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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 --------------------------------- xxxxxxxxxxxxxxxxxxxxxxxxx------------------------------------ ----------------xxxxxxxxxxxxxxxxxxxxxxxxxx-------------------------------------