Inflation (notes from 2/2/15)

• Rise in general level of prices
• Standard for Inflation is 2-3%

Measuring Inflation

• Inflation Rate
• Measures the percentage increase in the price level over time
• Key indicator of the economy’s health
• Deflation
• Decline in the general price level
• Disinflation
• Occurs when the inflation rate itself declines

• CPI (which stands for consumer price index)
• Measures inflation by tracking yearly price of a fixed basket of consumer goods and services
• In addition, CPI indicates changes in the cost of living and the price level

Solving Inflation Problems

• Finding inflation rate using market basket data
• (Current year market basket value - Base year market basket value)/Base year market basket value x 100
• Finding inflation rate using price indexes
• (Current year price index - Base year price index)/Base year price index x 100
• Estimating inflation using the rule of 70
• Rule of 70 is used to calculate the number of years it will take the price level to double at any given rate of inflation
• Years needed to double inflation= 70/(Annual inflation rate)
• Determining real wages
• Real Wages = Nominal Wages/Price Level x 100
• Finding real interest rates
• Real Interest Rate = Nominal Interest Rate - Inflation Premium
• Cost of borrowing or lending money adjusted for expected inflation
• Nominal Interest Rate
• Unadjusted cost of borrowing or lending money

Causes of Inflation

• Demand-pull inflation
• Caused by an excess of demand over output that pulls prices upwards
• Cost-push Inflation
• Caused by a rise in per unit production cost due to increasing resource cost
• Effects of Inflation
• Helped by Unanticipated Inflation
• Borrowers- Debt will be repaid with cheap dollars
• People locked in Fixed Contracts
• Hurt by Unanticipated Inflation
• Fixed Income people
• Savers
• Lenders/Creditors
  
  
  (Cola means cost of living adjustments)

Unemployment

• Percentage of people that do not have jobs but are in the labor force

Labor Force

• Number of people in a country that are classified as either employed or unemployed

Unemployment Rate

• (# of Unemployed)/(# of unemployed + # of employed) x 100

Not in the labor force

1. Kids
2. Retired People
3. Military Personnel
4. Mentally Insane
5. Incarcerated
6. Stay at Home Parents
7. Full Time Students
8. Discouraged Workers

Official Employment Statistics

Start with total population of the U.S.

• Subtract those under 16
• Subtract those in military
• Subtract those that are institutionalized

This leaves the “Non Institutional Adult” population

• Subtract retired people
• Subtract homemakers
• Subtract full time students over the age of 16
• Subtract discouraged

This leaves the “Civilian Labor Force”

• Count employed (full/part time workers)
• Count employed (Unpaid workers in family business)
• Count those on strike, sick leave, vacation
• Count employed because they are actually looking for work

This becomes the “Unemployment Rate” in %

Four Types of Unemployment

• Frictional Unemployment- People between jobs (Choosing new opportunities, new lifestyle, new choices, new educational level)
• Seasonal Unemployment- Waiting for the right season to conduct your trade (Mall Santa Claus, Easter Bunny)
• Cyclical Unemployment- Downturns in business cycle (Recessions/Troughs)
• Bad for society and individuals
• Structural Unemployment- Lack of skills, decline in industry, technology changes
• Factory worker and factory moves somewhere else
• Can’t read or write

Full Employment

• Occurs when there is no cyclical unemployment present in the economy
• Natural Rate of Unemployment (NRU)
• 4-5% (Desired Goal)

Why is unemployment good?

• Less pressure to raise wages
• More workers are available for future expansions

Why is unemployment bad?

• Not enough consumption (GDP)
• Too much poverty
• Too much government assistance needed

Okun’s Law

1. For every 1% of unemployment above the natural rate of unemployment causes a 2% decline in Real GDP