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Macroeconomics 6th Edition Hubbard Solutions Manual Full Chapter PDF
Macroeconomics 6th Edition Hubbard Solutions Manual Full Chapter PDF
Solutions Manual
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CHAPTER 9 | Unemployment and Inflation
9.5 Using Price Indexes to Adjust for the Effects of Inflation (pages 676–678)
Use price indexes to adjust for the effects of inflation.
To correct for the effects of inflation, we divide a nominal variable by a price index and
multiply by 100 to obtain a real variable.
9.6 Nominal Interest Rates versus Real Interest Rates (pages 678–680)
Distinguish between the nominal interest rate and the real interest rate.
The real interest rate is the nominal interest rate minus the inflation rate.
Key Terms
Consumer price index (CPI), p. 673. A Menu costs, p. 681. The costs to firms of
measure of the average change over time in the changing prices.
prices a typical urban family of four pays for the
goods and services they purchase. Natural rate of unemployment, p. 669. The
normal rate of unemployment, consisting of
Cyclical unemployment, p. 669. Unemployment frictional unemployment and structural
caused by a business cycle recession. unemployment.
Deflation, p. 680. A decline in the price level. Nominal interest rate, p. 678. The stated
interest rate on a loan.
Discouraged workers, p. 659. People who are
available for work but have not looked for a job Price level, p. 673. A measure of the average
during the previous four weeks because they prices of goods and services in the economy.
believe no jobs are available for them.
Producer price index (PPI), p. 676. An average
Efficiency wage, p. 672. An above-market wage of the prices received by producers of goods and
that a firm pays to increase workers' services at all stages of the production process.
productivity.
Real interest rate, p. 678. The nominal interest
Employed, p. 658. In government statistics, rate minus the inflation rate.
someone who currently has a job or who is
temporarily away from his or her job. Structural unemployment, p. 669.
Unemployment that arises from a persistent
Frictional unemployment, p. 668. Short-term mismatch between the skills or attributes of
unemployment that arises from the process of workers and the requirements of jobs.
matching workers with jobs.
Unemployed, p. 658. In government statistics,
Inflation rate, p. 673. The percentage increase someone who is not currently at work but who is
in the price level from one year to the next. available for work and who has actively looked
for work during the previous month.
Labor force, p. 658. The sum of employed and
unemployed workers in the economy. Unemployment rate, p. 658. The percentage of
the labor force that is unemployed.
Labor force participation rate, p. 660. The
percentage of the working-age population in the
labor force.
Chapter Outline
Why Is JPMorgan Chase Laying Off Workers?
Many workers lost their jobs during the 2007–2009 recession and the banking industry was hit especially
hard. JPMorgan Chase, the largest bank in the United States, saw its profit decline by two-thirds from 2007
to 2009. By 2015, the U.S. economy and JPMorgan were well into a recovery, but banks were still
struggling for three key reasons: Interest rates remained at low levels, increased regulation caused some
banks to stop certain activities—such as making student loans—and technological change resulted in more
activity taking place online. In May 2015, JPMorgan announced it would lay off 5,000 workers. Three other
banks—Bank of America, Citigroup, and Wells Fargo—also laid off workers for similar reasons.
The labor force is the sum of employed and unemployed workers in the economy. The unemployment
rate is the percentage of the labor force that is unemployed. Discouraged workers are people who are
available for work but have not looked for a job during the previous four weeks because they believe no
jobs are available for them. The labor force participation rate is the percentage of the working-age
population in the labor force. The employment-population ratio measures the percentage of the working
age population that is employed.
some drawbacks, the establishment survey has the advantage of being determined by actual payrolls. In
recent years, some economists have come to rely more on establishment survey data than on household
survey data in analyzing current labor market conditions.
G. Revisions in the Establishment Survey Employment Data: How Bad Was the
2007–2009 Recession?
To avoid long waits in supplying data, such as the employment data from the establishment survey, to
policymakers and the general public, government agencies typically issue preliminary estimates that they
revise as additional information becomes available.
Teaching Tips
The end of the chapter in the main text includes a special category of exercises titled Real-Time Data
Exercises. These exercises help students become familiar with a key data source, learn how to locate data,
and develop skills in interpreting data. Those exercises marked with a red circle allow students and
instructors to use the very latest data from the web site of the Federal Reserve Bank of St. Louis (FRED).
Many RTD exercises require more elaborate calculations than other problems and the use of Excel
spreadsheets.
Extra Making
How Unusual Was the Unemployment Situation Following the
the
2007–2009 Recession?
Connection
The Great Depression of the 1930s left its mark on nearly everyone who lived through it. The Depression
began in August 1929, became worse after the stock market crash in October 1929, and reached its lowest
point in 1933, following the collapse of the banking system. Real GDP fell by more than 25 percent
between 1929 and 1933—the largest decline ever recorded. The unemployment rate in 1933 was above 20
percent—the highest rate ever recorded. The unemployment rate did not return to its 1929 level until
1942, the year after the United States entered World War II. With the unemployment rate so high for so
long, many people were out of work for years. As one historian put it: “What was distinctive about the
Great Depression, in fact, was . . . the extraordinary lengths of time that most jobless men and women
remained out of work.”
By the 2000s, many people in the United States, including most economists and policymakers, believed
that prolonged periods of unemployment such as the U.S. economy had suffered from during the 1930s
were very unlikely to happen again. Although the 1981–1982 recession had been severe and the
unemployment rate had risen above 10 percent for the first time since the 1930s, the recovery was strong,
and many unemployed workers found new jobs relatively quickly. So, following the 2007–2009
recession, most economists and policymakers were unprepared for how slowly the unemployment rate
declined and for how much the average period of unemployment rose. During the 1981–1982 recession,
the unemployment rate peaked at 10.8 percent in December 1982, but 18 months later, in June 1984, it
had already declined to 7.2 percent. In contrast, after the recession of 2007–2009, the unemployment rate
peaked at 10.0 percent in October 2009, while 18 months later it had declined by only 1 percentage point
to 9.0 percent. The following figure shows that the average period of unemployment was twice as high
following the 2007–2009 recession as following any other recession since the end of World War II.
Unemployment was so persistent and widespread that a survey taken by the Pew Research Center in the
spring of 2011 found that more than half of all households had experienced at least one member losing his
or her job during the previous year. Another Pew survey taken in June 2011 found that more than half of
people with jobs expected to receive a pay cut or to lose their job during the next year. As we have seen,
one drawback to the unemployment data is that workers who drop out of the labor market are no longer
counted by the BLS as unemployed. As a result, some economists focus on the employment–population
ratio because it measures the fraction of the population that has jobs. The following figure shows the
employment–population ratio for the period from 1948 through mid-2013. The overall upward trend of
the ratio reflects the increased labor force participation rate of women. In each recession, the
employment–population ratio falls as some workers lose their jobs. The fall of the employment–
population ratio was particularly dramatic during the recession of 2007–2009, and the ratio was actually
even lower four years after the end of the recession. The fall of the employment–population ratio may be
the best indication of how weak the U.S. labor market was during and after the 2007–2009 recession.
As we will see in later chapters, explaining the weakness of the U.S. labor market during these years had
become a top priority of economists and policymakers.
Sources: Alexander Keyssar, Out of Work: The First Century of Unemployment in Massachusetts, New York: Cambridge University
Press, 1986, p. 290; Federal Reserve Bank of St. Louis; U.S. Bureau of Labor Statistics; Pew Research Center, “The Recession,
Economic Stress, and Optimism,” May 4, 2011; and Pew Research Center, “Views of Personal Finances,” June 23, 2011.
Question
An article published in the New York Times in July 2011 argued: “For the second straight year, the
recovery in the job market has essentially stalled. This chart, showing the share of adults with jobs, offers
the best summary you’ll find.” The “share of adults with jobs” is known more formally as the
employment–population ratio. Why might the employment–population ratio provide the “best summary”
of the state of the job market rather than the unemployment rate?
Source: David Leonhardt, “Overly Optimistic, Once Again,” New York Times, July 8, 2011.
Answer
A weakness of the unemployment rate is that it does not count as unemployed those workers who drop
out of the labor force. As a result, some economists focus on the employment-population ratio because it
measures the fraction of the working-age population that has jobs.
B. Structural Unemployment
Structural unemployment is unemployment that arises from a persistent mismatch between the skills or
attributes of workers and the requirements of jobs. This type of unemployment can last for longer periods
than frictional unemployment because workers need time to learn new skills.
C. Cyclical Unemployment
When the economy moves into recession, many firms find their sales falling and cut back on production.
As production falls, firms lay off workers. Cyclical unemployment is unemployment caused by a
business cycle recession.
D. Full Employment
The natural rate of unemployment is the normal rate of unemployment, consisting of frictional
unemployment and structural unemployment. The natural rate of unemployment is also called the full-
employment rate of unemployment.
Teaching Tips
Though categorizing unemployment as frictional, structural, or cyclical is useful in understanding the
sources of unemployment, the Bureau of Labor Statistics provides estimates of total unemployment. It
does not classify unemployment as frictional, structural, or cyclical.
a. Calculate the percentage of the unemployed who lost their jobs (Job Losers) and the percentage
that left their jobs (Job Leavers) from 2008 to 2014.
b. Calculate the percentage of the unemployed who were unemployed as the result of entering the
labor force, either for the first time or as reentrants, from 2008 to 2014.
Step 3: Calculate the percentage of the unemployed who were unemployed as the result
of entering the labor force from 2008 to 2014.
The percentage of reentrants and new entrants for 2008 is: [(2,472 + 766)/8,924] 100 =
36.3 percent. The percentages for each year are included final column in the above table. The
main source of unemployment is job losers, followed by reentrants and new entrants. There
were more reentrants—people who lost or quit jobs in the past, dropped out of the labor force
and are now looking for new jobs—than new entrants to the labor force.
In 1938, the federal government enacted a minimum-wage law. If the minimum wage is set above the
market wage, the quantity supplied of labor will be greater than the quantity of labor demanded. As a result,
the unemployment rate will be higher than it would be without the minimum wage. Studies estimate that a
10 percent increase in the minimum wage reduces teenage unemployment by about 2 percent.
B. Labor Unions
Labor unions are organizations of workers that bargain with employers for higher wages and better
working conditions for their members. In unionized industries, the wage is usually above what otherwise
would be the market wage, but most economists believe that this does not result in an increase in the
overall unemployment rate because only about 9 percent of workers outside the government sector are
unionized.
C. Efficiency Wages
An efficiency wage is an above-market wage that a firm pays to increase workers’ productivity.
Efficiency wages are another reason economies experience some unemployment even when cyclical
unemployment is zero.
33 percent in 1948 to 58 percent in 2012. In the early part of the twenty-first century, the labor force will
be affected by the aging of the “baby boomers”—Americans born between 1946 and 1964. According to
the U.S. Census Bureau by 2050 the number of Americans aged 65 and older is expected to rise to 83.7
million from about 43.1 million in 2012. Despite improvements in health care and the increased life
expectancy of Americans, many older workers are leaving the labor force. In 1960, 78 percent of men
between the ages 60 and 64 and 31 percent of men 65 years and older were in the labor force. Today these
figures are about 55 percent and 17 percent, respectively. The average age of retirement today is 62,
compared to an average age of 65 in 1965.
There are several reasons why many workers today retire earlier than in years past. First, many boomers
have greater disposable incomes than people in other age groups and choose to use this income to
consume more leisure. Second, career advancement becomes more difficult after age 40. Third, over
60 percent of U.S. corporations offer older workers early retirement plans, while only about 5 percent
offer incentives to delay retirement. If these trends continue, the disappearance of baby boomers from the
labor force will have a significant impact on the size of the labor force.
a. What effect will the retirement of the baby boomers have on the unemployment rate?
b. Can the size of the labor force increase despite of the retirement of older workers?
Step 2: What effect will the retirement of baby boomers will have on the unemployment
rate?
Holding other factors that affect the labor force constant, as baby boomers retire, the
unemployment rate will rise because the numerator of the unemployment rate formula would
not change much (relatively few baby boomers are unemployed), while the denominator
becomes smaller as the labor force declines.
Step 3: Explain whether the size of the labor force can increase despite the retirement of
older workers.
It is possible, but unlikely, that the labor force will increase due to the retirement of older
workers, because the birth rate in the 1980s and 1990s was less than in the 1950s and 1960s.
To offset the decline in the labor force due to the retirement of the baby boomers, there would
have to be new job seekers—either immigrants or current U.S. residents who had not been in
the labor force.
The price level is a measure of the average prices of goods and services in the economy. The inflation
rate is the percentage increase in the price level from one year to the next. The GDP deflator is the
broadest measure of the price level, but to know the impact of inflation on the typical household, the
deflator can be misleading. Changes in the consumer price index come closest to measuring changes in
the cost of living as experienced by the typical household.
Theatre
Admission
for One Diet
Year Person Popcorn Pizza Coke
1 $5.00 $2.00 $12.00 $1.25
2 6.00 2.50 12.50 1.40
3 6.50 3.00 13.00 1.50
Assume that Year 1 is the base year. Calculate the value of the CPI for each year and the rate of inflation
for Years 2 and 3.
Step 3: Calculate the value of the CPI and the inflation rates for Years 2 and 3.
The CPI is the ratio of the value of the market basket in a given year to the value of the
market basket in the base year, multiplied by 100. We can use the CPI to calculate the
inflation rate, which is the percentage change in the CPI from Year 1 to Year 2 and from Year
2 to Year 3. These values are in the following table:
Value of the
Market Rate of
Year Basket CPI Inflation
1 $25.25 100.0 —
2 28.40 112.5 12.5%
3 30.50 120.8 7.4%
Extra Making
Explaining How the CPI Measures the Price Level and Rate of
the
Inflation
Connection
There are many misconceptions about how the consumer price index (CPI) is constructed and exactly
what it measures. Economists John Greenlees and Robert McCelland addressed these misconceptions in
an article published in the Monthly Labor Review. They explain that “…when prices change, the goal of
the CPI is to measure the percentage by which consumers would have to increase their spending to be as
well off with the new prices as they were with the old prices…” The following information regarding the
CPI and its construction are taken from the Greenlees and McCelland article.
Since 1978, the Bureau of Labor Statistics (BLS) has published the CPI for all urban consumers (CPI-U)
and the CPI for urban wage earners and clerical workers (CPI-W). Though the items and prices included
in both indexes are the same, the weights given to some of the index components differ. The U.S. Census
Bureau administers a Telephone Point-of-Purchase Survey in which consumers are asked where they
recently purchased goods and services. The BLS uses these data to select a sample of grocery stores,
service stations, doctors’ offices and other locations at which to collect prices. Representative samples of
items from these locations are selected and prices of the items are collected regularly by BLS employees.
Individual item-area indexes are constructed and the indexes are averaged together using weights based
on the Consumer Expenditure Survey, which is conducted for the BLS by the Census Bureau.
The all-items CPI-U is the CPI that is reported most widely, but the CPI-U and the CPI-W are both used
to make cost-of-living adjustments. The CPI-W is the index used to make annual Social Security and
federal retirement cost-of-living adjustments and is often used for periodic wage adjustments in collective
bargaining agreements. The CPI-U is used for indexation of tax brackets and personal exemption amounts
in the federal tax system. CPI data are also used in the construction of the National Income and Products
Accounts (NIPA). For example, CPI component indexes are inputs into the NIPA Personal Consumption
Expenditures (PCE) price index and are used in the calculation of real GDP.
In 2002, the BLS began publishing the chained Consumer Price Index for urban consumers (C-CPI-U).
This more closely approximates a cost-of-living index by reflecting consumer substitution among item
categories. Over time, some goods and services consumers commonly bought are replaced by new goods
and services. Adjustments to the CPI must be made to avoid having a shrinking market basket that is
unrepresentative of what consumers are buying. For many food items, the substitution is facilitated
because the BLS measures prices on a per-ounce or per-pound basis, rather than a per-item, basis.
Greenlees and McCelland use a simple example of a maker of a candy bar that replaces a 1-ounce bar
with a 1.5-ounce bar that sells for the same 75 cent price. The BLS would record a 50 percent increase in
price rather than recording that the price of the bar had not changed. More complicated adjustments are
required when an item, such as a standard-definition television set, is replaced in a store by a high-
definition set that has a much higher price, but also higher quality. The BLS uses sophisticated techniques
to estimate how much of the price difference is due to the higher quality of the set, rather than an increase
in price for a given quality.
Source: John S. Greenlees and Robert B. McCelland, “Addressing misconceptions about the Consumer Price Index,” Monthly
Labor Review, August 2008, pp. 3–19.
Using Price Indexes to Adjust for the Effects of Inflation (pages 676–678)
9.5 Learning Objective: Use price indexes to adjust for the effects of inflation.
Price indexes give us a way of adjusting for the effects of inflation so that we can compare dollar values
from different years. To correct for the effects of inflation, we can divide a nominal variable by a price
index and multiply by 100 to obtain a real variable. Economic variables that are calculated in current-
year prices are referred to as nominal variables.
Step 2: Begin by defining the real wage in 2013 and 2018, and explaining what the
values of the real wage represent.
The number of dollars a worker receives is the worker’s nominal wage. To calculate the
worker’s real wage, we have to divide the nominal wage by the CPI for that year and multiply
by 100. We can make the following calculations for the two years:
For 2013:
$27
100 $11.59
233
For 2018:
$27
100 $10.38
260
The base year for the CPI is the average of prices during the period 1982–1984. So, the
values for the real wage we calculated are in 1982–1984 dollars. In other words, these values
for the real wage tell us that in 2013, $27 would buy what $11.59 would have bought in
1982–1984, and that in 2018, $27 would buy what $10.38 would have bought in 1982–1984.
Step 3: Complete the answer by calculating the percentage change in the real wage
Caterpillar workers will receive.
This percentage change equals:
$10.38 $11.59
100 10.4%.
$11.59
We can conclude that if the estimate of the CPI in 2018 is correct, an average Caterpillar worker
will experience about a 10 percent decline in his or her real wage between 2013 and 2018.
Extra Credit: The values we computed for the real wages Caterpillar workers earn are measured in
1982–1984 dollars. Because this period is more than 30 years ago, the values are somewhat difficult to
interpret. We can convert the earnings to 2013 or 2018 dollars by using the method we used earlier to
calculate your mother’s salary. But notice that, for purposes of calculating the change in the value of real
average hourly earnings over time, the base year of the price index doesn’t matter. The change from 2013
to 2018 would still be −10.4 percent, no matter what the base year of the price index was. If you don’t see
that this is true, test it by using the mother’s salary method to calculate the real wage for 2013 and 2018 in
2013 dollars. Then calculate the percentage change. Unless you make an arithmetic error, you should find
that the answer is still −10.4 percent.
Question
In 1924, the famous novelist F. Scott Fitzgerald wrote an article for the Saturday Evening Post titled
“How to Live on $36,000 a Year,” in which he wondered how he and his wife had managed to spend all
of that very high income without saving any of it. The CPI in 1924 was 17, and the CPI in 2012 was 230.
What income would you have needed in 2012 to have had the same purchasing power that Fitzgerald’s
$36,000 had in 1924? Be sure to show your calculation.
Source: F. Scott Fitzgerald, “How to Live on $36,000 a Year,” Saturday Evening Post, April 5, 1924.
Answer
We can convert Fitzgerald’s 1924 nominal income of $36,000 to an equivalent income in 2012 by
multiplying the 1924 nominal income by the ratio of the CPI for 2012 to the CPI for 1924: $36,000 ×
(230/17) = $487,059. So, you would have needed an income of $487,059 in 2012 to have the same
purchasing power that Fitzgerald’s $36,000 had in 1924.
Question
Use the information in the table in the next column to determine the percentage changes in the U.S. and
French real minimum wages between 1957 and 2012. Does it matter for your answer that you have not
been told the base year for the U.S. CPI or the French CPI? Was the percentage increase in the price level
greater in the United States or in France during these years?
Sources: John M. Abowd, Francis Kramarz, Thomas Lemieux, and David N. Margolis, “Minimum Wages and Youth
Employment in France and the United States,” in D. Blanchflower and R. Freeman, eds., Youth Employment and Joblessness in
Advanced Countries, Chicago: University of Chicago Press, 1999, pp. 427–472 (the value for the minimum wage is given in
francs; it was converted to euros at a conversion rate of 1 euro = 6.55957 francs); Insee online data bank, www.insee.fr; U.S.
Department of Labor; and U.S. Bureau of Labor Statistics.
Answer
In the United States, the real minimum wage in 1957 was $3.70: [($1.00/27) × 100], and in 2012 it was
$3.15: [($7.25/230) 100]. In France, the real minimum wage in 1957 was €1.9: [(€0.19/10) × 100], and in
2012 it was €7.09: [(9.43/133) × 100]. Therefore, between 1957 and 2012, there was a 14.9 percent decrease
in the real minimum wage in the United States: [($3.15 – $3.70)/$3.70] × 100. And, there was a 273.2
percent increase in the real minimum wage in France: [(€7.09 – €1.9)/€1.9] × 100. It does not matter
whether we have information about the base year as long as we have the CPI data. Whatever the base year
is, we would get the same percentage increase in prices. The percentage increase in the price level was less
in the United States {[(230 – 27)/27 × 100] = 752%} than in France {[(133 – 10)/10 × 100] = 1,230%}.
The difference between nominal and real values is important when money is being borrowed and lent.
Because it is corrected for the effects of inflation, the real interest rate provides a better measure of the
true cost of borrowing and the true return to lending than does the nominal interest rate. The nominal
interest rate is the stated interest rate on a loan. The real interest rate is the nominal interest rate minus
the inflation rate. For the economy as a whole, we can measure the nominal interest rate as the interest
rate on three-month U.S. Treasury bills. The nominal interest rate will be less than the real interest rate
when the inflation rate is negative. Deflation is a decline in the price level.
a. What was the real interest rate in the years 1980, 1981, 1984, 1985, 2011, and 2012?
b. In which of these years was the real interest highest? In which years was the real interest rate
negative?
Step 2: Calculate the real interest rate for the years 1980, 1981, 1984, 1985, and 2011
through 2015.
Real interest rates for the given years are:
Step 3: In which of these years was the real interest rate highest? In which years was the
real interest rate negative?
The real interest rate was highest, 5.17 percent, in 1984 and was negative in 1980 and 2011
through 2015. A negative real interest rate means that lenders are receiving a negative real
return on funds they have loaned. When the real interest rate was negative in 1980, it rose the
following year. Eventually, nominal interest rates will rise in order to make the real interest rate
positive. Although this did not happen between 2011 and 2015, at some point investors will
demand a positive interest rate in order to convince them to keep buying Treasury securities.
Extra Making
Low Real Interest Rates on Treasury Debt Force Investors to
the
Consider Alternatives
Connection
The federal government’s deficit declined from $1.4 trillion in fiscal year (October 1–September 30) 2009
to $439 billion in fiscal year 2015. Although the size of deficit fell, the total national debt climbed to over
$19 trillion in 2016. The U.S. Treasury has to sell hundreds of billions of dollars in securities annually to
pay interest on this debt. Holding the demand constant, an increase in supply of Treasury securities will
lead to lower prices and higher interest rates. But because the demand for Treasury securities also
increased, interest rates remained low throughout 2015. Low real interest rates encourage firms and
consumers to borrow to fund construction of new buildings, equipment and purchases of automobiles and
other durable goods. But bondholders and retirees who seek steady income view low real interest rates on
Treasury securities differently. William Gross, co-founder of PIMCO, the world’s largest bond fund
advised bondholders to “. . . find something else that’s attractive.” While Princeton economist Burton
Malkiel agreed that U.S. Treasury securities are currently poor choices for investors, he endorsed two
other types of bonds: (1) Tax-exempt municipal bonds, issued by state and local governments, that offer
yields higher than those on Treasury debt, some of which are tied to reliable sources of revenue (for
example, bridge and tunnel fees) and are free of state and local taxes; (2) bonds issued by foreign
countries that are in better fiscal condition than the United States. Australia, for example, has a low debt-
to-GDP ratio and abundant natural resources that can be used to fuel economic growth. Malkiel suggests
that another strategy for savers: buy a portfolio of blue-chip common stocks that offer dividends.
Sources: Matt Phillips, “Real Interest Rates: 1919–The Present,” Wall Street Journal, October 13, 2011; Burton G. Malkiel, “The
Bond Buyer's Dilemma,” Wall Street Journal, December 7, 2011; Matt Cover, “At Current Rate of Federal Borrowing,
Government on Track to Hit Legal Limit on National Debt on March 14,” cnsnews.com, February 24, 2011; and "U.S. deficit
falls to $680 billion," CNNMoney, October 30, 2013.
Extra Making
the How What’s So Bad about Falling Prices?
Connection
When the rate of inflation is higher than expected it can cause problems for consumers, workers, and
firms. But what if an economy begins to experience falling prices—deflation, rather than inflation? A
falling price level might seem like good news for the economy. After all, falling prices should encourage
consumers to increase their spending as goods and services become less expensive. In fact, though,
deflation tends to have the opposite effect on consumers. Episodes of deflation are relatively rare, but we
can draw some lessons from two important deflationary episodes: the United States during the 1930s and
Japan during the 1990s. In both cases, many consumers reduced their spending in the face of falling
prices, apparently because they were waiting for prices to go even lower. Waiting for prices to fall even
lower was also a problem for the U.S. housing market in the late 2000s. A large run-up in housing prices
took place from 2002 to 2006. When prices began to decline, many potential buyers postponed purchases
in the expectation that prices would continue to fall.
The following figure shows changes in the CPI in the United States during the years between 1925 and
1940. The beginning of the Great Depression in 1929 caused the country to experience severe deflation.
The deflation of the 1930s hurt the U.S. economy not just because it may have led some consumers to
postpone purchases but also because it increased the burden on borrowers. Suppose that in 1929 you had
borrowed money for five years at a nominal interest rate of 5 percent. What real interest rate would you
have paid during those years? We have seen that to calculate the real interest rate, we need to subtract the
inflation rate from the nominal interest rate. With deflation, the change in the price level is negative, so to
calculate the real interest rate, we are in effect adding the change in the price level to the nominal interest
rate. The following table uses the actual deflation rate in each year to calculate the resulting real interest
rates on your loan:
The bottom row of the table shows that although the nominal interest rate on your loan is only 5 percent,
in three of the five years the real interest rate you pay is greater than 10 percent. In fact, high real interest
rates inflicted serious losses on both household and business borrowers during the early 1930s and
contributed to the severity of the Great Depression.
During the 2001 and 2007–2009 recessions, some policymakers and economists feared that the U.S.
economy would experience deflation. Fortunately, significant deflation did not occur. If it had, those
recessions would likely have been more severe than they were.
Question
During the late nineteenth century in the United States, many farmers borrowed heavily to buy land.
During most of the period between 1870 and the mid-1890s, the United States experienced mild deflation:
The price level declined each year. Many farmers engaged in political protests during these years, and
deflation was often a subject of their protests. Explain why farmers would have felt burdened by
deflation.
Answer
When there is unanticipated deflation, the real interest rate on loans increases. This result holds because
with the nominal interest rate on a loan fixed, falling prices (deflation) means that the real interest rate is
greater than the nominal interest rate. Therefore, the burden of debt on farmers would have increased
during these years.
Let’s assume that the old clunker you have been driving needs $500 in repairs in order to pass an annual
car inspection. You are considering buying a new car, and you contact car dealers and banks to determine
the best deal you can get on a car loan. Assume two different scenarios: (a) The lowest interest rate you
find on a five-year car loan is 10 percent, and the annual rate of inflation for the next five years will be
9 percent. (b) The lowest interest rate you can find on a five-year car loan is 6 percent, and the annual rate
of inflation for the next five years will be 1 percent.
Question: Under which scenario—(a) or (b)—will you pay less, in real income, for your car loan?
Answer: Although the nominal interest rate is much lower under scenario (a), you should base your
decision on the real interest rate. Of course, you will not know what the actual rate of inflation will be in
the future, but if the rate of inflation is 9 percent annually, the real rate of interest on your car loan will be
only 1 percent. Under scenario (b), if the annual rate of inflation is 1 percent over the duration of your
loan the real rate of interest will be 5 percent. You will pay less in real income under scenario (a) even
though the nominal interest rate is much higher than it is under scenario (b).
Review Questions
1.1 The unemployment rate is calculated monthly from data gathered by the U.S. Bureau of the
Census in its household survey. The unemployment rate equals the percentage of the labor force
that is unemployed: (Unemployed/Labor Force) × 100. The three conditions to be counted as
unemployed are: the person (1) did not work in the previous week, (2) was available for work,
and (3) actively looked for work at some time during the previous four weeks.
1.2 The official Bureau of Labor Statistics (BLS) measure of the unemployment rate understates the
true degree of unemployment to the extent that it does not count discouraged workers as
unemployed because they have stopped looking for a job, and it counts involuntary part-time
workers as employed even though these workers would prefer to work more hours. The official
BLS measure overstates the true degree of unemployment because: (1) some people claim to be
actively looking for work but are not so they can remain eligible for government payments to the
unemployed, and (2) some people have jobs in the underground economy although they claim to
be unemployed.
1.3 African Americans and Hispanics tend to have above-average unemployment rates, and whites
and Asians tend to have below-average unemployment rates. High school dropouts and high
school graduates tend to have above-average unemployment rates, and college graduates tend to
have below-average unemployment rates.
1.4 The labor force participation rate measures the percentage of the working-age population that is
in the labor force: (Labor Force/Working-Age Population) × 100. Since 1948, the labor force
participation rate has decreased for men and increased for women.
1.5 The employment-population ratio measures the percentage of the working-age population that is
employed: (Employment/Working-Age Population) × 100. An unemployed person dropping out
of the labor force would decrease the unemployment rate, but it would not change the
employment-population ratio.
1.6 The household survey is a sample of 60,000 households chosen to represent the U.S. population
and provides information on the employment status of everyone in the household 16 years of age
and older. The establishment survey is a sample of 300,000 business establishments and gathers
information on the total number of people who are employed and on a company payroll. The
household survey includes information on both employment and unemployment, while the
establishment survey includes information only on employment. Many economists prefer the
establishment survey because it is based on actual payrolls, rather than on unverified answers as
in the household survey.
The number of people unemployed can be found using the definition that the unemployment rate
equals the number of unemployed divided by the sum of the number of unemployed and the
number of employed. The labor force equals the employed plus the unemployed. The working-
age population can be found using the definition that the labor force participation rate equals the
labor force divided by the working-age population. The employment-population ratio equals the
number of employed divided by the working-age population.
1.8 Including homemakers as employed would decrease the unemployment rate because it increases
the size of the labor force but leaves unchanged the number of unemployed. Including
homemakers as employed would increase the labor force participation rate because it increases
the labor force but leaves unchanged the working-age population. Including homemakers would
increase the employment-population ratio because it increases the number of employed but does
not change the working-age population.
1.9 The formula for the unemployment rate is: (Number of unemployed/Labor force) × 100. The
labor force is equal to the sum of the employed and the unemployed. Holding constant the
number of people employed in June 2015, an increase in the labor force participation rate would
mean the size of the labor force had increased, which could only have happened if the number of
people unemployed had increased. Both the numerator and the denominator in the above equation
for the unemployment rate would increase, but as we saw in Solved Problem 9.1 on page 660,
adding the same number to both the numerator and the denominator of a fraction that is less than
one increases the value of the fraction. Therefore, the unemployment rate would have been
greater than 5.3 percent in June 2015.
1.10 a. During an economic expansion we would expect that the number of jobs created to increase
as the economy expands, so the numerator of the employment-population ratio will increase
relative to the denominator, causing the ratio to increase.
b. As the unemployment rate decreased following the end of the 2007-2009 recession, the
employment-to-population “has increased far less…than the unemployment rate alone would
indicate” in part because during these years members of the baby boom generation began
retiring. But the employment-population ratio was also slow to recover for people 25 to 54
years of age, who typically are in the labor force. As the Making the Connection on page 664
discusses, there are several reasons, including “labor market scarring” and an increase in the
number of people receiving Social Security Disability Insurance, that help explain the slow
recovery of the employment-population ratio. A weakness of the unemployment rate is that it
does not count as unemployed those workers who drop out of the labor force. As a result,
some economists focus on the employment-population ratio because it measures the fraction
of the working-age population that has jobs.
1.11 The employment-population rate increases when the increase in the number of employed workers is
greater than the increase in population. The number of people in the labor force–the numerator of
the labor force participation rate—increases as the number of employed workers increases, but also
as the number of people who are counted as unemployed increases. Employment can increase
without increasing the labor force participation rate if unemployment increases at the same time,
perhaps because discouraged workers rejoin the labor force as they see more job opportunities being
created. In early 2015, the increase in the number of people employed must have occurred at the
same time as an increase in the number of people unemployed. The result was an increase in the
employment-population ratio but an unchanged labor force participation rate.
1.12 a. These workers are not counted as unemployed in the BLS data because they are no longer
actively looking for work.
b. The BLS will count these graduates as part of the labor force even if they don’t have jobs, so
long as they are actively looking for work.
1.13 The unemployment rate can increase while employment increases if the number of discouraged
workers and other people not previously counted as unemploymed entering the labor force more
than offsets the effect of the employment increase. In this case, the number of people counted as
unemployed in Georgia was increasing faster than the increase in employment, causing the
unemployment rate to increase.
1.14 President Obama was referring to the net increase in jobs. The U.S. economy would have created
far more than 11 million jobs over the five-year period, but it would have also destroyed many
jobs. There was a net increase of 11 million jobs.
Review Questions
2.1 The three types of unemployment are frictional unemployment, structural unemployment, and
cyclical unemployment. Frictional unemployment is short-term unemployment that arises from
the process of matching workers with jobs. Structural unemployment is unemployment that arises
from a persistent mismatch between the skills and attributes of workers and the requirements of
jobs. Cyclical unemployment is unemployment caused by a business cycle recession. Cyclical
unemployment and structural unemployment result in greater hardship than frictional
unemployment, but it is difficult to conclude whether greater hardship results from cyclical or
structural unemployment. An important consideration is the length of time before the unemployed
can find new jobs. In a typical recession, the typical cyclically unemployed person is out of work
for a relatively brief period. The 2007-2009 recession is an exception to this generalization.
2.2 Frictional unemployment arises from the process of matching workers with jobs. Because job
search takes time, there are always some workers who are frictionally unemployed because they
have begun a job search and have not yet found a job. The more difficult or lengthier the job
search process is, the greater the amount of frictional unemployment.
2.3 The natural rate of unemployment is the normal rate of unemployment, consisting of frictional
unemployment plus structural unemployment. The natural rate of unemployment is considered
the full-employment rate of unemployment.
2.5 You should disagree. The economy would operate less efficiently if frictional unemployment
were eliminated. By devoting time to job search, workers end up with jobs they find satisfying
and in which they can be more productive. Similarly, by searching for employees who are well
suited to job openings, firms are able to operate more efficiently. Government policy to enhance
the job search process of matching workers with jobs could make the economy operate more
efficiently, but eliminating frictional unemployment would not be efficient.
2.6 For someone frictionally unemployed, good advice would be to keep searching. The person has
the required skills, but matching worker skills to job openings takes time. For someone
structurally unemployed, advice should center on the need to retrain, find another occupation, or
possibly move to another part of the country where jobs that require the person’s skills are more
readily available. Someone cyclically unemployed should be advised to realize that the search
will take longer because of the recession, and to consider temporarily taking a lower-paying job
or going back to school until the economy improves.
2.7 a. Unemployment that results from job quits would be classified as frictional unemployment,
assuming that those how quit their jobs wish to remain in the labor force.
b. Assuming that those who quit their jobs wish to remain in the labor force, an increase in the
number of quits suggests that it is becoming easier to find jobs. Those who quit their jobs
must be confident that they will find other, better jobs.
2.8 The workers referred to in the story are likely to be structurally unemployed because they lack the
skills required for the available jobs.
Review Questions
3.1 The payment of government unemployment insurance likely raises the unemployment rate.
Unemployment insurance payments lower the opportunity cost (the income lost by not working)
of continuing to search for a job, which leads the unemployed to spend more time searching for a
job. The payment of government unemployment insurance lessens the severity of recessions by
helping the unemployed maintain their income and spending.
3.2 The federal minimum-wage law and efficiency wages push the wage above the market wage,
causing some unemployment. In unionized industries, the wage is usually above what otherwise
would be the market wage, resulting in employers hiring fewer workers. Most economists do not
believe that the existence of unions increases the overall unemployment rate, though, because in
the United States fewer than 9 percent of workers outside the government sector are unionized.
3.3 A significant reason that the unemployment rate in the United States has been lower than the
unemployment rates in Canada and countries in Western Europe is the more generous
unemployment compensation payments and social insurance programs in Canada and Western
Europe, which lower the opportunity cost of continuing to search for a job.
3.6 a. and c. are likely to increase the unemployment rate. Lengthening the time workers are
eligible to receive unemployment insurance lowers the opportunity cost of a job search. An
increase in union membership pushes more wages above market wages, thereby increasing
unemployment.
b. and d. are likely to reduce the unemployment rate. Abolishing the minimum wage lowers the
wage from above the market wage for some workers. Making information on job openings
more available shortens the search involved in frictional unemployment.
3.7 Henry Ford was paying an efficiency wage, which can cut a firm’s cost by increasing the
productivity of workers, increasing the quality of workers willing to work for the firm, and
decreasing the turnover of workers.
3.8 a. Labor turnover refers to companies having to replace workers who quit their jobs.
b. One reason why Wal-Mart, IKEA and other firms increased the wages they pay to newly
hired workers was to decrease labor turnover. These firms probably believe that hiring and
training new workers would be more costly than paying workers higher wages.
Measuring Inflation
9.4 Learning Objective: Define the price level and the inflation rate and understand how
they are computed.
Review Questions
4.1 The GDP deflator is the broadest measure of the price level because it includes the prices of all
final goods and services included in GDP. The Consumer Price Index measures the prices of
goods and services purchased by a typical urban family of four. The Producer Price Index
measures the prices of goods and services at all stages of the production process.
4.2 The government uses the Consumer Price Index to measure changes in the cost of living because
the CPI tracks changes in the prices paid by a typical urban family of four.
4.3 The potential biases include substitution bias, increase in quality bias, new product bias, and
outlet bias. The Bureau of Labor Statistics updates the market basket every two years to reduce
substitution bias and new product bias, uses statistical methods to reduce quality bias, and
conducts point-of-purchase surveys to track where consumers actually make their purchases to
reduce outlet bias.
4.4 The Consumer Price Index is an average of the prices of final goods and services purchased by a
typical urban family of four. The Producer Price Index is an average of the prices received by
producers of goods and services at all stages of production, not just the final stage.
4.6 There is no contradiction because the inflation rate measures the percentage change in the price
level. The inflation rate says nothing about the level of prices. Prices of goods and services may
seem expensive even though those prices are increasing at a slow rate. As long as the inflation
rate is positive, the CPI will increase and each year its value will be “the highest it’s ever been.”
4.7
The CPI for 2015 = [($136.50/$130) × 100] = 105; CPI for 2016 = [($140.40/$130) × 100] = 108.
So, the inflation rate for 2016 = [(108 − 105)/105) × 100] = 2.9%.
4.8
City April 2014 April 2015 Percent Change
New York 174.5 179.3 2.75%
Miami 183.2 198.5 8.35%
Phoenix 145.4 150.4 3.44%
Dallas 136.8 148.8 8.77%
San Francisco 192.5 211.5 9.87%
a. The percent change is calculated as [(April 2015 index value – April 2014 index value)/April
2014 index value] × 100. As is shown in the table, housing prices in all five markets rose
from April 2014 to April 2015. The largest increase in prices occurred in San Francisco (9.87
percent). The smallest increase in prices occurred in New York (2.75 percent).
b. We cannot determine on the basis of these numbers which city had the most expensive homes
because the numbers are not dollar amounts but indexes that measure prices in each city in a
given month relative to what they were in that city in the base month.
4.9 a. During the period from point B to C when the CPI did not change, the country experienced
zero inflation.
b. During the period from point 0 to A when the CPI increased at an increasing rate, the country
experienced an increasing inflation rate.
c. During the period from point A to B when the CPI increased at a decreasing rate, the country
experienced a slowdown in inflation (disinflation).
d. During the period from point C to D when the CPI decreased, the country experienced
deflation.
4.10 The BLS’s motivation in changing its methods of calculating the CPI was to more accurately
measure the rate of inflation. Before these revisions most economists believed that the CPI had
biases that caused it to overstate the rate of inflation by as much as one percentage point.
4.11 Until the BLS updates the market basket of goods used to compute CPI to include the new iPhone
model, the introduction of the new iPhone will have no effect on the CPI. Note, though, that the
introduction of the new iPhone model contributes to the increase in quality bias that causes changes
in the CPI to overstate the true inflation rate. Consumers are getting a better product when they buy
the new iPhone model, but they are paying the same price as they did for the older model.
Review Questions
5.1 A nominal variable is a variable measured in current dollars, which means that it is measured
using the actual prices from that time period. A real variable is a variable measured in constant
dollars, which means that it is measured using prices from a base year. That is, a real variable is
adjusted for the effects of inflation.
5.2 As prices of goods and services decrease during a period of deflation nominal earnings are likely
to rise slowly, and may even fall. Real earnings will not fall as much as nominal earnings, and
will rise if the decline in prices is greater than the decline in nominal earnings. Therefore, real
average hourly earnings are likely to increase faster than nominal average hourly earnings during
a period of deflation.
Real GDP for 1929 = (Nominal GDP/GDP price deflator) × 100 = ($104.6 billion /9.9) × 100 =
$1,056.6 billion. Real GDP for 1933 = ($57.2 billion/7.4) × 100 = $773.0 billion. The percentage
decline in real GDP between 1929 and 1933 = [($773.0 billion – $1,056.5 billion)/ $1,056.6
billion] × 100 = –26.8%.
5.4 We can convert Fitzgerald’s 1924 nominal income of $36,000 to an equivalent income in 2014 by
multiplying the 1924 nominal income by the ratio of the CPI for 2014 to the CPI for 1924:
$36,000 × (237/17) = $501,882. So, you would have needed an income of 501,882 in 2014 to
have the same purchasing power that Fitzgerald’s $36,000 had in 1924.
5.5 In the United States, the real minimum wage in 1957 was $3.70: [($1.00/27) × 100], and in 2014
it was $3.06: [($7.25/237) 100]. In France, the real minimum wage in 1957 was €2.38:
[(€0.19/8) × 100], and in 2014 it was €9.07: [(€9.61/106) × 100].
Therefore, between 1957 and 2014, there was a 17.3 percent decrease in the real minimum wage
in the United States: [($3.06 – $3.70)/$3.70] × 100. And, there was a 281.1 percent increase in the
real minimum wage in France: [(€9.07 – €2.38)/€2.38] × 100.
It does not matter whether we have information about the base year as long as we have the CPI
data. Whatever the base year is, we would get the same percentage increase in prices. The
percentage increase in the price level was less in the United States—[(237 – 27)/27 × 100] =
777.8%—than in France—[(106 – 8)/8 × 100] = 1,225.0%.
5.6 If three cups of coffee and a doughnut can be purchased in 2014 for $10 and for $2,000 in 2054,
the CPI would have to be 200 times greater in 2054 than in 2014 because 200 × $10 = $2,000.
Therefore, the CPI in 2054 would be 237 × 200 = 47,400.
5.7 The real receipts in 2015 dollars for each film are listed in the last column below. The first
column shows the rankings of the top ten films based on their earnings in 2015 dollars.
Review Questions
6.1 The nominal interest rate is the stated interest rate on a loan, while the real interest rate is the
nominal interest rate minus the inflation rate.
6.2 Because the nominal interest rate is the real interest rate plus the inflation rate, an increase in
expected inflation raises the nominal interest rate by the increase in the expected rate of inflation,
assuming that the real interest rate remains constant.
6.3 It is impossible to know whether a particular nominal interest rate is “high” or “low” without
knowing the inflation rate. It is the real interest rate that matters to borrowers and lenders, not the
nominal interest rate. A nominal interest rate of 5 percent with an inflation rate of zero results in a
higher real interest rate than a nominal interest rate of 20 percent with an inflation rate of
19 percent.
6.4 If the economy is experiencing deflation, the nominal interest rate will be lower than the real
interest rate. The real interest rate equals the nominal interest rate minus the inflation rate, but
with deflation the inflation rate is negative.
6.7 The inflation rate from June 2014 to June 2015 as measured by the CPI was: [(237.8
237.3)/237.3] × 100 = 0.21 percent. With the nominal interest rate on the one-year Treasury bill
of 0.10 percent, the real interest rate equaled 0.10 percent – 0.21 percent = 0.11 percent.
Investors were willing to invest in Treasury bills in 2014 with negative real interest rates because
the bills have low risk (investors were certain the U.S. Treasury would pay the bills off when the
matured) and are easy to buy and sell (they have high liquidity).
6.8 If the monthly inflation rate is 4 percent, the annual inflation rate is about 60 percent. To see this,
notice that at a 4 percent inflation rate, the price level is rising 4 percent per month. If the price level
starts at 100, after two months it would have increased to 100 × 1.04 × 1.04 = 108.2; after three
months it would have increased to 100 × 1.04 × 1.04 × 1.04 = 112.5; and after twelve months to 100
× (1.04)12 = 160.1, or by 60.1 percent. So, the real interest rate would be 4% − 60% = –56%.
6.9 We can answer by using the method of calculating the real interest rate explained in the example
of DVDs on page 678 in the textbook: Real interest rate = Nominal interest rate – Inflation rate.
With $1,000 you can purchase 500 hamburgers at the beginning of the year. If you lend $1,000
for one year at an interest rate of 5 percent, you will receive $1,050 at the end of the year. With
the higher price of hamburgers, at the end of the year you can buy $1,050/$2.08 = 504.8
hamburgers. So, you can purchase [(504.8 − 500)/500] × 100 = 0.96% more hamburgers.
Therefore, the real interest rate you receive on the loan is 0.96 percent. Notice that this is very
close to the real interest rate on the loan calculated by subtracting the 4 percent inflation in
hamburger prices from the 5 percent nominal interest rate on the loan.
Review Questions
7.1 We know from the circular flow of expenditures and income that when inflation increases the
nominal value of expenditures, it must also increase nominal incomes. Consequently, inflation
does not reduce the purchasing power of the average consumer.
7.2 Inflation affects the purchasing power of money. People with incomes that rise faster than the rate
of inflation enjoy an increase in purchasing power, while people with incomes that rise more
slowly than the rate of inflation are hurt by a decrease in purchasing power. In general, inflation
hurts people on fixed incomes, such as retired persons who may be receiving a pension of a fixed
number of dollars each year. (As noted in the text, though, Social Security payments received by
retired workers increase every year by an amount equal to the percentage change in the CPI.)
7.3 Unanticipated inflation is the greater problem. Anticipated inflation can be incorporated into
nominal interest rates and nominal wage contracts. Unanticipated inflation causes the actual real
interest rate and actual real wage rate received to differ from the expected real interest rate and
the expected real wage rate.
7.4 Menu costs are the costs to firms of changing prices. The Internet allows firms to change prices at
little cost so that it has reduced the size of menu costs.
7.5 Deflation can cause consumers to reduce their current spending in anticipation of future lower prices,
and unanticipated deflation increases the burden on borrowers by raising the real interest rate above
the expected real interest rate.
7.7 a. Real income is nominal income adjusted for increases in the price level. With inflation, the
real income for James will decrease because he receives a fixed income. However, the
interest income for Frank will likely increase with inflation. Therefore, it is likely that Frank
will have a higher real income 10 years from now.
b. If James’s pension increases each year by the same percentage as the inflation rate, then it is
likely that 10 years from now he will have a higher real income than Frank, whose interest
income is originally $200 less per month than James’s pension income.
7.8 The real interest rate is the cost to Apple of borrowing funds from investors. Therefore, a low real
interest rate is good for Apple and bad for investors, much like a low price is usually good for
consumers, but bad for producers. Inflation was expected to be 2 percent, but turned out to be
6 percent, causing the expected and actual real interest rates to differ. The expected real interest
rate equals the nominal interest rate minus the expected inflation rate. The actual real interest rate
equals the nominal interest rate minus the actual inflation rate. In this case, the expected real
interest rate is 4 percent but the actual real interest rate equals 0 percent (6 percent nominal
interest rate minus the 6 percent actual inflation rate). Because the actual real interest rate is less
than the expected real interest rate, Apple pays less than it thought it would to borrow, and it
gains. Because the investors are receiving a smaller payment than expected in return for lending
funds to Apple, the investors lose.
7.9 Consumers would defer purchases if they expected deflation to continue so that they would pay
even lower prices in the future. Consumers would buy more if they believed that inflation would
follow a period of falling prices.
7.10 When there is unanticipated deflation, the real interest rate on loans increases. This result holds
because with the nominal interest rate on a loan fixed, falling prices (deflation) means that the
real interest rate is greater than the nominal interest rate. Therefore, the burden of debt on farmers
would have increased during these years.
D9.2 a. and b. Data used in the graph in c. below covers the period from August 2010 to August 2015.
c.
d. The inflation rate of 3.85 percent in September 2011 was the highest during these years. The
inflation rate for each month equals the percentage change in the CPI over the previous
twelve months.
D9.3 a. and b. Data used in the graph in c. below covers the period from August 2007 to August 2015.
c.
d. The inflation rate as measured by the CPI was more volatile than the inflation rate as
measured by the CPI less prices of food and energy. In June 2009 the inflation rate measured
by the CPI was 1.23 percent; using the CPI less food and energy prices the rate of inflation
was 1.71 percent. The highest inflation rate as measured by the CPI less food and energy
prices between July 2007 and July 2015 was 2.50 percent in August 2008. The highest
inflation rate as measured by the CPI for the same time period was 5.50 percent in July 2008.
D9.4 a. The CPI for food and beverages in August 2015 was 247.25, and in August 2010, it
was 219.88. The CPI for apparel in August 2015 was 126.55, and in August 2010, it was
118.96. The CPI for transportation in August 2015 was 202.22, and in August 2010,
it was 192.29. The CPI for medical care in August 2015 was 446.81, and in August 2010, it
was 389.06.
b. The inflation rate over the entire period from August 2011 to August 2015 for food and
beverages was: [(247.25 – 229.50)/229.50] × 100 = 7.73%; for apparel, it was: [(126.55 –
123.71)/123.71] × 100 = 2.30%; for transportation, it was: [(202.22 – 214.59)/214.59] × 100
= 5.76%; for medical care, it was: [(446.81 – 401.38)/401.38] × 100 = 11.32%. These
inflation rates are the percentage changes over the entire four-year period, not annual
inflation rates.
c. Transportation experienced the lowest inflation rate (5.76 percent), and medical experienced
the highest inflation rate (11.32 percent).
D9.5 a. In August 2015, the number of unemployed equaled 8,029 thousand, the civilian labor force
equaled 157,065 thousand, and workers with part-time employment for economic reasons,
slack work, or business conditions equaled 3,841 thousand. These data are reported monthly
and measured in thousands of persons.
b. The civilian unemployment rate equaled [(8,029 thousand/157,065 thousand) × 100] = 5.1%.
The civilian unemployment rate including persons who are underemployed equaled: [(8,029
thousand + 3,841 thousand)/157,065 thousand] × 100 = 7.6%.
D9.6 a. In August 2015, the number of unemployed men equaled 4,261 thousand, the number of
unemployed women equaled 3,768 thousand, the civilian labor force for men equaled 83,472
thousand, and the civilian labor force for women equaled 73,593 thousand. These data are
reported monthly and are measured in thousands of persons.
b. The unemployment rate for men equaled: [(4,261 thousand/83,472 thousand) × 100] = 5.1%,
and the unemployment rate for women equaled: [(3,768 thousand/73,593 thousand) × 100] =
5.1%.
c. Discouraged workers are people who are available for work but have not looked for a job
during the previous four weeks because they believe no jobs are available for them. If there is
no other change in the labor force, an increase in discouraged workers would decrease the
unemployment rate because discouraged workers are not counted as unemployed.
D9.7 a. In August 2015, the number of unemployed equaled 8,029 thousand, civilian employment
equaled 149,036 thousand, and those not in the labor force equaled 94,031 thousand.
b. The working-age population equals the labor force plus those not in the labor force. In
August 2015, the labor force equaled: 8,029 thousand + 149,036 thousand = 157,065
thousand, and the working-age population equaled: 157,065 thousand + 94,031 thousand =
251,096 thousand. The employment-population ratio equals civilian employment divided by
the working-age population, which for August 2015 equaled: [(149,036 thousand/251,096
thousand) × 100] = 59.4%.
c. If the economy entered a recession, one would expect the employment-population ratio to
decline as fewer people would have jobs.
D9.8 a. The civilian unemployment rate equaled 5.1 percent in August 2015, and it equaled 7.2
percent in August 2013. The natural rate of unemployment equaled 5.06 percent in August
2015 and 5.16 percent in August 2013. Note that the natural rate of unemployment is
calculated on a quarterly, not monthly, basis.
b. The cyclical unemployment rate equals the unemployment rate minus the natural rate of
unemployment. The cyclical unemployment rate equaled (5.1% 5.06%) = 0.04 % in August
2015 and equaled (7.2% 5.16%) = 2.04% in August 2013.
c. In August 2015 the economy was very close to full employment and potential GDP.
D9.9 a. In August 2015, the number of unemployed equaled 8,029 thousand, civilian employment
equaled 149,036 thousand, employment level – part-time for economic reasons equaled 6,483
thousand, and not in the labor force, searched for work and available equaled 1,812 thousand.
b. The official unemployment rate equals the number of unemployed divided by the labor force,
which equals the unemployed plus the employed. For August 2015, the official
unemployment rate equaled: [(8,029 thousand/(8,029 thousand + 149,036 thousand) × 100]
= 5.1%.
c. This broader measure of the unemployment rate would include as unemployed the three
categories of unemployed: unemployed; employed but part-time for economic reasons; and
not in the labor force, searched for work and available. In August 2015, this broader measure
of the unemployment rate equaled: [(8,029 thousand + 6,483 thousand + 1,812
thousand)/(8,029 thousand + 6,483 thousand + 1,812 thousand + 149,036 thousand)] × 100=
9.9%.
d. One would expect the gap between the official rate of unemployment and the broader rate of
unemployment to widen during recessions and narrow during expansions. One would expect
the number of part-time workers for economic reasons and discouraged workers to rise during
a recession and fall during an expansion.
D9.10 a. In August 2015, the 3-month Treasury bill interest rate equaled 0.07 percent and the
University of Michigan inflation expectation equaled 2.8 percent.
b. The expected real interest rate equals the nominal interest rate minus the expected inflation
rate. In August 2015, the expected real interest rate for the three-month Treasury bill equaled
0.07% 2.8% = 2.73%.
c. If the actual inflation rate is greater than the expected inflation rate, borrowers gain and
lenders lose from the actual real interest (nominal interest rate minus the actual inflation rate)
being below the expected real interest rate.
D9.11 a. In August 2015 the CPI equaled 238.316 and average hourly earnings of private production
and nonsupervisory employees equaled $21.07, and in August 2014 the CPI equaled 237.852
and average hourly earnings equaled $20.68.
b. The average hourly real wage in August 2015 equaled [($21.07/238.316) × 100] = $8.84, and
in August 2014 equaled [($20.68/237.852) × 100] = $8.69. With the CPI having a base period
of 1982–1984, the real wage is measured in 1982–84 dollars.
c. The percentage change in the average hourly nominal wage equaled: [(21.07 – 20.68)/20.68]
× 100 = 1.89%, and the percentage change in the average hourly real wage equaled: [(8.84 –
8.69)/8.69] × 100 = 1.69%.
d. Given that the average hourly real wage increased 1.69 percent from August 2014 to August
2015, the average worker was better off.