Inflation and Unemployment

Lesson Purpose:
A major problem in teaching economics is dealing with what people know that isn’t so, or at the very least, is incomplete.  Familiarity with the media conversation about economic conditions leads to a comfort level that, unfortunately, keeps many people from wondering about their beliefs or testing them against new knowledge and experiences.  That everyone “knows” about inflation and unemployment makes it more difficult to teach.  But it also increases the value of helping students arrive at a sound understanding of the concepts, models, and terminology of economic issues that will be an ongoing part of their daily economic lives.

This lesson goes beyond the data and terminology of measuring inflation and unemployment to look at the impact on the economy and on individuals of changes in the levels of prices and employment.  By acknowledging the continuity of change, focusing on how change redefines winners and losers in the economy, and by pointing out that things are not always what they seem, lessons on employment and inflation can demonstrate how economics education adds value to people’s lives and helps them know more that is so.

Key Terms:

employment rate inflation consumer price index nominal
unemployment rate interest capital market real

Content Standards:

Standard 12: Students will understand that: Interest rates, adjusted for inflation, rise and fall to balance the amount saved with the amount borrowed, thus affecting the allocation of scarce resources between present and future uses.
Benchmarks:
grade 12:

  • The real interest rate is the nominal or current market interest rate minus the expected rate of inflation.
  • Higher real interest rates provide incentives for people to save more and to borrow less. Lower real interest rates provide incentives for people to save less and to borrow more.
  • Real interest rates normally are positive because people must be compensated for deferring the use of resources from the present into the future.
  • Higher interest rates reduce business investment spending and consumer spending on housing, cars, and other major purchases.  Policies that raise interest rates can be used to reduce these kinds of spending, while policies that decrease interest rates can be used to increase these kinds of spending.

Standard 18: Students will understand that: A nation’s overall levels of income, employment, and prices are determined by the interaction of spending and production decisions made by all households, firms, government agencies, and others in the economy.
Benchmarks:
grade 12:

  • One person’s spending is other people’s income.  Consequently, an initial change in spending (consumption, investment, government, or net exports) usually results in a larger change in national levels of income, spending, and output.
  • When desired expenditures for consumption, investment, government spending, and net exports are greater than the value of a nation’s output of final goods and services, GDP rises and inflation occurs and/or employment rises.
  • When desired expenditures for consumption, investment, government spending, and net exports are less than the value of a nation’s output of final goods and services, GDP decreases and inflation and/or employment decreases.

Standard 19: Students will understand that: Unemployment imposes costs on individuals and nations.  Unexpected inflation imposes costs on many people and benefits some others because it arbitrarily redistributes purchasing power.  Inflation can reduce the rate of growth of national living standards, because individuals and organizations use resources to protect themselves against the uncertainty of future prices.
Benchmarks:
grade 8:

  • When unemployment exists, an economy’s production is less than potential GDP and some labor resources are not used.
  • Inflation reduces the value of money.

grade 12:

  • The unemployment rate is the percentage of the labor force that is willing and able to work, does not currently have a job, and is actively looking for work.
  • The unemployment rate is an imperfect measure of unemployment because it does not (1) include workers whose job prospects are so poor that they are discouraged from seeking jobs, or (2) reflect part-time workers who are looking for full-time work.
  • Unemployment rates differ for people of different ages, races, and sexes.  This reflects differences in work experience, education, training, and skills, as well as discrimination.
  • Unemployment can be caused by people changing jobs, by seasonal fluctuations in demand, by changes in the skills needed by employers, or by cyclical fluctuations in the level of national spending.
  • Full employment means that the only unemployed people in the economy are those who are changing jobs.
  • The consumer price index (CPI) is the most commonly used measure of price-level changes.  It can be used to compare the price level in one year with price levels in earlier or later periods.
  • Expectations of increased inflation may lead to higher interest rates.
  • The costs of inflation are different for different groups of people. Unexpected inflation hurts savers and people on fixed incomes; it helps people who have borrowed money at a fixed rate of interest.
  • Inflation imposes costs on people beyond its effects on wealth distribution because people devote resources to protect themselves from expected inflation.

Session Objectives:

  • Review the circular flow model developed in the previous session.
  • Review the total spending equation:  GDP = C + I + G + (X-M).
  • Referencing the national economic goals of equity, stability, and full employment, use the circular flow model to point out how dis-equilibrium between changes in total expenditures and changes in total output affects price and employment levels.
  • Demonstrate how changes in employment and price levels are natural conditions of a market economy.
  • Define the employment rate and the unemployment rate, and demonstrate how they are calculated. Demonstrate how both can rise at the same time.
  • Identify the causes/types of unemployment and how each affects the economy.  (Relate to the circular flow model and business cycle model.)  Define the natural rate of unemployment and emphasize its necessity to a healthy economy.  Identify the historical patterns re which level of government tends to deal with each type of problem unemployment.
  • Identify limitations of unemployment data and discuss issues related to measurement of unemployment.
  • Model a process for analyzing the impact of employment policies – for example, minimum wage laws or right-to-work laws.
  • Define inflation and differentiate from changes in relative prices.
  • Review the difference between real and nominal values.
  • Define and distinguish between the consumer price index (CPI) and the GDP deflator as measures of inflation, and demonstrate how each is calculated.
  • Identify limitations of CPI data and discuss issues related to measurement of inflation.
  • Identify the consequences of inflation and discuss issues related to those consequences, including: resource reallocation; currency devaluation; unintended income distribution; distribution of benefits and costs throughout groups in the population; and vested interests that benefit from policies promoting inflation.
  • Discuss capital markets, interest rates, and inflation.
  • Discuss the relationship between inflation and unemployment. 

Key Content:

  • Everyone’s income derives from other people’s spending.
  • The employment rate is the percent of the labor force that is employed.  The labor force consists of the non-institutionalized civilian population, aged 16 or older, working or looking for work.
  • The unemployment rate is the percent of the labor force that is unemployed, willing to work, and actively looking for employment.
  • Inflation is a sustained rise in the general price level of goods and services.
  • Inflation reduces the purchasing power of money.
  • Interest rates are the prices necessary to get individuals and households to save, instead of spending money for immediate consumption.
  • Nominal interest rates must exceed real interest rates by the percent of inflation in order to provide effective incentives for saving.

Mythconceptions:

  • If employment is rising, unemployment must be falling.
  • High school and college students are not counted in the labor force.
  • In terms of people’s standard of living, rising prices are bad and rising wages are good.
  • People who work part time are not counted in government employment statistics.
  • The lower the unemployment rate, the better.
  • Increases in the minimum wage raise living standards for workers who are young, inexperienced and/or unskilled.
  • High prices are synonymous with inflation.
  • The lower the inflation rate, the better.
  • Inflation hurts everyone in the economy.

Frequently Asked Questions:

  • How can the economy create new jobs and still have a rising unemployment rate?
  • Why is it not considered inflation when energy/oil/gasoline prices rise?
  • Is it possible/desirable to have 0% unemployment?
  • Is it possible/desirable to have 0% inflation?
  • How can people in debt benefit from inflation?
  • Does inflation always destroy purchasing power?
  • If everybody had COLAs, would there be any need to worry about inflation?

Classroom Activity Options

  • Connect the natural rate of unemployment to the Production Possibilities Frontier model.  Then ask student groups to place other national economies on the frontier graphic based on their recent histories of unemployment.
  • Assign students to gather unemployment, employment, and inflation data for 5 major cities in different regions (including the one in which they live) of the United States, compare and contrast the data, and propose an explanation for similarities and differences among locations.
  • Assign students the task of gathering unemployment, employment, and inflation data on 5 industrialized economies from 1900 to the present, analyzing the data, and explaining how those economies are similar to and/or different from the U.S. economy.
  • Use illustrations / case studies / research assignments as the basis for discussion of current public issues related to unemployment, including:
    • minimum wage legislation (when the market wage is above/below the legislated wage);
    • the problem of enticing “discouraged workers” back into the labor market, and the effect on unemployment rates of programs that succeed in doing so; and
    • the potential impact of specific demographic changes (i.e. the “baby boomer” generation reaching retirement age) on employment management, employment rates, and unemployment rates.
  • Explain the reallocation effect of inflation and identify the winners and losers.  Discuss / debate to what extent the outcomes are fair / equitable / desirable.