Download Ch. 11: Inflation and Unemployment

1.
Inflation.
Introduction:
 Inflation - A general increase in the price of goods and services in an entire economy over
time.
 Deflation – A general decrease in the level of prices.
 To explain why Canadian government stress the goal of price stability, let’s examine
Inflation in detail, how it is measured, and its implications for the economy.
 The Consumer Price Index.
 Limitations of CPI (Consumer Price Index.)
 The GDP Deflator.
 Inflation’s Effects.
The Consumer Price Index (CPI).
 A Measure of price changes for a typical basket of consumer products.
Figure 11.1 Simple Consumer Price Index.
 Item weights – The proportions of each good in the total cost of the basket of consumer
good in total cost of the basket of consumer goods used to calculate CPI.
 Base year – The survey year used as a point of comparison in subsequent years.
2.
 A typical price index includes many more items. Modal distribution of other basic needs in
Fig 11.2
Fig 11.2 Consumer Price Index Weights (1986).
Nominal vs. Real Income.
 Cost of Living – The amount consumers must spend on the entire range of goods and
services they buy.
 E.g.  a consumer’s monthly income increases from $1000 to $1050 in a year when CPI
rises from 1.0 to 1.10. If the consumer’s own monthly purchases roughly correspond to
those in the representative “Shopping Basket,” he can evaluate the personal impact of
inflation.
 Nominal Income – Income expressed in current dollar.
 Real Income – Income expressed in constant base – year dollars. Measures the purchasing
power of the household over time.
Real Income = Nominal Income / CPI.
3.
 To keep up with inflation, his/her income would have to increase by the same percentage
as the increase in prices – that is, by 10% or $100 to $1100.
Limitation of the CPI.
 Consumer Differences:
 CPI may not apply to consumer’s individual cost of living because individual
consumption patterns not always match with those of the typical urban
households.
 Changes in Spending Patterns.
 Changes in consumption patterns are ongoing and gradual.
 E.g.  More cell phones and CD players were steadily bought in the 1990s. As
prices rise consumers tend to buy fewer items. These products have too high a
weight in the CPI basket, meaning that the index overstates the rate of inflation.
 Product Quality.
 A product’s tremendous improvement in quality may change an individual’s
standard of living but it will not be reflected in the CPI. (E.g. – Medicines or
stereos).
The GDP Deflator.
 An indicator of price changes for all goods and services produced in the economy, and
weights them in terms of the economy’s total output.
 GDP deflator receives less publicity than then CPI. The results of the two indicators (GDP
deflator and CPI) give similar but not identical estimates of inflation.
Fig 11.3 – Simple GDP Deflator.
4.
Nominal vs. Real GDP.
 Nominal GDP – Gross Domestic Product expressed in current year.
 Real GDP – Gives an indication of the purchasing power of an entire economy.
Real GDP = Nominal GDP / GDP Deflator
Fig 11.4 Finding Real Gross Domestic Product.
Inflation’s Effect.
 If household ↑ but Inflation ↑ at a higher rate, then household’s purchasing power ↓.
 If household ↑ and inflation rate ↑ proportionally, then household maintains purchasing
power.
 Cost – of – living adjustment clauses (COLA)  Provisions for income adjustment to
accommodate changes in price level, which are included in wage contracts.
 Fully Indexed Incomes  Nominal incomes that automatically increases by the rate of
inflation.
 Partially Indexed Incomes  Nominal incomes that increases by less than the rate if
inflation.
 Fixed Incomes Nominal incomes that remain fixed at some dollar amount regardless of
the rate of inflation.
 Nominal Interest rate: The interest rate expressed in money terms.
 Real interest rate: The nominal interest rate minus the rate if inflation.
Real interest rate = Nominal interest rate – inflation rate.
5.
 Inflation premium: A percentage built into a nominal interest rate to anticipate the rate of
inflation for the loan period.
Nominal interest rate = desired real interest rate + inflation premium.
Brief Review.
 Inflation is a general increase in the prices of goods and services in the entire economy. A
general fall in prices is known as deflation.
 The consumer price index (CPI) is one indicator of inflation, or changes in the cost of
living. The CPI measure price changes in a typical “Shopping Basket” of consumer
products.
 Whereas a nominal income is expressed in current dollars, real income is expressed in
constant base-year dollars. Real income equals nominal divided by the current value of
CPI.
 The GDP deflator measures price changes for all goods and services produced in the
economy, and weights them in terms of the economy’s total output. Nominal GDP divided
by the current value of GDP deflator gives the economy’s real GDP, or real output.
 The extent to which inflation affects individual’s purchasing power varies. Those people
whose incomes are fully indexed to inflation rates maintain purchasing power. However,
those with partially indexed or fixed incomes lose purchasing power.
 Lenders also lose from inflation if inflation is higher than they anticipated with the
inflation premium.
Unemployment
Introduction.
Labour population -The population with specific exclusions, from which Statistics Canada takes
a random sample for the labour force survey
-includes all residents of Canada except those in the Northwest Territories, Yukon, Native
reserves, and institutions (jails, psychiatric hospitals)
Labour Force- All people who either have a job or are seeking active employment (excludes
those who do work in formal job market)
Participation Rate- The percentage of the entire labour force population that makes up the
labour force
Participation rate = Labour Force
x 100
Labour Force Population
Ex. In 1993 Canada’s labour force was 13.946 million and the labour force population was
21.392 million
65.2% = 13 946 000
21 392 000
The Official Unemployment Rate- The number of unemployed people in the labour force as a
percentage of the entire labour force
Ex. The 1993 Labour force of 13.946 people was composed of 12.383 million people who were
employed and 1.562 million people who were not.
Unemployment Rate = Unemployment in Labour Force x 100
Labour Force
11.2%= 1 562 000
13 946 000
Drawbacks
Because of how the unemployment rate is calculated, it may underestimate or overstate the true
level of unemployment in the economy. Critics point to the factors: underemployment,
discouraged workers, and dishonesty.
2.
Fig 11.7 – The Canadian Labour force (1993)
Underemployment- The problem of workers being underutilized, either as part-time workers or
by working at jobs not appropriate to their skills or education. It is sometimes argued that the
official rate understates unemployment by ignoring the underplayed workers.
Discouraged Workers-Unemployment statistics do not take into account unemployed people who have given up
looking for work.
Dishonesty- Some people responding to Statistics Canada’s labour market survey may state that
they are actively looking for work, when they really are not.This makes it possible for the official
rate to overstate employment.
Types of Unemployment
There are four different types of unemployment: frictional, structural, cyclical, and seasonal
unemployment
Frictional Unemployment- Unemployment due to being temporarily between jobs or looking for
a first job. It is a permanent feature of labour markets, represents about 3% of the labour force at
all times.
Structural Unemployment- Unemployment due to a mismatch between people and jobs. This
type of unemployment occurs because of gradual changes in the economy. Long term
adjustments in what, how, and where products are produced cause such unemployment.
Cyclical Unemployment- Unemployment due to the ups and downs of economies and
businesses, causing unemployment to rise and fall.
3.
Seasonal Unemployment- Unemployment due to the seasonal nature of some occupations and
industries
Full Employment
It is the highest reasonable expectation of employment for the economy as a whole, as is defined
in terms of the Natural Employment Rate
Fig 11.8 – The Unemployment Rate.
Natural Employment Rate- which is the unemployment rate that defines full employment.
Includes frictional unemployment, but traditionally excludes cyclical and seasonal
unemployment.
Increases over the past few decades in both the actual and the natural unemployment rates
represent worrisome trends, which can be explained by the following factors:
Structural Change
-Structural Adjustments in an economy occur when there are changes regarding what products
are produced and how
-Pace of structural change has accelerated over past decade
-removal of trade barriers and growth of service sector and shrinking of manufacturing sector
have caused long-term structural unemployment
Unemployment Insurance
4.
- Financial cushion provided by unemployment insurance allows job seekers to devote more time
and effort to searching for employment than in the past, increasing frictional unemployment
-Reforms to unemployment have made it easier for those experiencing seasonal and structural
unemployment to claim benefits
-Therefore it can be a factor in increasing the unemployment rate
Changing Participation Rates
-Youth add supply of unskilled workers
-When first entering, as they acquire skills and work experience they also suffer greater frictional
unemployment than more experienced workers
-Resulting in increased participation rates among young Canadians swelling ranks of the
unemployed
Minimum Wage
-Min wage has increased in past few decades
-Young people are more likely to be affected by minimum wage laws, this has meant an increase
in the number of people looking for work
-Study showed 10% increase in min. wage reduces employment by 1% for male teens and 2.7%
for female teens
The Costs of Unemployment
-high unemployment hurts Canadian economy and individuals
-Costs of unemployment for the entire economy are indicated by the GDP gap
GDP Gap- The difference between potential and actual real output, or Gross Domestic Product,
of an economy
Potential Output- The real output, or Gross Domestic Product, associated with full employment
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