Question

Suppose that the government altered the computation of the unemployment rate by including people in the military as part of the labor force.

a. How would this affect the actual unemployment rate?

b. How would such a change affect estimates of the natural rate of unemployment?

c. If this computational change were made, would it in any way affect the logic of the short-run and long-run Phillips curve analysis and its implications for policy making? Why might the government wish to make such a change?

Short answer

Hence the Phillips curve, both in the short and long run, would continue to correctly anticipate the relationship between unemployment and inflation rates.

Step-by-step solution

step 1

The natural rate of unemployment is the hypothetical level of unemployment that would exist in an economy if aggregate demand, short-run aggregate supply, and long-run aggregate supply were all in long-run equilibrium.

It's the product of structural and frictional unemployment. The natural rate of unemployment does not include cyclical unemployment.

step 1

The natural rate of unemployment is the hypothetical level of unemployment that would exist in an economy if aggregate demand, short-run aggregate supply, and long-run aggregate supply were all in long-run equilibrium.

It's the product of structural and frictional unemployment. The natural rate of unemployment does not include cyclical unemployment.

step 2

Short-run In the short run, the Phillips curve depicts a trade-off between unemployment and inflation.

It illustrates an inverse link between these two variables, meaning that a fall in the unemployment rate causes an increase in inflation, and vice versa.

step 3

Phillips curves shift in the short run due to changes in inflation rate predictions.This is because any changes in inflation expectations would cause workers to negotiate a higher nominal compensation rate with their employers in order to offset the effect of a fall in their real wage rates.

This would raise the cost of manufacturing and reduce profitability for businesses, forcing them to reduce supply and raise inflation rates at the expense of lower unemployment rates.

step 4

At the natural rate of unemployment, the long-run Phillips curve is a vertical straight line.

There is no trade-off between unemployment and inflation, and any attempt to adjust unemployment rates would result in a vertical straight line movement higher or downward.

It demonstrates that in the long run, the inflation rate and unemployment rate are unrelated, and that changes in the inflation rate have no effect on the unemployment rate.

step 5

Phillips curves change over time due to changes in the natural rate of unemployment.

The long-run Phillips curve would shift to the right if the natural rate of unemployment increased, and the long-run Phillips curve would shift to the left if the natural rate of unemployment decreased.

step 6

(a) The following formula is used to calculate the unemployment rate:

$\text{Unemployment rate}=\frac{\text{Unemployedworkers}}{\text{LaborForce}}$

If the government modifies the mechanism for calculating the unemployment rate to include military personnel, the actual unemployment rate will fall since the denominator in the above formula will grow.

Even if the labor force grows as a result of the military's membership, the number of unemployed workers/labors remains unchanged.

step 7

(b) Because the inclusion of the military is neither a structural (industrial re-organisation) nor a frictional shift, the natural rate of unemployment would remain unchanged (gap between job change).

As a result, the natural rate of unemployment would not change.

step 8

(c) The natural rate of unemployment is vertically represented by the long-run Phillips curve. As a result, if the natural rate of unemployment does not vary, the long-run Phillips curve does not alter.

There will be no difficulties for policymakers, and there will be no policy repercussions.

The long-run Phillips curve will shift if the natural rate of unemployment varies. A shift in the short-run Phillips curve would be caused by a change in the real unemployment rate.

This means that changes in the labor force as a result of military participation cannot defy the logic of the long-run or short-run curves.

The Phillips curve, both in the short and long run, would continue to correctly anticipate the relationship between unemployment and inflation rates.