Ch12-AK

1A) According to http://www.bls.gov/web/laumstrk.htm, in February 2008 South Dakota was the state with the lowest unemployment (2.6%), while Michigan had the highest (7.2%). Industrial composition varies widely across states. Cyclical and structural unemployment tends to affect some industries more than others. States with many industries that are sensitive to these phenomena will experience big fluctuations in unemployment.

1B) According to http://www.bls.gov/web/laummtrk.htm, in February 2008 the unemployment rate in Utica-Rome was 6.1%.

1C) http://www.bls.gov/webapps/legacy/cpsatab1.htm will allow you to run an interactive query. In February 2008, the LF participation rate was 72.4% for men, and 59.1% for women. Much of this difference can probably be explained by decisions to choose childcare over formal employment. Trends suggest that male participation rates have declined (from 86.4% in 1950), while female rates have risen (from about 33.9% in 1950). Social stigmas about women in the workplace and men who choose not to work have declined. Also, an aging population can contribute to declining LF participation rates, which is a large concern for most industrialized nations. (Many countries experienced a baby boom in the 1960s. Those workers are retiring soon).

1D) The table provides measures that better account for the misery caused by not working (it accounts for discouraged workers).

2) Buffalo had a dynamic economy in the 19^th and early 20^th century. But technological progress and changing transportation routes have drastically altered the industrial composition of Buffalo. Beginning in 1959, many workers began to lose their jobs. Fortunately, the US is a large country, so these workers could move and find employment elsewhere. The reduced demand for occupational skills within certain industries, however, would have caused massive structural unemployment. Note that the effects of this can be long lasting. Also note also that when these workers eventually take jobs below their skill level, unemployment will decline, but “underemployment” will rise. Buffalo is now trying to respond by attracting biotech, ethanol, and gambling firms.

3A) CPI₀₁ = 100*(15*1000 + 5*2000)/ (15*1000 + 5*2000) = 100

CPI₀₂ = 100*(20*1000 + 10*2000)/ (15*1000 + 5*2000) = 160

Inflation = 60%

3B) CPI₀₁ = 100*(15*1200 + 5*2200)/(20*1200 + 10*2200) = 63

CPI₀₂ = 100*(20*1200 + 10*2200)/(20*1200 + 10*2200) = 100

Inflation = (100-63)/63 = 58.6%

3C) The % change of the GDP deflator in HW 10 estimated inflation to be 58.6% and 60% as well. In general, we should NOT expect the two methods to give identical results. The GDP deflator ignores foreign and used goods in its estimates of the price level, whereas the CPI measures the price of a “fixed basket” sample of goods (this basket will include some newly produced, foreign, and used goods). One problem that the CPI has but the GDP deflator avoids is that a fixed basket assumes that consumers don’t seek new substitutes when the price of an individual good rises. The CPI vs. GDP deflator differences in the estimation of an economy’s price level will, therefore, cause the inflation estimates to be substantially different. (This homework exercise was a poor example since rather than using a representative basket, the CPI looked at the price of ALL goods that the economy produced, but no foreign or used goods).

4) Negative inflation is called “deflation”, and can be more burdensome than positive inflation. Japan experienced this phenomenon in the late 1990s, and the US experienced it during the Great Depression.

One problem is that consumption might fall dramatically. Suppose you want to purchase an ipod, but you expect the price to drop. What do you do? Most people hold on to their money and wait a little while before making a purchase. Now, suppose that you expect the price of ALL goods to drop. You might not buy much at all. You may wait a very long time to buy anything. This drop in demand for products could lead to layoffs and massive unemployment. Suddenly, the economy enters a downward spiral…

A “nice” thing about inflation is that it can fool otherwise intelligent people for short periods of time. Suppose business is slow and a firm wants to pay workers lower wages. Many employees protest nominal wage cuts. Sometimes firms respond by laying off workers. Other times, firms will hold nominal wages constant and hope that inflation will decrease the REAL wage paid to employees. (Think about how Twain’s villagers insisted upon maintaining their high nominal wages). In a world of deflation, this trick won’t be possible.

For one final problem with deflation, consult page 318 of your textbook.

5) Use the CPI calculator at http://data.bls.gov/cgi-bin/cpicalc.pl; a dollar’s worth of goods and services in 2007 would have only cost $0.59 in 1989.

6) The Phillips Curve is a short run trade-off between unemployment and inflation. Policy makers can stimulate the economy in the short run by printing more money and lowering interest rates (we will discuss this topic in great length in later chapters). Firms start to invest more and hire more workers, so unemployment drops. However, the increase in money supply, as well as the increase in economic activity among firms, causes the price of all products to rise. That is, policy makers can decrease unemployment only through increased inflation.

In the 1960s, policy makers decided that moderately high inflation was acceptable for maintaining low unemployment. Workers are smart, however. Realizing that their real wages were declining every year, they started demanding large increases in their nominal wages to compensate for the increases in prices. Firms couldn’t afford to pay everyone high wages, so some people became unemployed. That is, unemployment increased even though inflation remained high. In the LONG RUN, there is no tradeoff between unemployment and inflation (Professor Phelps researched this phenomenon), and the Phillips Curve is a fallacy.

Ask yourself: what is the unemployment rate in the long run?