UNEMPLOYMENT

Output (GDP), inflation and unemployment are the three main economic variables
watched by the media, investors, politicians, businesses to assess the health of the
economy. Some goals of the economy are economic stability, low and stable inflation,
real growth in output!income, low unemployment, etc. "here is disagreement about what,
if anything, the government can do to promote econ stability!growth.
FLUCTUATIONS IN THE ECONOMY - BUSINESS CYCLES
Expansion # $ow unemployment, strong retail sales, rising stoc% mar%et, strong and
positive growth in real output, strong car and housing mar%ets, etc.
Contraction/recession # &igh unemployment, wea% retail sales, declining stoc% mar%et,
low or neg. growth in real output, falling car!housing sales.
Recession - 'sually defined as two or more consecutive (uarters of negative real GDP
growth.
Depression - prolonged and severe recession lasting years. 'nemployment was )*#)+,
for most of the -./*s.
ECONOMIC FLUCTUATIONS AND THE LABOR MARKET
Swings in the business cycle influence the demand for labour and the unemployment rate.
Some definitions
Labor Force 0 "hose over -1 who are either employed or actively loo%ing for a 2ob
(unemployed).
-
RATE OF LABOR FORCE PARTICIPATION 0 $abor 3orce ! "otal population.
4ot in the labour force 0 3ull time household wor%ers, full time students, retirees, and
disabled.
"he $3P (labor force participation) for women has been increasing (more than +*, of
married women now wor% compared to )*, in -.5*s) and for men $3P has been
decreasing.
UNEMPLOYMENT RATE 0 (4umber of persons unemployed ! $abor force) 6 -**.
'nemployment rate is the percentage of persons in the labor force who are either
-) 7vailable for wor% and are actively loo%ing for a 2ob8 or
)) 9aiting to start a new 2ob, or return (due to layoff) to an old 2ob within /* days.
REASONS FOR UNEMPLOYMENT
:n a dynamic economy, there will periods of labour mobility as wor%ers move
-) from contracting industries into e6panding industries, and
)) into and out of the labor force during a lifetime (education, child raising, etc.).
3irms and entire industries are constantly changing. Some are e6panding and hiring
people and others are contracting and laying people off. "here are new industries that
didn;t even e6ist )* years ago # computer technology, <=>s, =Ds, cellular phones, cable
"<, ?PO, web page design, etc. that have provided millions of new 2obs. Other
industries have contracted or gone out of business # carburetors, typewriters, etc.
"housands of new products are introduced every year, many fail. "housands of new
companies start every year and many fail. 7n economy is a very dynamic system
characteri@ed by constant change. 7s the economy changes, new opportunities are
constantly emerging, and others are disappearing. Aar%et is a net 2ob creator, but it is also
a 2ob destroyer. BCreative Destruction.B
)
Point: in a dynamic economy, unemployment is natural and in some ways even very
healthy. =hange ma%es us uncomfortable, but in most cases ma%es us better off in the
long run.
! Ne" entrant#! Graduates from high school, college, technical school, grad school, etc.
People loo%ing for a 2ob for the first time.
$! Re-entrant#! People going bac% to school for further education!grad school, etc.
7bout /C, of unemployed are people entering or re#entering the labour mar%et after
getting education and training, investing in human capital.
%! Peo&'e 'e(t )ob# *o'+ntari', to find something better, better match, better hours, or
move to a new city or state, etc.
-! Peo&'e ".o /ot 0i#1i##e0 because company went ban%rupt, wor%ers fired for cause,
downsi@ing, budget cuts, outsourcing, factory moved to another state or country, etc.
2! Peo&'e ".o /ot 'ai0 o((, with the e6pectation of going bac% to wor%. $ayoffs due to
seasonal factors (slow down in construction wor% during winter), temporary slow down,
factory renovation, etc.
Demographics, age, se6, race, etc. affect unemployment significantly. Note:
'nemployment rate is higher for young people compared to older people, as they try to
figure out what career is best suited to their talents and abilities.
'nemployment has a positive side # people are trying to find a better 2ob, or a more
pleasant wor% environment, or move to a better area, or find a 2ob that better suits them.
Dob moves generally enhance wor%er productivity and earnings. People can e6pect 5 or +
careers now in their lifetime.
THREE TYPES OF UNEMPLOYMENT # Economists classify unemployment into
three theoretical categories
/
3 Frictiona' +ne1&'o,1ent # 7 result of the BfrictionsB in the economy created by
incomplete, imperfect information. 9or%ers may not be aware of all of the 2obs available
and employers may not be aware of all of the (ualified employees. :nformation is costly
and imperfect. ?ecause wor%ers and employers don;t have access to perfect information,
there is some un due to the lac% of complete information.
3or e6ample, employers don;t always hire the first candidate, they may engage in a
lengthy search process. :t is costly to hire and train an employee and it is sometimes
difficult or costly to terminate an employee, so employers may be cautious. 7nd
employees don;t always ta%e the first 2ob offer that comes along, they are also cautious as
they try to find the best match, best compensation pac%age, etc.
"here are ways to reduce frictional unemployment, and the lac% of information.
&eadhunters, employment agencies speciali@e in trying to match up employers and
employees. "rade maga@ines and 2ournals advertise. =olleges have career service offices,
etc. :nternet may reduce the cost of obtaining information, could reduce frictional
unemployment. 3rictional unemployment is natural, doesn;t necessarily represent
inefficiency.
$3 Str+ct+ra' +ne1&'o,1ent - 9ith frictional unemployment, the wor%ers are (+'',
4+a'i(ie0, but the search process may be time consuming, leading to temporary periods
of unemployment. 9ith #tr+ct+ra' +ne1&'o,1ent5 wor%ers are unemployed a result of
the dynamic changes in the economy that ma%e someone;s labor s%ills obsolete. "hey are
faced with possible retraining and a career change if their s%ills have become obsolete.
9or%ers are structurally unemployed when they are no 'on/er (+'', 4+a'i(ie0 in the new
economy. "he BstructureB of the economy has changed, leading to temporary
unemployment for wor%ers who are now un(ualified.
5
Causes of structural:
a! Tec.no'o/ica' c.an/e # new products, new industries, new opportunities for some,
reduced opportunities for others. >estructuring, downsi@ing, and outsourcing have
created new opportunities, new 2obs, but eliminated other 2obs. Economy is changing as
we move into the :nformation 7ge and as international competition intensifies. :ncreasing
premium for education and high s%illed 2obs.
b! S.i(t# in &+b'ic #ector &rioritie#! Examples end of =old 9ar, reduction on defense
spending, base closings. >egulation or Deregulation may create structural unemployment
# airline and truc%ing industries were deregulated in early F*s, industries changed,
resulting in some structural unemployment.
%! C,c'ica' +ne1&'o,1ent - temporary unemployment due to recession from reduced
demand for labour during an econ downturn. Stabili@ation policies could help minimi@e
cyclical unemployment. &istorically, unemployment rate has been lin%ed to the business
cycle and the real growth rate of the economy. During an e6pansion, output growth is
high and unemployment is low. During a recession, output growth is low or negative and
unemployment is high.
EMPLOYMENT FLUCTUATIONS - HISTORICAL RECORD
FULL EMPLOYMENT # Doesn;t mean @ero unemployment. 9e could achieve @ero
unemployment with forced labor, or a chain gang approach. 9e really don;t want @ero
unemployment, it could be a sign of a stagnant economy. Some unemployment is natural,
e6pected and healthy. People are trying to ma%e their lives better, resulting in natural
turnover in the labor mar%et.
Full employment/Full output # efficient use of labour and resources in the econ, allowing
for frictional and structural unemployment. :n 'S, it is estimated to be .5#.+,. Aeans
that +#1, unemployment rate is natural.
+
Natural rate of unemployment = 3rictional G Structural unemployment.
Note: 3ull employment 0 4atural >ate of 'nemployment
Examples: 'nemployment is higher for young people, so as the baby boom generation
entered the wor% force, a higher percentage of the labor force was young, which pushed
up the natural rate of unemployment by -, in the 1*s and C*s.
'nemployment rate fluctuates with the business cycle. 7ctual unemployment was below
the natural rate during the e6pansion of the late F*s and was again below the natural rate
in the e6pansion of the late -..*s. Auch of the study in the field of Aacroeconomics is
loo%ing at why actual unemployment differs from the natural rate, and why the natural
rate changes over time.
P+b'ic Po'ic, affects the natural rate. 9hen public policy ma%es it more e6pensive to
employ wor%ers or fire wor%ers, natural rate increases. 9hen public policy ma%es it
more attractive to remain unemployed, natural rate increases. "he more static!less
dynamic the labour mar%et due to policy, the higher the natural rate.
Examples: Aost European countries have very high unemployment rates (C.+,#)*,)
compared to '.S. >eason Public policy in Europe ma%es is relatively more e6pensive to
hire wor%ers, and also ma%es it relatively more attractive to remain unemployed vs.
'.S.
Final point: 3ull production vs. full employment. 3ull employment is not a desirable goal
if it involves employment at unproductive 2obs. Example =uba may have full
employment in the sense that everyone has a B2ob,B but it is not operating at full output or
full production.
1
MEASUREMENT PROBLEMS FOR UNEMPLOYMENT RATE
-. Discouraged wor%ers, who have given up loo%ing for a 2ob, are 4O" counted in the
labor force, so are 4O" counted in unemployment rate. O4$H those people who are
actively 2ob searching are counted in unemployment rate.
"he current unemployment rate of 5.-, unemployment rate doesn;t count discouraged
wor%ers, so actual rate (counting discourage wor%ers) is higher. :n the -..- recession, the
Dept. of $abor estimated -m discouraged wor%ers, about *.F, of the wor%force.
). Part#time wor%ers are 4O" classified as unemployed, even though they may desire
full#time employment. Someone wor%ing only one hour a wee% is still considered to be
EAP$OHED, even though they may be loo%ing for a full time 2ob. "here could be
significant '4EAP$OHAE4" that is not calculated in unemployment rate. Dept. of
$abor doesn;t distinguish between part#time and full#time, everybody wor%ing at all is
counted as employed.
/. Some unemployed people claim to be actively loo%ing for a 2ob, and are counted as
unemployed, when they may not be seriously see%ing employment at all. People
receiving assistance in the form of unemployment insurance, welfare programs, general
assistance, 73D=, food stamps, etc. may be classified as unemployed (loo%ing for wor%),
even though they are not seriously 2ob hunting. 3or e6ample, if you (ualify for -F wee%s
of unemployment benefits, how long would most people remain unemployedI
:ncreasing unemployment benefits could actually increase unemployment rate, e.g.
Europe.
5. 'nderground economy # some people counted as unemployed may actually be wor%ing
in the under ground economy, or off the boo%s.
Despite these measurement problems, the '4EAP$OHAE4" >7"E (along with GDP)
is one of the most closely watched economic variables.
C
EFFECTS OF INFLATION #
Inflation 0 an increase in the general price level, calculated as the percentage change in a
price inde6. 4ote unless otherwise specified, BinflationB generally refers to consumer
inflation, calculated from the =onsumer Price :nde6 (=P:). :nflation erodes the
purchasing power of the dollar, since positive rate of inflation indicates that prices O4
7<E>7GE are increasing. /, inflation means that prices rose by /,, on average. Some
goods increased by more than /,, some less than /,. :nflation is the percentage change
in a price inde6 (P:).
Example: Price inde6 (P:) goes from )** to ))*, :nflation rate is -*, ())* # )** ! )**) 6
-**.
9e can see that inflation in low inflation countries tends to be more stable (-# 5,) and
high inflation tends to be more volatile (?ra@il, /, # )*+*,). One of the problems with
high inflation is that is tends to be erratic and unpredictable leading to a high level of
uncertainty about the future. 9e want $O9, S"7?$E inflation, since it creates certainty
and stability in the economy. One of the most significant factors in the record#setting
-..-#)**- economic e6pansion was the underlying price level stability (low and stable
inflation) of that decade.
Antici&ate0 *#! Unantici&ate0 In('ation 6 E7&ecte0 *#! S+r&ri#e In('ation
'nanticipated, or surprise inflation is inflation that was not e6pected by most people.
People are caught off guard. 9hen inflation is high and volatile, people never %now what
to e6pect, ma%es business planning difficult. 7nticipated inflation is a change in the price
level that is e6pected by most decision ma%ers.
For example, we could e6pect inflation ne6t year to be /,. :f it turns out to be /,, it was
e6pected. :f it turns out to be -),, there would be ., that was une6pected.

F
COSTS OF INFLATION #
&igh and variable rates of inflation ma%e the economy operate less efficiently for several
reasons
-! In('ation 0i#tort# 'on/ ter1 &ro)ect# an0 contract#! Examples long term labor
contracts, long term contracts between companies and suppliers, mortgages, long term
debt, life insurance policies, capital investments, business investments, etc.
Example German man who bought a life insurance for his wife and daughter, say -m
mar%s, when it was cashed it would only buy a loaf of bread.
:f inflation is high and uncertain, people may not enter into potentially profitable long#
term relationships and pro2ects, leading to a reduction in trade and investments, reducing
economic progress. Or people spend more time and energy on contracts, or ma%e shorter
contracts, or more complicated contracts.
Example: :n all of =entral and South 7merica, only Panama has /* year fi6ed#rate
mortgages. &ow would a ban% in ?ra@il, Ecuador or <ene@uela %now what nominal
interest rate to charge on a /* year loan!mortgage, given the uncertainty about future
inflationI Panama uses the '.S. dollar, so it has about the same inflation rate as the
'.S.
:t would also be very ris%y to invest in ?ra@il or ?ulgaria, given the high and variable
rates of inflation there. :nvestment would flow to more stable economies li%e '.S.,
Europe, and Dapan with low inflation.

.
$! Re#o+rce# /et +#e0 +& tr,in/ to a*oi0 t.e ne/ati*e e((ect# o( in('ation!
"ime, attention and energy get diverted away from productive activities to trying to
protect against the effects of inflation. :nvestment gets distorted away from productive
uses toward inflation hedges and speculation. Production possibilities are reduced.
Example: Aenu costs # costs of changing price tags during high inflation. "hin% of the
economic costs imposed on the economy when prices change daily. BShoe $eather
=ostsB
%! In('ation re0+ce# t.e 8in(or1ation content8 o( &rice#! !
Aar%et prices transmit information about relative scarcity, supply and demand
conditions, etc. :nflation distorts the important economic information delivered by
prices. >elative prices are distorted and prices can;t co#ordinate econ activity as well.
Econ efficiency is reduced. People lose faith in the econ system.
Example producer sees that prices for its products are rising, e.g. gasoline. :f prices are
rising 2ust because of inflation, producer would then want to raise prices. :f prices are
rising because an increase in real demand, then producer would want to increase output.
During periods of high inflation, it ma%es it harder to distinguish between the two effects,
leading to confusion and a less efficient economy.
-*
STA9FLATION #
:nflation (easy money) can act initially as an econ stimulant and temporarily lead to econ
growth, but it is artificial and temporary and leads to mal#investment. Economy will
eventually e6perience an econ hangover, as the negative effects of inflation slowly distort
the econ and lead to a stagnant economy.
Stagflation describes the condition of .i/. in('ation an0 .i/. +ne1&'o,1ent, or high
inflation and sluggish output growth. &igh misery inde6 (:43 G '4EAP$OHAE4"
>7"E 0 A:SE>H :4DEJ).
Example: :n the mid and late C*s '.S. inflation was high and variable (averaged about
-),) and unemployment rate averaged about -*,, stoc% mar%et was flat for a decade,
and there were two serious recessions (C5#C+ and C.#F*). 3rom -.F/#)*** inflation was
low and stable and the economy was in recession for only F months.
One of the challenges of modern macroeconomics is to develop policies that contribute to
low and stable rates of inflation, and sustained growth rates of real output. One
alternative for monetary policy :nflation "argeting li%e in =anada, 'K and Europe.
:HAT CAUSES INFLATION;
Ailton 3riedman (uotes B"oo much money chasing too few goods.B B:nflation is always
and everywhere a monetary phenomenon.B 9e will consider inflation in detail later, but
the main factor causing inflation is e6cessive growth in the money supply. Aonetary
E6pansion 0 :nflation
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