Economics II: Labor and Income; GDP, Growth, Unemployment, Inflation; Money, the Fed, Exchange Rates, Fiscal Policy

This is Unit Fourteen of Social Sciences and History, part one of two: economics from the labor market to the price index. Unit thirteen closed on one rule at the margin and four prices. This part turns to macroeconomics, and it carries one habit: every macro measure is defined by what it excludes and what it divides by. GDP counts final goods, within the country, in a year, and each of those words excludes a distractor on the exam's sample question seven. The unemployment rate divides by the labor force, not by adults, and the difference is the whole trick of the item. Inflation divides by the starting index, not the base year, when the question asks for this year. Ask what a measure excludes and what it divides by, and the three procedures in this part answer themselves. By the end you will be able to say what sets labor demand and a monopsony's wage. To answer sample question seven. To say what determines growth. To compute the unemployment rate. And to compute inflation from an index.

Five entries on labor markets: labor demand from the marginal product, monopsony, unions, bilateral monopoly, and the earnings gaps voiced as the anchor voices them.

Labor demand.

SSH 1301 Labor Demand From the Marginal Product

A firm demands labor for the value of its marginal productivity: in a competitive output market the value of the marginal product, marginal product times price; otherwise the marginal revenue product, marginal product times marginal revenue. It hires until wage equals labor demand. The first rule is never to pay above marginal productivity. Supply and demand set the competitive wage.

Monopsony.

SSH 1302 Monopsony: One Buyer of Labor

A monopsony is the sole employer in a labor market, the one mill in a mill town. To hire more workers it must raise the wage for all, so the marginal cost of labor exceeds the wage. It hires where that marginal cost equals its labor demand: fewer workers, lower wage. Monopoly is one seller; monopsony one buyer.

Unions.

SSH 1303 Unions and Collective Bargaining

A labor union negotiates as a group with employers over pay and conditions: collective bargaining. Union workers are paid more on average than comparable others, so either they are more productive or employers hire fewer of them. Membership has fallen for decades, for four reasons: the service shift, globalization, worker-friendly laws, and organizing rules. The dilemma is the anchor's framing.

Bilateral monopoly.

SSH 1304 Bilateral Monopoly's Indeterminate Wage

A bilateral monopoly is a labor market with a union on the supply side and a monopsony on the demand side. Both hold monopoly power, so employment ends lower than under competition, but the wage could be higher or lower depending on who negotiates better: the union pulls up, the monopsony pulls down. Indeterminate is the answer.

Earnings gaps.

SSH 1305 Earnings Gaps: Discrimination and the Controversy Over Its Share

Discrimination in a labor market is paying workers with the same characteristics different amounts because of race, gender, religion, age or disability. Women and Black workers earn less on average, and the anchor reports controversy over how much discrimination explains against education and experience, with lost sales and lost workers as the market pressures against it. The anchor's sentence is garbled; the sense is voiced, no verdict.

Seven entries on GDP: the definition, two ways to count, double counting, nominal to real, the cycle, per capita, and the sample question.

GDP.

SSH 1306 GDP: Final, Within, in a Year

Gross domestic product measures the value of the output of all final goods and services produced within a country in a year: three tests, final, within the country, this year. Economists take the quantities produced, multiply by prices, and sum. It can be measured from purchases or from production. Sample question seven lives at the end of this topic.

Two ways to count.

SSH 1307 Two Ways to Count: Spending and Production

From the purchase side, demand divides into consumption, investment, government, exports and imports. From the production side, output divides into durable goods, nondurable goods, services, structures and inventories: a car, food, a haircut, a factory, unsold stock. National income sums wages, rent, interest and profit, the BEA's components. The glossary lists profit twice and omits interest, an error recorded.

Double counting.

SSH 1308 Double Counting and Intermediate Goods

To avoid double counting, GDP counts only final output, not intermediate goods. An intermediate good is output provided to other businesses at an intermediate stage; a final good is used directly for consumption, investment, government or trade. Count the bread, not the flour and the bread. Whether a good is final depends on its buyer.

Nominal and real.

SSH 1309 Nominal to Real: The Price Index

The nominal value of a statistic is the announced value; the real value is adjusted for inflation. To convert several years' nominal data, choose a base year and use a price index to express each year in the base year's money. Nominal up eight, prices up five: real about three. Real growth is the exam's growth.

The business cycle.

SSH 1310 Peak, Recession, Trough, Depression

Real GDP has risen dramatically over the long term, but unevenly, and the speeding and slowing is the business cycle. A recession is a significant decline in national output; a depression an especially lengthy and deep one. Recessions begin at the peak and end at the trough: peak, down, trough, up. Unit eight's two-quarter rule is that anchor's.

Per capita and what GDP leaves out.

SSH 1311 GDP Per Capita and What GDP Leaves Out

To compare countries, convert GDPs to a common currency by the exchange rate, then divide by population: GDP per capita, the better measure, a large poor country against a small rich one. GDP is a rough indicator of living standards, omitting leisure, environment, health, education, non-market work, inequality. The standard of living includes what markets never price.

The sample question.

SSH 1312 GDP or Not? Sorting the Distractors

Sample question seven asks what GDP measures, and the key is the anchor's definition: the value of the output of all final goods and services produced within a country in a year. Each word excludes a distractor. Final excludes intermediate goods, the flour inside the bread, which would be double counting. Within a country excludes gross national product, which includes what domestic labor and business produce abroad and excludes what foreigners produce here; net national product subtracts depreciation from GNP. In a year makes it a flow, not a stock of wealth. Output excludes financial transactions and used goods, which produce nothing new. And produced excludes the well-being GDP does not count: leisure, environment, health, non-market work. Nominal GDP is the announced figure, real GDP inflation-adjusted, per capita divided by population. Choose the option that says the value of final goods and services produced within the country in a year. Distractors name total spending by households alone, national income earned by citizens anywhere, the sum of all transactions, or the nation's wealth. A firm's output made abroad is GNP, not GDP. Steel sold to a carmaker is intermediate, excluded. The trap is GNP against GDP: location decides GDP, ownership decides GNP. The second trap is treating GDP as welfare; the anchor calls it a rough indicator. What the measure excludes is the whole answer, which is this lecture's habit.

Four entries on growth: two percent a year since eighteen hundred, productivity as the primary determinant, capital deepening and technology, and convergence against diminishing returns.

Growth's arrival.

SSH 1313 Two Percent a Year Since 1800

Since the early nineteenth century the world's leading economies have expanded GDP per capita about two percent a year, modern economic growth, facilitated by the Industrial Revolution, which the glossary dates to the early eighteen hundreds. In the last half-century Japan, South Korea and China have shown the potential to catch up. Small differences compound into enormous gaps.

Productivity.

SSH 1314 Productivity Is the Primary Determinant

Labor productivity is the value produced per worker or per hour. Its growth rate is the primary determinant of long-term growth and higher wages, and compound growth behaves like compound interest. The United States slowed from nineteen seventy-three to eighty-nine, rebounded, then grew under one percent yearly from twenty eleven to sixteen. The dates and rates are the anchor's.

The components.

SSH 1315 Capital Deepening and Technology, Broadly Meant

The aggregate production function turns human capital, physical capital and technology into GDP per capita. Capital deepening is a rise in capital per worker, physical or human. Technology, economically, is all new methods of production: major inventions, small ones, better management, better institutions; invention advances, innovation applies. A healthy climate adds markets and supportive policy.

Convergence.

SSH 1316 Convergence and Diminishing Returns

Convergence is low-income economies catching up with high-income ones. New investment in capital yields huge gains where capital is scarce and less where it is abundant, a first tractor against a tenth, since returns diminish; high-income economies must keep inventing. Innovation can offset diminishing returns. Institutions that sustain innovation are the anchor's caveat.

Five entries on unemployment: the labor force, computing the rate, its patterns, cyclical unemployment and sticky wages, and the natural rate.

The labor force.

SSH 1317 Employed, Unemployed, Out of the Labor Force

The adult population divides into the labor force and those out of it; the labor force divides into employed and unemployed. To count as unemployed a person without a job must be willing, able, and actively looking; otherwise they are out of the labor force, as discouraged workers, who stopped looking, are. The underemployed count as employed.

Computing the rate.

SSH 1318 The Rate's Denominator: Computing Unemployment

The exam gives population counts and asks the unemployment rate, or the participation rate, and the anchor's definitions are the arithmetic. The unemployment rate is the number unemployed divided by the labor force, not the overall adult population. The labor force participation rate is the share of adults who are either employed or unemployed and looking. The Current Population Survey, run by the Census Bureau for the Bureau of Labor Statistics, measures the share of the labor force unemployed; the establishment payroll survey measures the net change in jobs each month. Unemployment costs the jobless income and stress and costs the economy the opportunity cost of unused resources. Two hundred adults, one hundred twenty employed, ten unemployed and looking, seventy neither: the labor force is one hundred thirty, the unemployment rate ten over one hundred thirty, about seven point seven percent, and participation one hundred thirty over two hundred, sixty-five percent. The discouraged stop looking: the rate falls though no one found work, because they left the denominator and the numerator together. Ask first who is in the labor force. The trap is dividing by the adult population, which understates the rate. The second trap is reading a falling rate as good news without checking participation. What it divides by is the whole item.

The patterns.

SSH 1319 Never Zero, No Long-Term Trend

The unemployment rate rises in recessions and falls back to about four to six percent when the economy is strong; it never reaches zero and shows no long-term rising trend. Rates differ by group: higher for Black and Hispanic workers, the less educated, and the young, while men's and women's rates are now similar. The international comparison is dated.

The short run.

SSH 1320 Cyclical Unemployment and Sticky Wages

Cyclical unemployment rises and falls with the business cycle. With flexible wages the labor market would clear, so economists explain why wages are sticky, especially downward: implicit contracts, efficiency wage theory, adverse selection of wage cuts, the insider-outsider model, and relative wage coordination; cut everyone's pay and the best leave. Efficiency wages hold that better-paid workers produce more.

The natural rate.

SSH 1321 The Natural Rate: Frictional Plus Structural

The natural rate of unemployment is the rate a healthy economy would show even without a recession. It includes frictional unemployment, workers moving between jobs, a coder between contracts; structural unemployment, when demand shifts permanently from a skill, a typesetter without presses; and the side effects of hiring and firing laws. Cyclical unemployment sits above the natural rate.

Three entries to close: a basket, an index and a base year, the two biases of a fixed basket, and the indices.

Computing inflation.

SSH 1322 A Basket, an Index, a Base Year: Computing Inflation

The exam gives prices or index numbers and asks the inflation rate, and the anchor's method is three steps. First, a basket of goods and services: a hypothetical set of items in fixed quantities meant to represent typical purchases. Second, the price level: the total cost of that basket, expressed as an index number, a unit-free figure set to one hundred in an arbitrary base year, so the index in another year shows the cumulative change; an index of one hundred five means five percent inflation since the base year. Third, the inflation rate: the percentage change between price levels or index numbers from one period to the next. The basket cost two hundred in the base year and two hundred twenty this year: the index is one hundred ten, and inflation since the base year ten percent. The index rose from one hundred ten to one hundred twenty-one: inflation this year is ten percent, not eleven, because the change is measured against one hundred ten. Ask what the denominator is: the base year for cumulative change, last year for the annual rate. The trap is subtracting index numbers and calling the difference a percentage; divide by the starting index. The second trap is the base year, which is arbitrary and carries no meaning of its own. What it divides by, once more.

The biases.

SSH 1323 Substitution Bias and Quality Bias

A fixed basket has two problems. Substitution bias: it overstates the rise in the cost of living because buyers substitute away from goods whose prices rise. Quality and new-goods bias: it overstates too, ignoring better quality and new goods, a basket still counting a decade-old phone. Both can be reduced, neither eliminated. Both push measured inflation too high.

The indices.

SSH 1324 CPI, Core, Deflator, PPI

The Consumer Price Index rests on a basket of the typical consumer's purchases; core inflation strips out volatile food and energy. The GDP deflator covers all GDP components; the Producer Price Index, producers' supplies and inputs; the Employment Cost Index, wages. Two to four percent yearly is the anchor's dated range. Inflation ran highest after the world wars and in the seventies.

Look at what you can now do. You can say a firm hires until wage equals the value of the marginal product, that a monopsony hires fewer at a lower wage, and that the earnings-gap controversy is voiced as the anchor's. You can answer sample question seven with GDP's definition, and say why final, within and in a year each exclude a distractor. You can say productivity growth is the primary determinant of long-term growth, and that convergence is a chance diminishing returns offer and innovation can offset. You can compute the unemployment rate by dividing by the labor force, and tell frictional from structural from cyclical. And you can compute inflation by dividing by the starting index. In every case you asked what the measure excludes and what it divides by, which is the habit this lecture was built on. Part two opens on who inflation hurts and helps, then carries money, the Fed, exchange rates and fiscal policy.