Unemployment and Inflation

By the end of this lesson, you will be able to define and calculate the unemployment rate, distinguish types of unemployment, explain how inflation is measured and its causes, and analyze the relationship between unemployment and inflation.

Unemployment

The unemployment rate:

$$\text{Unemployment Rate} = \frac{\text{Unemployed}}{\text{Labor Force}} \times 100$$

Labor force: employed + unemployed (those actively seeking work).

NOT in the labor force: retired, full-time students, homemakers, discouraged workers. The labor force participation rate measures what fraction of working-age adults are in the labor force.

Types of Unemployment

Frictional unemployment: workers between jobs; time spent searching for a new position. Always exists; reflects normal job market search. Not a problem — some is healthy.

Structural unemployment: mismatch between workers' skills and available jobs. Caused by technological change or industry shifts. More persistent; may require retraining.

• Example: coal miners displaced by natural gas; auto workers displaced by robots

Cyclical unemployment: caused by economic downturns (recession). Rises during contractions; falls during expansions. The key target of macroeconomic policy.

Seasonal unemployment: predictable fluctuations (lifeguards in winter; tax accountants after April 15).

Natural rate of unemployment (NAIRU): the level of unemployment that exists when the economy is at full employment — the sum of frictional and structural unemployment. In the US, roughly 4–5%.

• "Full employment" does NOT mean 0% unemployment
• Cyclical unemployment = actual unemployment − natural rate

The Hidden Unemployment Problem

The official unemployment rate (U-3) has limitations:

Discouraged workers: people who have given up looking for work; not counted as unemployed; not in the labor force.

Underemployed: people working part-time who want full-time work, or people working below their skill level.

U-6 rate: the broadest measure — includes part-time workers who want full-time work and marginally attached workers. Usually 3–5 percentage points higher than U-3.

Inflation

Inflation: a sustained increase in the general price level.

Consumer Price Index (CPI): measures the average change in prices paid by consumers for a fixed basket of goods and services (food, housing, transportation, healthcare, etc.).