econ test

Study Guide for Chapter 9

Chapter 9: Unemployment and Inflation

Learning Objective:

1. Define the unemployment rate and the labor force participation rate, and demonstrate how to compute and interpret them.

2. Identify the three types of unemployment.

3. Explain what factors determine the unemployment rate.

4. Define the price level and the inflation rate, and demonstrate how to compute and interpret them.

5. Use the price indexes to adjust for the effects of inflation.

6. Distinguish between the nominal interest rate and the real interest rate.

7. Explain the problems that inflation or deflation causes.

***It is a little bit challenging chapter. Study each topic very thoroughly and practice lots of questions.

Section 9.1

Labor force:

Understand the definition of unemployment clearly (slide 3): they are willing and able to work, and who are actively looking for work but have not found a job (either part-time or full-time). In that sense, “unemployed” should be a part of labor force (i.e., potential workers) (see slide 3).

Measuring unemployment rate:

Keep in mind that it is a ratio of unemployed to labor force (=employed + unemployed), not employed. The Bureau of Labor Statistics (BLS) reports the unemployment rate (monthly data).

You should know how to calculate the unemployment rate with data (see the worksheet).

Labor force participation rate:

You should know how to compute this rate using the formula (slide 3). Pay attention to its trend over time. Notice that the labor force participation rates of adult men vs. adult women are very different (see slide 8)

Problems with measuring the unemployment rate

Understand two different measurements of unemployment: U-3 (official) vs. U-6 (broad).

What makes a difference? There are two factors below (see slide 6):

-Discouraged workers: U-3 doesn’t consider discourage workers as a part of labor force (i.e., they are not a part of unemployed ,because they quit looking for a job), while U-6 includes them as a part of unemployed.

-Involuntary part-time workers: First of all, remember that all part-time workers are employed. There is no distinction between part-time and full-time workers to compute the unemployment rate.

Then, who are involuntary part-time workers? All people who are in part-time jobs but want full-time jobs. U-3 treats all involuntary part-time work as employed (exactly the same as full-time workers), while U-6 consider them as underemployed (i.e., partially unemployed). For example, if you have a part-time (20 hours per week), you are a half employed and a half unemployed (see worksheet).

You should know how to compute both U-3 and U-6 (see worksheet).

***Notice that U-6 is much higher than U-3 (see slide 7).

Section 9.2

Frictional unemployment:

It’s not a serious economic problem. Why?

Cyclical unemployment:

It’s a serious economic problem. Why? The economy need to create more jobs, because the number of job seekers are greater than the number of job vacancies.

Structural unemployment:

It’s not a serious economic problem. Why?

*** You should identify the types of unemployment and understand what makes differences.

Full employment (slide 14: very important):

Keep in mind that the unemployment rate is not equal to zero at full employment. Why?

Understand the concept of potential GDP and natural rate of unemployment.

Section 9.3

How do government policies affect the unemployment rate?

-Unemployment insurance (or compensation) and other payments to the unemployed

-Minimum wage laws

-Labor union

-Efficient wages

***Try to understand my note only (slide 18-20)

Section 9.4

Understand the concept of price index and inflation, and know how to compute the inflation rate (slide 24).

Measuring consumer price index (CPI)

Compute the CPI using the formula of the CPI (see slide 26-27) and

Is CPI accurate? Why or why not?: understand the following 4 biases (slide 28).

-Substitution bias

-Increase in quality bias

-New product bias

-Outlet (or discount price) bias

GDP deflator vs. CPI (slide 29)

Examine how to compute the CPI and GDP deflator, and try to figure out what makes differences.

Section 9.5

Nominal vs. real wages (or income)

When your salary or wage (i.e., nominal income or wage) increases, can you say that you become better because of more money? That’s the question you should be able to answer! Also, you should know how to compute real income using the formula and interpret it. (slide 32)

Nominal vs. real interest rates

It is very similar to the previous topic (nominal income vs real income). You should know how to compute real interest rate with data (slide 33) and interpret it.

Section 9.6

Anticipated vs. unanticipated inflation

Redistribution cost of inflation

It addresses change in purchasing power of money, not the change in amount of money.

For example, suppose you borrow $10,000 with interest rate (i.e., nominal interest rate)of 5% per year from a bank over 1 year. And assume that inflation rate is expected to be 3% ( expected or anticipated inflation rate, not actual one) during that year. If you sign the loan contract and borrow money from that bank, that means that you promise to pay back its principal (=$10,000) and interest ($10,000 x 0.05= $500) one year later. If then, how much will be real interest rate ( in terms of the purchasing power of money)? If actual inflation rate turns out be exactly the same as the expected one (3%), the real interest rate will be 5-3=2%. What if actual inflation rate (4%) turns out to be higher than the expected one (3%)? Then, actual real interest rate (5-4=1%) is lower than expected real interest rate (5-3=2%). If this is the case, the borrower will pay less purchasing power of money (1%) than the expected one (2%). In this case, you (borrower) will be a winner, while the lender will be a loser. If actual inflation rate (2%) turns out to be lower than the expected one (3%), the answer will be exactly opposite to the previous case. It is called “the redistributed cost of inflation”. (practice mock exam questions.)

***DO NOT forget to practice questions on mock exam and worksheet.