Download ECON00 Chapter 3

Chapter 3
Costs of (Not)
Working and Living
Unemployment and
Inflation
LEARNING OBJECTIVES
3.1
What the unemployment rate measures and
misses, and different types of unemployment
3.2
The natural rate of unemployment
and its connection to GDP gaps
3.3
Inflation rate and calculating it
3.4
Use of the quantity theory of money to explain
inflation rate
3.5
Phillips Curve and its connections to demandpull and cost-push inflations
continued…
WHO IS UNEMPLOYED?
HEALTHY & UNHEALTHY TYPES OF UNEMPLOYMENT
Unemployment rate measures percentage of labour force
out of work and actively searching for jobs, but misses
involuntary part-time and discouraged workers. Four types
of unemployment — frictional, structural, seasonal, cyclical.
Only cyclical is both unhealthy and a problem.
Fig. 3.1
Labour Force Categories for Working-Age
Population, May 2009
Labour Force
18 380 600
(employed +
unemployed)
Unemployed
1 548 400
Not in Labour Force
8 869 400
Employed
16 832 200
Working-Age Population 27 250 000
Fig. 3.2: Unemployment Rates in Canada, 1926 - 2009
Fig. 3.3: Unemployment & Underutilization of Labour, May 2009
Percentage of
Labour Force
Official unemployment rate
8.7
Involuntary part-time workers
2.6
Discouraged workers
0.2
Total Underutilization Rate
11.5
Fig. 3.4
Provincial Unemployment Rates, May 2009
Province
Unemployment Rate
Newfoundland/Labrador
15.1
Prince Edward Island
13.1
Nova Scotia
8.9
New Brunswick
8.8
Quebec
8.7
Ontario
9.4
Manitoba
4.9
Saskatchewan
4.9
Alberta
6.6
British Columbia
7.6
Fig. 3.5
Varieties of Unemployment
Type of
Healthy/
Problem that
Unemployment Unhealthy Needs
Addressing?
Cause
Frictional
Healthy
No
Normal, healthy market
adjustments of demand
and supply
Structural
Healthy
Yes (worker
Technological change,
retraining)
international
competition, resource
depletion
Seasonal
Neutral
No
Weather and seasons
Cyclical
Unhealthy
Yes (fiscal or
monetary policy)
Business cycles
HOW FULL IS “FULL EMPLOYMENT?”
THE NATURAL RATE OF UNEMPLOYMENT
Natural rate of unemployment at full employment,
where only healthy frictional, structural, seasonal
unemployment. Relative to natural rate, unemployment
rate is higher in recessionary gap and lower in inflationary gap.
UNEMPLOYMENT
Statistics Canada sorts working-age population
(age 15 and over) into three categories
– employed
working full-time or part-time at paid job
– unemployed
not doing paid work and actively searching for
job; on temporary layoff; about to start new
job
– not in the labour force
not employed or unemployed
(full-time student, homemaker, retiree)
continued…
• Labour force = employed + unemployed
• Unemployment rate
percentage of people in labour force who are
unemployed
Unemployed
× 100
– Unemployment Rate =
Labour Force
continued…
• Labour force participation rate
– percentage of working-age population in
labour force (employed or unemployed)
– Labour Force Participation Rate
Labour Force
=
Working Age Population
× 100
continued…
• Unemployment rate misses
– involuntary part-time workers
employed part-time but would rather
have full-time job, and can’t find one
– discouraged workers
want to work but have given up
actively searching for jobs
• Labour underutilization rate
unemployment rate including unemployed,
involuntary part-time, discouraged workers
Healthy and unhealthy types of unemployment
Frictional unemployment
due to normal labour turnover and job search; healthy part
of changing economy; not a problem
Structural unemployment
due to technology or international competition making
workers obsolete; healthy part of
changing economy; problem requiring retraining
Seasonal unemployment
due to seasonal changes in weather;
neither healthy nor unhealthy; not a problem
Cyclical unemployment
due to fluctuations in economic activity; unhealthy part of
changing economy; problem needs addressing
NATURAL RATE OF UNEMPLOYMENT
Natural rate of unemployment
unemployment rate at full employment; includes
frictional, structural, seasonal unemployment
full employment
is not zero percent unemployment
but zero percent cyclical unemployment
Fig. 3.6
Real GDP and
Output Gaps and Unemployment
Output Gap
Unemployment Rate
None
Natural rate of unemployment —
full employment (only frictional,
Potential GDP
Real GDP equals
potential GDP
structural, seasonal unemployment)
Real GDP below
potential GDP
Recessionary gap
Unemployment rate above natural
rate (cyclical unemployment)
Real GDP above
potential GDP
Inflationary gap
Unemployment rate below natural
rate (less than normal frictional,
structural, seasonal employment)
• Natural rate of unemployment and potential GDP
– when unemployment = natural rate
real GDP = potential GDP
full employment
– when unemployment > natural rate
real GDP < potential GDP
recessionary gap
cyclical unemployment
– when unemployment < natural rate
real GDP > potential GDP
inflationary gap
• Economists disagree about the natural rate
LIGHTENING UP YOUR WALLET:
WHAT IS INFLATION?
Inflation hurts those on fixed incomes,
creates risk for business investment and can increase
in a vicious cycle of expectations. Inflation rate overstates
cost of living increases, missing switches to cheaper
and improved products/services.
INFLATION
• Inflation is persistent rise in average prices
and fall in value of money
– spend more to get same products/services
– your money is worth less
• Consumer Price Index (CPI)
measure of average prices of a fixed shopping
basket of products and services
– CPI = 100 for the base year, currently 2002
Fig. 3.7
Consumer Price Index Basket
Health,
personal care
4.7%
Recreation,
education,
reading
12.2%
Alcoholic beverages,
tobacco products
3.1%
Food 17%
Transportation
19.9%
Clothing,
footwear
5.4%
Shelter 26.6%
Household operations,
furnishing and equipment
11.1%
• Inflation rate
annual percentage change in consumer price index
– Inflation =
CPI for current year − CPI for previous year
CPI for previous year
× 100
– Core inflation rate
inflation rate excluding volatile categories
Fig. 3.8
Inflation Rates in Canada, 1960 - 2009
Fig. 3.9
Inflation Rates and Core Inflation Rates
in Canada, 1960 - 2009
• Inflation is a worry because of falling value of
money
– inflation reduces purchasing power
of people with fixed (unchanged dollar)
income or savings
– nominal interest rate
observed interest rate; dollars per year
in interest as percentage of dollars saved
– realized real interest rate
is nominal interest rate adjusted for inflation
= nominal interest rate − inflation rate
• Inflation is a worry because
– unpredictable prices create risk
and discourage business investment
– expectations of inflation can
cause inflation
• Predictable inflation rate
between 1 and 3 percent
is the Bank of Canada’s aim
VICIOUS CYCLE
• Deflation
persistent fall in average prices and rise in
value of money
– consumers may postpone purchases,
causing contraction and increasing
unemployment
– deflation benefits
savers but hurts
borrowers
– deflation is worse
than low inflation
• CPI fixes quantities in shopping basket to isolate
only the impact of changing prices on cost of living
– when prices rise, CPI misses switches to
cheaper substitutes and new/improved
products
– inflation rate based on CPI overstates
increases in cost of living
INFLATION STARTS WITH “M”
THE QUANTITY THEORY OF MONEY
Quantity theory of money explains inflation from
increases in quantity of money, holding constant
velocity of money and quantity of real output.
Fig. 3.10 Simple Circular Flow
QUANTITY THEORY OF MONEY
• For any economy with money, M × V = P × Q
– M
quantity of money
– V
velocity of money
number of times a unit of money
changes hands
– P
average prices; Consumer Price Index
– Q
aggregate quantity of real output
– P×Q
nominal GDP
• There must be enough money, multiplied by
velocity, to allow sales of output produced
(nominal GDP)
continued…
• Quantity Theory of Money
increase in quantity of money causes an equal
percentage increase in inflation rate
– take equation M × V = P × Q and
fix V and fix Q at potential GDP
– “printing money causes inflation”
• Inflation always accompanied by increase in
quantity of money
WHEN TIM HORTONS PAYS $18 PER HOUR:
UNEMPLOYMENT AND INFLATION TRADEOFFS
Phillips Curve shows tradeoff between unemployment
and inflation consistent with demand-pull inflation.
Cost-push inflation, changes in expectations and natural rate
of unemployment complicate the original Phillips Curve.
UNEMPLOYMENT – INFLATION TRADEOFFS
• Phillips Curve
graph showing inverse relation between
unemployment and inflation
• Demand-pull inflation
rising average prices caused by increases
in demand explain Phillips Curve’s tradeoff
between unemployment and inflation
– during expansions, demand is key force
causing shortages and pulling up prices
for inputs (wages) and outputs
Fig. 3.11 Phillips Curve in Canada, 1946 - 1969
• Cost-push inflation
rising average prices caused by decreases in supply
— does not fit Phillips Curve
– caused by supply shocks
events directly affecting business’s costs,
prices, and supply. Decrease in supply key force
pushing up output prices, while pushing economy
into contraction, increasing unemployment.
– can cause stagflation
simultaneous recession (unemployment)
and inflation
Fig. 3.12 Phillips Curve in Canada, 1946 - 2009
• Both demand-pull and cost-push inflation require
accompanying increase in quantity of money
• Trade-offs between unemployment and inflation
of Phillips Curve are complicated due to changes
in
– expectations
– natural rate of unemployment
Fig. 3.13 Types of Inflation
Type of Inflation
Demand-Pull
Cost-Push
Phase of business cycle
Expansion
Contraction
Unemployment
 unemployment
 unemployment
Inflation
 inflation
 inflation
Relation between
Unemployment and
Inflation
Tradeoff
(Phillips Curve)
Simultaneous
(Stagflation)