Chapter 15: Unemployment

• The unemployment rate is the percentage of those who would like to work who do not have jobs.
The Bureau of Labor Statistics calculates this statistic monthly based on a survey of thousands of households.
• The unemployment rate is an imperfect measure of joblessness. Some people who call themselves unemployed may actually not
want to work, and some people who would like to work are not counted as unemployed because they have left the labor force after an
unsuccessful search.
• In the U.S. economy, most people who become unemployed find work within a short period of time.
Nonetheless, most unemployment observed at any given time is attributable to the few people who are unemployed for long periods of
time.
• One reason for unemployment is the time it takes workers to search for jobs that best suit their tastes and skills.
This frictional unemployment is increased by unemployment insurance, a government policy designed to protect the incomes of workers
who lose their jobs.
• A second reason our economy always has some unemployment is minimum-wage laws. By raising the wage of unskilled and
inexperienced workers above the equilibrium level, minimum-wage laws raise the quantity of labor supplied and reduce the quantity
demanded. The resulting surplus of labor represents unemployment.
• A third reason for unemployment is the market power of unions. When unions push the wages in unionized industries above the
equilibrium level, they create a surplus of labor.
• A fourth reason for unemployment is suggested by the theory of efficiency wages. According to this theory, firms find it profitable to
pay wages above the equilibrium level. High wages can improve worker health, lower worker turnover, raise worker quality, and
increase worker effort.
Chapter 16: The Monetary System
• The term money refers to assets that people regularly use to buy goods and services.
• Money serves three functions. As a medium of exchange, it is the item used to make transactions. As a unit of account, it provides the
way to record prices and other economic values. As a store of value, it offers a way to transfer purchasing power from the present to
the future.
• Commodity money, such as gold, is money that has intrinsic value: It would be valued even if it were not used as money. Fiat money,
such as paper dollars, is money without intrinsic value: It would be worthless if it were not used as money.
• In the U.S. economy, money takes the form of currency and various types of bank deposits, such as checking accounts.
• The Federal Reserve, the central bank of the United States, is responsible for regulating the U.S. monetary system. The Fed chair is
appointed by the president and confirmed by the Senate every four years. The chair is the head of the Federal Open Market
Committee, which meets about every six weeks to consider changes in monetary policy.
• Bank depositors provide resources to banks by depositing their funds into bank accounts. These deposits are part of a bank's
liabilities. Bank owners also provide resources (called bank capital) for the bank. Because of leverage (the use of borrowed funds for
investment), a small change in the value of a bank's assets can lead to a large change in the value of the bank's capital. To protect
depositors, bank regulators require banks to hold a certain minimum amount of capital.
• The Fed controls the money supply primarily through open-market operations: The purchase of government bonds increases the
money supply, and the sale of government bonds decreases the money supply. The Fed also has other tools to control the money
supply.
It can expand the money supply by decreasing the discount rate, increasing its lending to banks, lowering reserve requirements, or
decreasing the interest rate on reserves. It can contract the money supply by increasing the discount rate, decreasing its lending to
banks, raising reserve requirements, or increasing the interest rate on reserves.
• When individuals deposit money in banks and banks loan out some of these deposits, the quantity of money in the economy
increases. Because the banking system influences the money supply in this way, the Fed's control of the money supply is imperfect.
• The Fed has in recent years set monetary policy by choosing a target for the federal funds rate, a short-term interest rate at which
banks make loans to one another. As the Fed pursues its target, it adjusts the money supply.
Chapter 20: Aggregate Demand and Aggregate Supply
• All societies experience short-run economic fluctuations around long-run trends. These fluctuations are irregular and largely
unpredictable. When recessions occur, real GDP and other measures of income, spend-ing, and production fall, while unemployment
rises.
• Classical economic theory is based on the assumption that nominal variables such as the money supply and the price level do not
influence real variables such as output and employment. Most economists believe that this assumption is accurate in the long run but
not in the short run. Economists analyze short-run economic fluctuations using the model of aggregate demand and aggregate supply.
According to this model, the output of goods and services and the overall level of prices adjust to balance aggregate demand and
aggregate supply.
• The aggregate-demand curve slopes downward for three reasons. The first is the wealth effect: A lower price level raises the real
value of households' money holdings, stimulating consumer spending. The second is the interest-rate effect: A lower price level
reduces the quantity of money households demand; as households try to convert money into interest-bearing assets, interest rates fall,
stimulating investment spending.
The third is the exchange-rate effect: As a lower price level reduces interest rates, the dollar depreciates in the market for foreign-
currency exchange, stimulating net exports.
• Any event or policy that raises consumption, invest-ment, government purchases, or net exports at any given price level increases
aggregate demand. Any event or policy that reduces consumption, investment, government purchases, or net exports at any given
price level decreases aggregate demand.
• The long-run aggregate-supply curve is vertical. In the long run, the quantity of goods and services supplied depends on the
economy's labor, capital, natural resources, and technology but not on the overall level of prices.
• Three theories have been proposed to explain the upward slope of the short-run aggregate-supply curve.
According to the sticky-wage theory, an unexpected fall in the price level temporarily raises real wages, inducing firms to reduce
employment and production.
According to the sticky-price theory, an unexpected fall in the price level leaves some firms with prices that are temporarily too high,
reducing their sales and causing them to cut back production. According to the misperceptions theory, an unexpected fall in the price
level leads suppliers to mistakenly believe that their relative prices have fallen, inducing them to reduce production. All three theories
imply that output deviates from its natural level when the actual price level deviates from the price level that people expected.
• Events that alter the economy's ability to produce output, such as changes in labor, capital, natural resources, or technology, shift the
short-run aggregate-supply curve (and may shift the long-run aggregate-supply curve as well). In addition, the position of the short-run
aggregate-supply curve depends on the expected price level.
• One possible cause of economic fluctuations is a shift in aggregate demand. When the aggregate-demand curve shifts to the left, for
instance, output and prices fall in the short run. Over time, as a change in the expected price level causes wages, prices, and
perceptions to adjust, the short-run aggregate-supply curve shifts to the right. This shift returns the economy to its natural level of output
at a new, lower price level.
• A second possible cause of economic fluctuations is a shift in aggregate supply. When the short-run aggregate-supply curve shifts to
the left, the effect is falling output and rising prices a combination called stagflation. Over time, as wages, prices, and perceptions
adjust, the short-run aggregate-supply curve shifts back to the right, returning the price level and output to their original levels.