Dr. Mohammed Alwosabi Econ 141- Ch.

Notes on Chapter 2
POPULATION SURVEY AND LABOR MARKET

BUSINESS CYCLE:
— We study macroeconomics to describe, analyze, and predict the
economic activity. But economic activity is not constant. It fluctuates
ups and downs for different reasons. These ups and downs are called
business cycle (or economic cycle).
— Economic activity is measured using RGDP. Estimates of GDP are
used for business cycle forecasting.
— To understand the business cycle we must distinguish between RGDP
and potential GDP (PGDP).
— RGDP is the market value of the total production measured at the
constant (base year) prices. RGDP eliminates the influence of
inflation and determines how much production has grown from one
year to another.
— PGDP is the RGDP when all country’s resources are fully employed.
— Since resources are not always fully employed, RGDP fluctuates
around PGDP.
— Business Cycle can be defined as periodic but irregular short run
upward and downward movements (fluctuations)in production and
employment (in RGDP around the PGDP).
— Every business cycle has two phases (expansion and recession) and
two turning points (peak and trough).

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Dr. Mohammed Alwosabi Econ 141- Ch.2

— Recession:
o A recession is a period in which is a significant decrease in
RGDP of the country that occurs for at least two quarters.
o A recession begins just after the economy reaches its peak of
activity and ends as the economy reaches its trough.

— Expansion:
o An expansion period in which there is a significant increase in
RGDP lasting for at least two quarters.
o During expansion, production RGDP
PGDP
of goods and services increases
and unemployment decreases. RGDP
o An expansion begins just after Peak

the economy reaches its trough Expansion

of activity and ends as the Trough

Recession
economy reaches its peak.
Time

— A peak:
o A peak is the point at which the real GDP stops increasing (an
expansion ends) and begins its decline (a recession begins). It
is the highest point.
o At the peak, employment, consumer spending, and production
hit their highest levels.
o When the peak lasts for a long time, we are in a period of
prosperity. One of the dangers of peak periods is that of
inflation.

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Dr. Mohammed Alwosabi Econ 141- Ch.2

— A trough:
o The trough is the time at which the real GDP stops its decline (a
recession ends) and starts expanding (an expansion begins). It
is the lowest point.
o When the trough lasts for a long time, we are in a period of
depression. Y
— Using production possibilities frontier (PPF),
the PGDP is on the curve itself where B D
resources are fully employed.
— If the RGDP is equal to PGDP the A C
economy is producing on the PPF at
points such as B or C or any point on the PPF. X

— If RGDP < PGDP this means some resources are not fully used
(resources are unemployed or underused) and it is represented by
points inside the curve such as A.
— If RGDP > PGDP this means resources are overused. This is
represented by point D outside the PPF.
— The economy grows throughout the years. Economic growth is the
expansion of the economy’s production possibilities. It is represented
by an outward shift of the PPF.

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Dr. Mohammed Alwosabi Econ 141- Ch.2

POPULATION SURVEY:
— The Population of a country can be divided into two groups:
1. Working-age population: the total number of people 16 years
and over (aged over 15 years) who are not in jails, hospitals, or
some other form of institutional care such as people in full-time
education.
2. Not in the working-age population such as those who are too
young to work or who are at institutional care and unable to
work (dependents).
— The working-age population is divided into two groups:
1. Those in the labor force
2. Those not in the labor force
— The labor force is all people who are able and willing to work and
divided into two groups:
a. Those who are employed
b. Those who are unemployed but actively seeking work
Labor force = employed + unemployed
o The employed person is the one who have a full time job or a
part-time job.
o The unemployed is the person who is without work and is
actively trying to find job or waiting to be called back to a job
from which he or she has been laid off or waiting to start a new
job.
— Not in the labor force includes any person who is in the working-age
population but is neither employed nor unemployed such as a person
who is not working but is not looking for a job, a full-time student or a
retired person.

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Dr. Mohammed Alwosabi Econ 141- Ch.2

LABOR MARKET INDICATORS:

— There are three labor market indicators
1. Unemployment Rate
o The unemployment rate is the percentage of the labor force that
is unemployed.
Unemployed
Unemployment rate = × 100
Labor force
o This is an indicator of the extent to which people want jobs but
can’t find jobs.
o The unemployment rate increases during recessions.
o Example:
Suppose the working age population is 220 million, the labor
force is 150 million, and the number of employed is 135 million.
What is the unemployment rate?

2. The Labor Force Participation Rate

o The labor force participation rate is the percentage of the
working-age population that is in the labor force.
Labor force
o Labor force participation rate = × 100
Working - age population
o This is an indicator of the willingness of people of working-age
to take jobs. If the labor force participation rate is rising and the
working-age population remains the same, then the number of
the labor force is rising.
o Exercise:
Suppose there are currently 100 people unemployed, 1500
people employed, and 2000 people in the working age
population. What is the labor force participation rate?

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Dr. Mohammed Alwosabi Econ 141- Ch.2

3. The Employment-to-Population Ratio

o The employment-to-population ratio is the percentage of
working-age people who have jobs.
employed
Employment − to − population ratio = × 100
Working − age population

o This is an indicator of availability of jobs. It fluctuates but its

fluctuations coincide with but are opposite to those in the
unemployment rate. It falls during recession and increases
during an expansion.

Discouraged workers
— Discourage workers are people available and willing to work but who
have not made an effort to find work within the last four weeks.
— These workers often leave the labor force temporarily during a
recession and re-enter during an expansion and become active job
seeker.
— Discouraged workers are not considered unemployed and not
included in the labor force because they are not actively seeking work.

Aggregate Hours:
— The three labor market indicators are useful sign of the health of the
economy and directly measure jobs. But they don’t tell us the quantity
of the labor used to produce RGDP. We cannot use them to calculate
the production of labor.
— Jobs are not all the same. The number of hours worked by the part-
time workers is less than full-time workers. And some people work
over time.

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Dr. Mohammed Alwosabi Econ 141- Ch.2

— Example:
For example, a 24 hour mini-mart might hire 6 students to work for 3
hours a day each, or might hire 2 full-time workers who work 9 hours a
day each. The total hours worked is the same in both cases. To
determine the total amount of labor used to produce RGDP we
measure labor in hours rather than number of workers in jobs.
— Aggregate hours are the total number of hours worked by all the
people employed, both full-time and part-time during a year.
— Money (nominal) wage rate is the actual money paid per period of
time.
— Real wage rate is the quantity of goods and services that an hour’s
work can buy. It is equal to the money wage rate divided by the price
level- the GDP deflator or CPI.
— If money wage rate is constant but price level rises, the real wage
decreases and the quantity of goods and services that an hour of work
can buy decreases.
— If money wage rate increases but price level remains constant, the
real wage increases and the quantity of goods and services that an
hour of work can buy increases.

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Dr. Mohammed Alwosabi Econ 141- Ch.2

— Exercise
Category Number
(millions)
Total population 500
Working full-time 200
Working part-time 80
Not working and looking for work 40
Want to work but no longer looking for work 20
Retired 60

Answer the following questions based on the information from the

above table,
1. What is the number of people unemployed? 40
2. What is the size of the labor force? 320
3. What is the number of discouraged workers?20
4. What is the number of people not in the labor force? 80
5. What is the working-age population? 400
6. What is the number of population 16 years or over? 400
7. What is the number of people under 16? 100
8. What is the unemployment rate? 12.5%
9. What is the labor force participation rate? 80%
10. What is the employment-to-population ratio? 70%

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Dr. Mohammed Alwosabi Econ 141- Ch.2

TYPES OF UNEMPLOYMENT:
— Unemployment exists because of people loosing their jobs or people
leaving their jobs.
— Job losers are people who are laid off permanently or temporarily and
are searching for new jobs.
— Job leavers are people who quit their jobs to look for something better.
— Entrants and reentrants that are people entering the labor force for the
first time or returning to the labor force and searching for work.
— Unemployment is classified mainly into the following types:

1. Frictional Unemployment:
— Frictional unemployment is unemployment associated with the
changing of jobs (or normal labor market turnover). It is transitional
unemployment due to the short run movement of people between jobs
and the first time job seekers such as new university graduates.
— It exists because of the ongoing creation and destruction of jobs which
result in people searching for jobs and firm searching for workers.
— There is a friction between when you decide to get a job and when
you actually find a job (i.e., between the old and the new job).
— Increases in the number of young people entering the labor force and
increases in unemployment benefit payments raise frictional
unemployment.
— Frictional unemployment is temporary unemployment for a specific
individual but it is permanent phenomenon in a dynamic and ongoing
economy and cannot be eliminated from the economy.

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Dr. Mohammed Alwosabi Econ 141- Ch.2

— Examples:
1. A student after getting his/her degree starts looking for a job.
The time between looking for a job and getting it, the student is
counted as part of the frictional unemployment in the country.
2. A person may quit his job to search for a better offer or may be
fired. He is looking for a new job. During the time between the
old and the new job this person is counted as part of the
frictional unemployment.

2. Structural Unemployment:
— Structural unemployment is a result of
1. the economy's structural and technological changes that result
in a mismatch between people’s skills and the requirements of
the new job opportunities.
2. international competition that changes the location of jobs
which leads to a mismatch between the location of jobs and the
location of the labor force.
3. the general decline of specific industries which result in laying
off their workers.
— Structural unemployment usually lasts longer than frictional
unemployment because workers must re-train and possibly re-allocate
to find a job.
— Most countries go through structural changes which result in structural
unemployment that cannot be eliminated. Structural unemployment is
painful especially for old workers who might find the best option may
be to retire early or take lower skilled, low-paying jobs.
— Structural unemployment cannot be eliminated from the economy.

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Dr. Mohammed Alwosabi Econ 141- Ch.2

— Examples:
1. Assembly line workers who have been replaced by robots are
structurally unemployed.
2. The individual that has no required skills or training for the job is
structurally unemployed
3. Replacing paper work by automated computer system which
results in the loss of jobs for those who cannot deal with
computerized systems is part of structural unemployment.
4. Workers who lost their jobs because of re-allocation of their
factories into cheaper labor countries are structurally
unemployed.

3. Cyclical Unemployment:
— Cyclical unemployment (also called involuntary unemployment) is the
unemployment that fluctuates over the business cycle due to a fall in
aggregate demand for goods and services which results in a
contraction in output across many industries.
— During the recession, RGDP decreases which results in an increase in
cyclical unemployment because of plant closures and worker lay-offs.
— During the expansion, RGDP increases and cyclical unemployment
decreases.
RGDP
— Unlike frictional and structural unemployment,
Zero CU
cyclical unemployment could be zero or
- CU
negative. PGDP
+ CU
o RGDP = PGDP, CU = zero. RGDP

o RGDP < PGDP, CU > zero.

Time
o RGDP > PGDP, CU < zero.

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Dr. Mohammed Alwosabi Econ 141- Ch.2

— Note that negative unemployment means more than full employment

(over employment).
— Example:
An autoworker that is laid off because the economy is in a
recession and then re-hired when the expansion begins has
experienced cyclical unemployment.

FULL EMPLOYMENT:
— Full employment occurs when there is no cyclical unemployment and
the only unemployment that exists is the frictional and /or structural.
— The unemployment rate at full employment is called the natural rate of
unemployment.
— Over the business cycle, RGDP fluctuates around PGDP and the
unemployment rate fluctuates around the natural rate of
unemployment.
1. When RGDP < PGDP that means UR > NRU, so CU is positive
2. When RGDP > PGDP that means UR < NRU, so CU is negative
3. When RGDP = PGDP that means UR = NRU, so CU equals zero
— Exercise:
Suppose the economy has unemployment rate equal to 3%. If the
natural rate of unemployment of the country is 8%.
a. What type of unemployment exists in the economy?
b. What is the size of this unemployment?
— Exercise:
Suppose the economy is experiencing frictional unemployment of 2
percent, structural unemployment of 3 percent and cyclical
unemployment of 5 percent. What is the natural rate of
unemployment?

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Dr. Mohammed Alwosabi Econ 141- Ch.2

— Exercise:
Fill in the following table:

Year LF NLF E U WAP LFPR UR

2001 ----- ----- 150 20 ----- 60% ----
2002 ----- ----- ----- 50 800 ----- 8%
2003 200 60 160 ---- ----- ----- ----
2004 300 80 ----- ---- ----- ----- 5%

LF = labor force, NLF = not in the labor force, E = employed worker, U

= unemployed, WAP = working-age population, LFPR = labor force
participation rate, UR = unemployment rate

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