and Inflation

• TheWhat Is Unemployment?
unemployed are those individuals
who do not currently have a job but
who are actively looking for work.
• The employed are individuals who
currently have jobs.
• Together, the employed and
unemployed comprise the labor force.
 Unemployment
Labor
Labor Force Measures
Force == employed
employed ++ unemployed
unemployed

• The unemployment rate is the percentage of people in

the labor force who are unemployed.

Unemployment Number of Unemployed

Rate = X 100
Labor Force
• The working age population
Unemployment includes
Measures
individuals 15 years of age and older.
• The labor force participation rate is
the ratio of people in the labor force to the
working-age population.

Labor Force Labor Force

Participation =
Population 15 and
Rate over
• For example, suppose an economy consists of:
Unemployment Measures
• 200,000 individuals 15 years and older.
• 122,000 employed.
• 8,000 unemployed.

Labor Force = (122,0000 + 8,000) = 130,000

Labor Force 130,000
Participation = = 65%
200,000
Rate

Unemployment 8,000
Rate = = 6.15%
130,000
 Employment and Unemployment Rate

The number of persons who were in the labor force was reported at 45.4
million of the estimated 73.1 million population 15 years old and over in
July 2019.

Source: PSA
Unemployment Rates Forecast)
 Who Are the Unemployed?
• It is difficult to determine if someone is truly looking for work,
therefore, to distinguish between those people who are
unemployed and those who are not in the labor force, surveys
must be conducted.
• The Philippine Statistics Authority (PSA) approved the clearance for the

•
Who conducts the
conduct of the 2019 Labor Force Survey (LFS)
statistics?
The LFS is undertaken quarterly by PSA to provide statistics on levels and
trends of employment, unemployment, and underemployment for the
country,
• Includes:
• Percent distribution of household population 15 years old and over, by
employment status, by region, sex, and age group
• Percent distribution of employed persons by highest grade completed, major
occupation group, major industry group, class of worker, total hours worked,
and nature of employment
• Percent distribution of employed persons wanting more hours of work by total
hours worked and major occupation group
• Percent distribution of unemployed persons by highest grade completed, by sex
and age group
• Percent distribution of unemployed persons looking for work by job search
method, number of weeks looking for work, by sex and region
 Who Are the Unemployed?

• People who were looking for work in

the recent past but did not find work
and stopped looking are considered
discouraged workers.
• Discouraged workers are not counted as
unemployed, but considered to have
dropped out of the labor force.
 Who Are the Unemployed?

• Workers who hold part-time jobs but

would prefer to have full-time jobs, and
workers holding jobs far below their
capabilities are called the
underemployed.
• It is also difficult to distinguish between
employed and underemployed workers.
• Cyclical
Types of Unemployment
unemployment is the result of
fluctuations in real GDP. Unemployment
rises when real GDP falls, and falls when
the economy improves.

 Frictional unemployment occurs

naturally in the economy. It refers to
the time it takes to find an
appropriate job.
 Types unemployment
• Structural of Unemployment
refers to
the mismatch between job openings
and the skills of workers seeking jobs.
• It is difficult to draw the line between
frictional and structural unemployment.
Are workers from the “old economy”
able to find jobs in the “new economy”?
 The Natural Rate of Unemployment

• When the economy is at full

employment, the unemployment rate
is not zero, but equal to the natural
rate of unemployment.

The natural rate of unemployment consists of
frictional and structural unemployment. It is the unemployment
that exists when actual GDP is equal to potential GDP—there is
no cyclical unemployment.
 The Natural Rate of Unemployment

• In some developed countries,

economists estimate that the natural
rate of unemployment is between
4.0% and 5.5%. In Europe it is
between 7% and 10%.
• The economy needs some frictional
unemployment to operate
efficiently.
 The Natural Rate of Unemployment

• When the growth rate of real GDP slows down relative to its
long-run trend, the actual unemployment rate exceeds the
natural rate of unemployment—cyclical
unemployment rises.
 On the other hand, if economic growth is
too rapid, the economy will “overheat” and
cyclical unemployment will be
negative.
• Excess unemployment cause both society and individuals
The Costs of Unemployment
to suffer:
 Excess unemployment means the economy is no longer producing
at its potential, i.e., some of society’s resources are being wasted;
 Lower employment translates into reduced income and immediate
hardship for individuals, especially those with fixed obligations;
• Unemployment cost can also linger into the future. Some
skills are likely to be lost as a result of prolonged
unemployment;
• Unemployment can impose psychological costs, i.e.,
divorce, crime, suicide, … etc.
 Unemployment and Inflation
• When the economy is “overheated,” and
unemployment rates are low, firms will find
it difficult to recruit workers, and
competition among firms will lead to
increases in wages.
• As wages increase, increases in prices soon
follow. The sign of overheating will be a
general rise in prices for the entire economy,
or inflation.
• The The Consumer
Consumer Price Index (CPI)Price Index
is an index that measures
changes in a fixed “basket of goods” which contains items
purchased by the typical consumer.
• The CPI is a measure of the value of money over time.

 Reality PRINCIPLE
What matters to people is the real
value or purchasing power of money
or income, not its face value.
• The The Consumer
CPI index Price
for a given year, say year K,Index
is defined
as:

CPI in Cost of Basket in Year K

= × 100
Year K Cost of Basket in base Year
 The Consumer Price Index
Example:
• Cost of basket in 1992, the base year = $200
• Cost of same basket in 1997 = $250

$200
C P I in 1 9 9 2 = x 100 = 100
$200

$250
C P I in 1 9 9 7 = x 100 = 125
$200

Prices increased an average of 25% over this

five-year period.
 The CPI and the Standard of Living
• Suppose you have $300 in 1992. How much would you
need to be able to have the same standard of living in
1997?
 Using the ratio of the CPI in 1997 to the CPI in 1992:

125  You need $375 in 1997

300 x = 375 just to maintain what
100
was your standard of
living in1992.
Components of the CPI
•The
BothCPI Versus
the CPI theGDP
and the GDP Deflator
deflator
(including the more recent chain price
for GDP) are measures of the average
prices for the economy.
• The CPI includes goods produced in
prior years, as well as imported goods,
while the GDP deflator does not.
Problems in Measuring Changes in Prices

• The CPI tends to overstate true changes in

the cost of living because it does not
allow for the share of the goods whose
prices have risen to decline in the typical
basket of goods used by the Commerce
Department.
 In reality, all indexes tend to overstate actual price changes, primarily
because we have a difficult time measuring quality
improvements in goods and services.
The CPI Tends to Overstate Price Changes

• Economists believe that the inflation rate

is overstated by between 0.5% and 1.5%
each year.
• This means that cost-of-living
adjustments to wages and social
security payments based on changes in
the CPI tend to be larger than they
should be.
 Inflation
• The percentage rate of change of a price index is the
inflation rate.
• Example:
• Price index in a country in 1998 = 200
• Price index in 1999 = 210

(2 1 0 - 2 0 0 )
I n f la t io n r a t e = = .0 5 = 5 %
200

Conclusion: the country experienced a 5% inflation

rate.
 Inflation
• Inflation refers not to the level of prices, whether they are high
or low, but to their percentage change from one year to another.
• If prices are high but remain the same from one year to another,
there would be no inflation during that time.
• Historically, the price level did not have a trend prior to the
1940s. After 1940, the price level increased sharply.
 Philippines Inflation Rate

Source: PSA
 Deflation
• Deflation is a period during which the
average level of prices falls.
• During the U.S. Great Depression,
between 1929 and 1933, average prices
fell 33%.
• As the average level of prices falls, wages
tend to fall. Therefore, deflation is a
problem because people may not be able
to pay their debts.
 The Costs of Inflation
• Costs associated with anticipated inflation;
 Menu costs or costs associated with physically
changing prices;
 Shoe-leather costs that results from holding
less cash or the additional wear and tear
necessary to hold less cash (more frequent trips
to Banks and ATMs);
 Tax system and financial system do not always
fully adjust to anticipated inflation.
The Short-Run Trade-Off between Inflation and Unemployment
 Figure 1 The Phillips Curve

Inflation
Rate
(percent
per year)

6 B

A
2

Phillips curve

0 4 7 Unemployment
Rate (percent)

Copyright © 2004 South-Western

 Figure 2 How the Phillips Curve is Related to Aggregate
Demand and Aggregate Supply

(a) The Model of Aggregate Demand and Aggregate Supply (b) The Phillips Curve

Price Inflation
Level Short-run Rate
aggregate (percent
supply per year)
6 B
106 B

102 A
High
A
aggregate demand 2
Low aggregate
Phillips curve
demand
0 7,500 8,000 Quantity 0 4 7 Unemployment
(unemployment (unemployment of Output (output is (output is Rate (percent)
is 7%) is 4%) 8,000) 7,500)

Copyright © 2004 South-Western

 Figure 3 The Long-Run Phillips Curve

Inflation
Rate Long-run
Phillips curve

1. When the High B

central bank inflation
increases
the growth rate
of the money
supply, the
rate of inflation 2. . . . but unemployment
increases . . . A remains at its natural rate
Low
in the long run.
inflation

0 Natural rate of Unemployment

unemployment Rate

Copyright © 2004 South-Western

 Figure 4 How the Phillips Curve is Related to Aggregate
Demand and Aggregate Supply

(a) The Model of Aggregate Demand and Aggregate Supply (b) The Phillips Curve

Price Long-run aggregate Inflation Long-run Phillips

Level supply Rate curve
1. An increase in 3. . . . and
the money supply increases the
increases aggregate inflation rate . . .
B
P2 demand . . . B
2. . . . raises
the price
A
level . . . P A
AD2
Aggregate
demand, AD
0 Natural rate Quantity 0 Natural rate of Unemployment
of output of Output unemployment Rate
4. . . . but leaves output and unemployment
at their natural rates.

Copyright © 2004 South-Western

 Figure 5 How Expected Inflation Shifts the Short-Run Phillips
Curve

2. . . . but in the long run, expected

inflation rises, and the short-run
Inflation Phillips curve shifts to the right.
Rate Long-run
Phillips curve

C
B

Short-run Phillips curve

with high expected
inflation

A
Short-run Phillips curve
1. Expansionary policy moves
with low expected
the economy up along the
inflation
short-run Phillips curve . . .
0 Natural rate of Unemployment
unemployment Rate
Copyright © 2004 South-Western
Figure 6 The Breakdown of the Phillips Curve

Copyright © 2004 South-Western

 Figure 7 An Adverse Shock to Aggregate Supply

(a) The Model of Aggregate Demand and Aggregate Supply (b) The Phillips Curve

Price Inflation
Level AS2 Rate 4. . . . giving policymakers
Aggregate a less favourable trade-off
supply, AS between unemployment
and inflation.
B
P2 B
3. . . . and 1. An adverse
raises A shift in aggregate A
the price P supply . . .
level . . . PC2
Aggregate
demand Phillips curve, P C
0 Y2 Y Quantity 0 Unemployment
of Output Rate
2. . . . lowers output . . .

Copyright © 2004 South-Western

Figure 8 The Supply Shocks of the 1970s

Copyright © 2004 South-Western

 Figure 9 Disinflationary Monetary Policy in the Short
Run and the Long Run
1. Contractionary policy moves
the economy down along the
Inflation short-run Phillips curve . . .
Long-run
Rate
Phillips curve

Short-run Phillips curve

with high expected
inflation
C B

Short-run Phillips curve

with low expected
inflation
0 Natural rate of Unemployment
unemployment 2. . . . but in the long run, expected Rate
inflation falls, and the short-run
Phillips curve shifts to the left.
Copyright © 2004 South-Western
Figure 10 The Thatcher Disinflation

Copyright © 2004 South-Western

 The Costs of Inflation
• When there is an unanticipated inflation, there
are winners & losers ;
 It causes unfair redistributions or transfers of
income between parties, i.e, when inflation is
higher than everyone expected, buyer with
fixed dollar contracts would gain and sellers
making a contract in dollar terms would lose;
 It also imposes real costs on the economy.
When people take actions based on beating inflation, the economy
becomes less efficient .
 Inflation,
The Phillips Unemployment,
curve states that  depends on
and the
 expected inflation, e Phillips Curve
 cyclical unemployment: the deviation of the actual rate of
unemployment from the natural rate
 supply shocks, 

e n
     (u  u )  
where  > 0 is an exogenous constant.

slide 44
(1) Y  Y   (P  P e )
Deriving the Phillips Curve from SRAS
(2) P  P e  (1  ) (Y Y )

(3) P  P e  (1  ) (Y Y )  

(4) (P  P1 )  ( P e  P1 )  (1  ) (Y Y )  

(5)    e  (1  ) (Y Y )  

(6) (1  ) (Y Y )    (u  u n )

(7)    e   (u  u n )  

slide 45
 The Phillips Curve and SRAS
SRAS: Y  Y   ( P  P e
)
e n
Phillips curve:      (u  u )  
• SRAS curve:
output is related to unexpected movements in the price
level
• Phillips curve:
unemployment is related to unexpected movements in the
inflation rate

slide 46
• Adaptive expectations: an approach that assumes
Adaptive expectations
people form their expectations of future inflation
based on recently observed inflation.
• A simple example:
Expected inflation = last year’s actual inflation

 e   1

 Then, the P.C. becomes

   1   (u  u n )  

slide 47
   Inflation un) 
 1   (uinertia
• In this form, the Phillips curve implies that
inflation has inertia:
• In the absence of supply shocks or cyclical unemployment,
inflation will continue indefinitely at its current rate.
• Past inflation influences expectations of current inflation,
which in turn influences the wages & prices that people set.

slide 48
 n
     (u  u )   inflation
Two causes of1rising & falling
• cost-push inflation: inflation resulting from supply
shocks.
Adverse supply shocks typically raise production
costs and induce firms to raise prices, “pushing”
inflation up.
• demand-pull inflation: inflation resulting from
demand shocks.
Positive shocks to aggregate demand cause
unemployment to fall below its natural rate, which
“pulls” the inflation rate up.
slide 49
 e n
In the short
Graphing the

  
Phillips  (u
curve  u )  
run, policymakers
face a trade-off

between  and u. 1 The short-run
e  Phillips Curve

u
un

slide 50
 e n
People adjust Shifting the

   curve
Phillips  (u  u )  
their
expectations
over time, so
e
the tradeoff  2 

only holds in  1e  
the short run.

E.g., an increase
u
in  shifts the
e un
short-run P.C.
upward.
slide 51