Chapter 6

Macroeconomic Measurements, Part I :Prices & Unemployment

 Economics
• Subject matter
• Branches of economics
• Thinking like an economists:
Fundamental questions in economics, good vs bad, scarcity,
utility, factors of production, rationing device, competition,
opportunity cost.
• Positive vs Normative Economics
 Introduction:

Macroeconomics is the branch of economics that deals with the entire

economy.
Macroeconomics is about:
(1) Macroeconomic Problems, (2) Macroeconomic Theories, (3)
Macroeconomic Policies and (4) Different views of how the economy
works.
• Most common measured variables are- Prices, unemployment & Gross
Domestic Product(GDP).
• Macroeconomic problems: High inflation rate, high unemployment rate,
high interest rate, low economic growth etc.
• Three Major Macroeconomic Goals are: Price Stability, Low
Unemployment, and High and Sustained Economic Growth.
Macroeconomic policies:

1) Fiscal Policy: Changes in government expenditure and/or changes in

taxes to achieve particular macroeconomic goals.

2) Monetary Policy: Changes in the money supply or the rate of growth of

money supply, to achieve particular macroeconomic goals.
Macroeconomic Measures:
Measuring Prices:
• Price level: A weighted average of the prices of all goods and services.
• Price index: A measure of the price level.
To measure prices, we use the Consumer Price Index (CPI).

CPI or Consumer Price Index is an index number for the price level;
the weighted average of prices of a specific set of goods and services
purchased by a typical household.

The CPI is based on a representative group of goods and services

purchased by a typical household. This representative group of goods
is called “market basket”.
 Computing CPI:
• We use a base year to calculate the CPI. Base year is a benchmark year
that serves as a basis of comparison for prices in other years.
• The CPI is equal to the Total dollar expenditure in the current year for
the base year market basket DIVIDED BY the Total dollar expenditure
in the base year for the same market basket. The result is then
multiplied by 100 (but no % sign)

n n
CPI  ( p1i q 0i /  p 0i q 0i )  100,
i 1 i 1
Where, O= base year, 1=current year, i=1,2…..,n ; number of goods

Rate of Inflation:
Percentage difference in the CPI from one year to any other year =
[ (CPI later year – CPI earlier year )/CPI earlier year ] X 100

• Inflation is an increase in the price level and is usually measured on an

annual basis.
 Real Income

Real income is a person’s nominal income adjusted for

any change in prices.
• The Real Income measurement is reached by dividing
Nominal Income by the Consumer Price Index, the
result multiplied by 100
Real Income = [(Nominal Income)/CPI] x 100
 Substitute Bias in Fixed Weight Measures:

• A fixed weight price assumes the same items are bought. So, it does not
reflect the fact that people might substitute one good for another as the
price of one good rises relative to another.

• A Substitute Bias is when one good is substituted for another: An example

is beef Bread is Substituted for chicken.

• As a result of the Substitution bias, fixed weight measures can overstate

the “cost of living”
 Other Measures:
• The Chain-Weighted Price Index corrects for the substitution bias
found in fixed weight measures. Here, the previous year is always
considered as the base year.

• The GDP deflator is based on all goods and services produced in an

economy.

GDP deflator = Nominal GDP/ Real GDP

[(Value of all final goods and services produced in that year at current
year average annual retail prices / value of all final goods and services
produced in the same year at base year average annual retail prices)] ×
100
Converting Prices and Money from One Year to
Another:

Income in X year (say, 2021) at Y year (say, 2015) price

= income in 2021 × (CPI of 2015 / CPI of 2021)
Income in X (say 2015) year at Y year (say, 2021) price
= income in 2015 × (CPI of 2021 / CPI of 2015)
 Unemployment
• Institutional Population (IP)= all persons under 16+ persons in armed
forces + institutionalized persons (prisoners, persons in mental
institutions, old homes).
• Total Population – IP = Civilian Noninstitutional Population (CNP)

The Potentially Employed are defined as: i) older than 16 years; ii) not in
the armed services; iii) not institutionalized (not in a prison or mental
institution or old homes). This is the “civilian non-institutional
population”.

CNP = Persons in LF +Persons not in LF

Labour Force (LF)= Employed + Unemployed

• A person is considered Employed if: he did at least one hour of paid

work during the survey week; worked in his or her own business or
profession; worked at least 15 hours per week as an unpaid worker in a
family-owned farm or business; was temporarily absent from work due
to illness, vacation, strike, or bad weather.
Unemployed Person= he did not work during the survey week, has actively
looked for work within the past 4 weeks and is available for work; is waiting
to be called back to a job from which he or she has been laid off; is waiting to
report to a job within 30 days.

• The Unemployment rate is equal to the number of people

unemployed divided by the number of people employed added to the
number of people unemployed.
U = (No. of unemployed / size of LF)×100

• The Employment rate is equal to the number of employed persons

divided by the Civilian Non-institutionalized Population.
E= (No. of employed / civilian non-institutional population)×100

• The labor force participation rate is equal to the Civilian Labor

Force divided by the Civilian Non-institutionalized Population.

LFPR = (LF/ CNP)×100

 Reasons for unemployed

• Job Loser: was employed in the civilian labor force, was either fired
or laid off.
• Job Leaver: was employed in the civilian labor force, quit his or her
job.
• Reentrant: A person who was employed, hasn’t been for a period of
time and is reentering the labor force.
• New Entrant: A person who has never held a full time job for two
weeks or longer.
• Unemployed persons = Job Losers+ Job Leavers
+Reentrants + New Entrants
 Types of Unemployment

• Frictional Unemployment: loss of employment is due to the natural

friction of the economy. This includes changing market conditions, and
those people who change jobs.
• Structural Unemployment: loss of employment due to elimination of
jobs from the economy.
Adding the Frictional Unemployment Rate and the Structural
Unemployment Rate provides you the Natural Unemployment Rate.
• Cyclical unemployment : unemployment due to business cycle
fluctuation.
• Seasonal unemployment: related to seasonality
• Disguised unemployment
Discouraged unemployment: A person who gives up looking for a job, for
whatever reason, is no longer considered part of the unemployment rate,
because the person has stopped looking for work. The unemployed worker
gets counted and the discouraged worker does not.
 Full Employment?
• Full employment exists when the economy is operating at the Natural
Unemployment Rate.
• The Difference between the Natural Unemployment Rate and the
Current Unemployment Rate (if any) is called the Cyclical
Unemployment Rate.