Chapter 5 Macroeconomic Measurements, Part I: Prices and Unemployment What This Chapter Is About There are many variables that economists measure—the price level, unemployment, gross domestic product (GDP), real gross domestic product (Real GDP), the economic growth rate, and so on. In this chapter we begin to discuss how economists measure certain variables. We focus on the price level and unemployment in this chapter; in the next chapter, we focus on GDP and Real GDP. Key Concepts in the Chapter a. price level b. base year c. nominal income d. real income e. inflation f. unemployment rate g. frictional unemployment h. structural unemployment i. natural unemployment The price level is the weighted average of the prices of all goods and services. Sometimes it is easier to think of the price level as an average price. For example, suppose the price of good A is $10, the price of good B is $20, and the price of good C is $30. The average price (of these three goods) is $20. In a large economy, there are many goods and services and each sells for a certain price. The average of all the prices of all the goods and services is the price level. The base year is one year in which all other years are measured up against. It is a benchmark year. Nominal income is current-dollar income. For example, suppose Suzanne earns an annual income of $60,000. This is her nominal income. Real income is one’s nominal income adjusted for price changes. Inflation is defined as an increase in the price level. In a later chapter, you will learn about two kinds of inflation—one-shot inflation and continued inflation. In this chapter, we simply define inflation and show how the inflation rate is measured. The unemployment rate refers to the percentage of the civilian labor force that is unemployed. Frictional unemployment is a type of unemployment. A person who is frictionally unemployed is an unemployed person who has transferable skills. For example, suppose Joe was just fired from his job as an auto factory worker. If there is another auto factory that is hiring factory workers, then Joe has skills that can be easily transferred to another job. Structural unemployment is a type of unemployment. A person who is structurally unemployed is an unemployed person who does not have transferable skills. He or she will have to acquire some additional training to get a job. Again, suppose Joe was just fired from his job as an auto factory worker. If the only companies that are hiring currently are computer companies, then Joe may not have the skills necessary to do this kind of work. He is structurally unemployed, and will have to acquire new work skills before he gets a job with a computer company. Natural unemployment is the sum of frictional unemployment and structural unemployment. The natural unemployment rate is the sum of the frictional and structural unemployment rates. For example, suppose the frictional unemployment rate is 2 percent and the structural unemployment rate is 3 percent. It follows that the natural unemployment rate is 5 percent. When the economy is operating at the natural unemployment rate, full employment is said to exist. 39 40 Chapter 5 Review Questions 1. What is the relationship between the price level and a price index? 2. Is the consumer price index (CPI) a reflection of the prices of all goods and services produced and purchased in an economy? Explain your answer. 3. If the CPI in a given year is 132, what does this mean? 4. Smith and Jones have the same nominal income, but they live in different countries. Does it follow that they have the same real income? Explain your answer. 5. Steve earned $40,000 income in 1987 and Jeff earned $40,000 in 2003. Was $40,000 in 2003 the same as $40,000 in 1987? Explain your answer. Macroeconomic Measurements, Part I: Prices and Unemployment 41 6. Explain how the CPI is calculated. 7. What is the difference between the civilian noninstitutional population and the civilian labor force? 8. If the unemployment rate is 5 percent, it does not follow that the employment rate is 95 percent. Explain why. 9. What are the four classifications of unemployed persons? 10. What is the difference between a reentrant and a new entrant. 11. Why aren’t discouraged workers considered unemployed? 42 Chapter 5 12. Give an example of someone who is structurally unemployed. Problems 1. In the table (that follows) we have identified current-year prices, base-year prices, and the marketbasket. Market Basket 10X 15Y 33Z Current-year prices (per item) $1.22 $1.66 $3.45 Base-year prices (per item) $1.10 $1.16 $2.55 What is the CPI for the current year? 2. The CPI was 140.3 in 1992 and 177.1 in 2001. What was the percentage change in prices during the time period 1992-2001? 3. Nominal income is $50,000 and the CPI is 143. What does real income equal? 4. Rebecca’s income increased by 20 percent over the last year and prices increased by 2 percent. Did Rebecca’s real income rise? Explain your answer. 5. Stacy earned $10,000 in 1967. If the CPI was 33.4 in 1967 and 177.1 in 2001, what was $10,000 equivalent to in 2001? Macroeconomic Measurements, Part I: Prices and Unemployment 43 6. Fill in the numbers missing from the table that follows. Category Civilian noninstitutional population Employed Civilian labor force Unemployment rate Persons unemployed Persons not in the labor force Number of persons 200 100 120 7. If the number of persons not in the labor force is 100, persons in the civilian labor force is 200, persons employed is 180, and persons unemployed is 20, then what is the labor force participation rate? 8. How does the labor force participation rate differ from the employment rate? 9. If you know the number of unemployed persons, job losers, and reentrants, is it possible to compute the number of job leavers? Explain your answer. 10. If the natural unemployment rate is 4.5 percent and the structural unemployment rate is 2.1 percent, is it possible to compute the cyclical unemployment rate? Explain your answer. What is the Question? Identify the question for each of the answers that follow. 1. The consumer price index. 44 Chapter 5 2. Take the nominal income and divide it by the CPI. Then take the quotient and multiply it by 100. 3. The number of persons employed plus the number of persons unemployed. 4. The natural unemployment rate minus the frictional unemployment rate. 5. This person is not considered unemployed (by the government), even though many people think this person should be considered unemployed. 6. The cyclical unemployment rate. 7. The first step is to subtract the CPI in the earlier year from the CPI in the later year. The second step is to divide by the CPI in the earlier year. The third step is to multiply by 100. 8. This happens if the CPI rises by more than your nominal income. Macroeconomic Measurements, Part I: Prices and Unemployment 45 9. This person did at least one hour of work as a paid employee during the survey week. 10. This person quit his job. 11. This person got fired but doesn’t (currently) have transferable skills. Multiple Choice Circle the correct answer. 1. If the CPI was 72.6 in 1979 and 144.5 in 1993, by what percentage did prices rise during the period 1979-1999? a. 100.3 percent b. 160.7 percent c. 99.0 percent d. 15.09 percent e. none of the above Good X sold for $40 in 1945. The CPI in 1945 was 18.0 and the CPI in 1999 was 166.6. What was the price of good X in 1999 dollars? a. $233.88 b. $243.76 c. $370.22 d. $211.89 e. none of the above A ___________ is a person who was employed in the civilian labor force and quit his or her job. a. new entrant b. reentrant c. job leaver d. job fixer e. none of the above The answer is: “a person employed in the civilian labor force who quits his or her job.” The question is: a. Who is a job loser? b. Who is an entrant? c. Who is a reentrant? d. Who is a job leaver? e. Who is a discouraged worker? 2. 3. 4. 46 Chapter 5 5. A __________ is a person who has never held a full-time job for two weeks or longer and is now in the civilian labor force looking for a job. a. new entrant b. reentrant c. job fixer d. job leaver e. job loser Which of the following statements is false? a. A discouraged worker is not counted as an unemployed worker. b. The frictional unemployment rate is less than the natural unemployment rate. c. The natural unemployment rate is greater than the structural unemployment rate. d. a and b e. none of the above Of all the categories of unemployment, most unemployed persons fall into the category of being a a. reentrant b. new entrant c. job leaver d. job loser e. none of the above If there are 35 job losers, 13 job leavers, 14 reentrants, and 10 new entrants, then there are ______ frictionally unemployed persons. a. 72 b. 35 c. 48 d. 62 e. There is not enough information to answer the question. The number of employed persons plus the number of unemployed persons equals the number of persons a. in the total population. b. in the civilian noninstitutional population. c. in the civilian labor force. d. not in the labor force. e. none of the above 6. 7. 8. 9. 10. If we subtract the number of people not in the labor force from the civilian noninstitutional population, we get the number of people in the a. ranks of the unemployed. b. civilian labor force. c. ranks of the employed. d. ranks of discouraged workers. e. none of the above 11. ____________ is an increase in the price level and is usually measured on an annual basis.. a. Deflation b. Inflation c. Stagflation d. Economic growth e. none of the above Macroeconomic Measurements, Part I: Prices and Unemployment 47 12. If your nominal income rises faster than prices, it follows that a. there is no inflation. b. there is deflation. c. your real income falls. d. your real income rises. e. b and c 13. The CPI contains ____________ goods and services than the GDP implicit price deflator. a. more b. fewer c. the same number of d. higher-quality e. lower-quality 14. The civilian noninstitutional population is equal to __________ plus __________. a. persons not in the labor force; employed persons b. employed persons; unemployed persons c. reentrants; entrants d. persons not in the labor force; persons in the civilian labor force e. the total population; reentrants 15. The labor force participation rate is equal to the a. civilian labor force divided by the civilian noninstitutional population. b. number of employed persons divided by the civilian labor force. c. unemployment rate minus the employment rate. d. number of entrants plus number of reentrants. e. none of the above True-False 16. The frictional unemployment rate minus the cyclical unemployment rate equals the natural unemployment rate. ____ 17. If the economy is operating at the natural unemployment rate, there is full employment. ____ 18. The price level is the weighted average of the prices of goods and services in the economy. ____ 19. If the unemployment rate is 8 percent and the natural unemployment rate is 5 percent, then the cyclical unemployment rate is 3 percent. ____ 20. The CPI is calculated by the Bureau of Labor Statistics. ____ Fill in the Blank 21. The _______________ _______________ is equal to the cyclical unemployment rate plus the natural unemployment rate. 22. The CPI is a _______________ _______________. 23. Nominal income adjusted for price changes is _______________ _______________. 24. As the optimal search time rises, the unemployment rate _______________. 25. The _______________ _______________ is a benchmark year.