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Inflation and
Unemployment
Day 1 Focus
its two measures – the
CPI and the GDP – and their
limitations
 Nominal and real incomes, both
for individuals and the entire
economy
 Effects of Inflation
 Inflation,
 Unemployment
continuing on Day 2
Definitions
Inflation – a general increase in the prices of
goods and services in an entire economy over
time.
Deflation – a general decrease in the level of
prices
Consumer Price Index
(CPI)

Most common tool to measure inflation

Measures price changes for a typical basket
of consumer products

Base Year – the survey year used as a point
of comparison in subsequent years

Item weights – the proportions of each good
in the total cost of the basket of consumer
goods used to calculate CPI
Example
1994
Prices
Q per month $ per month
Weights
Hamburgers
$2.00
10
$20
20/50=0.4
Milkshakes
$1.00
30
$30
30/50=0.6
1995
1995 price x 1994 Q
Hamburgers
$2.20
Milkshakes
$1.05
$1.05 x 30 = $ 31.50
Total
$ 22.00 + 31.50 = $53.50
$2.20 x 10 = $22.00
CPI Example Con’d
Inflation = total cost of the base year – total cost
of the new year
 In this example : $53.50 - $50 = $3.50 or 7%
($3.50 / $50)
 1995 CPI is 1.07

Nominal versus Real
Income
Cost of living – the amount consumers
must spend on the entire range of goods
and services they buy
 Nominal income – income expressed in
current dollars
 Real income – income expressed in baseyear dollars
 Real income = nominal income
CPI


Purchasing power is inversely related to CPI
Example

A consumer’s income increased from $1000 to
$1050 at the same time the CPI is 1.10
Real income = Nominal income
CPI
= $ 1050
= $ 954.55
1.10

Since the increase of income is lower than
inflation, the consumer’s purchasing power is
lowered
 A higher income rate will allow consumers to
battle inflation
Limitation of CPI
 Consumer
Differences
 Changes in Spending Patterns
 Product Quality
GDP deflator

An indicator of price changes for all goods
and services produced in the economy
 Updated every year to increase accuracy,
but takes time.
 Since it takes time, CPI is more popular
 Example on page 312 and 313
Simple GDP Deflator
Output of Current Output at Output
current
Microchips Price
at 1994
price
Price
1994 1000
$ 0.20 $ 200
$ 200
GDP
Deflator
1995 2000
$ 0.30
$ 600
$ 400
1.5
1996 2500
$ 0.40
$1000
$ 500
2.0
Year
1.0
Finding Real Gross
Domestic Product
Year
Nominal GDP
GDP Deflator
(current $ billion) (1986 = 1.00)
Real GDP
(1986 $ billion)
1968
$ 75.4
0.3000
$ 251.3
1986
$ 505.7
1.0000
$ 505.7
1993
$ 710.7
1.2394
$ 573.4
Nominal Versus Real GDP
Nominal GDP – Gross Domestic Product in
current dollars
 Real GDP – Gross Domestic Product in
base year dollars
 Real GDP = Nominal GDP
GDP deflator

Inflation Effects

Income
 Cost-of-living-adjustment clauses : provision
for income adjustments to accommodate
changes in price levels, which are included in
wage contracts
 Fully indexed incomes: nominal incomes that
automatically increase by the rate of income
 Partially indexed incomes: nominal incomes
that increase by less than the rate of inflation
 Fixed income: nominal incomes that remain
fixed at some dollar amount regardless of the
rate of inflation
Inflation Effects con’d

Borrowing and Lending
 Nominal interest rates : the interest rate
expressed in money terms
 Real interest rates : the nominal interest rate
minus the rate of inflation
 Real interest rates
= nominal interest rate – inflation rate
 Inflation premium : a percentage built into a
nominal interest rate to anticipate the rate of
inflation of the loan period
Example
1.
Suppose that the inflation rate for this year is 2%.
If Mr.X made a loan of $10,000 at 5% per annum
from Y.D Bank. Calculate the interest to be paid at
the end of the year. Identify the nominal interest
rate and real interest rate.
Nominal Interest = $10,000 x 5%
= $500
Therefore, interest to be paid is
= $ (10,000 + 500)
= $ 10,500
Nominal interest rate = 5%
Real interest rate = 5% - 2% (nominal – inflation)
= 3%
Review Questions
1. What is the difference between Consumer Price
Index and the GDP Deflator?
2. What is the difference between nominal income
and real income?
3. What is the difference between nominal GDP and
real GDP?
4. If the nominal GDP for this year is higher than the
GDP of the base-year 1993. Does it necessarily
mean the economy is producing more?
Review Questions Part 2
1. How would you know if the economy is producing
more?
2. What are the limitations of the Consumer Price
Index?
3. How do you find the real interest rate? Why is it
important to find it out if you are a lender?
Day 2 Focus
 Labour force
and unemployment
 Limitations of the official
unemployment rate
 Frictional, structural, cyclical, and
seasonal unemployment
 Full employment, the reasons for
changes in unemployment, and the
costs of unemployment
What Causes
Unemployment?

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



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Education Levels
Lack of Work Experience
Regions
Shifts in Industry
Personal Factors (laziness, drugs, etc.)
Labour Unions
Changes in the National/International
Economy
Seasonal Requirements
Government Policies/Programs
Unemployment

The unemployment rate is the one most often
highlighted in the media, discussed by politicians,
and noticed by Canadians.
 To see why unemployment provokes considerable
anxiety, we must:
– understand unemployment
– how it is measured
– its implications for individuals and for the economy as a
whole.
The Labour Force Survey

Statistics Canada keeps track of the Canadian
workforce through a monthly survey of about
59,000 household.
 Labour force population is from which Statistics
Canada takes a random sample for the labour force
survey.
– Excluding residents under the age of 16 and those who live
in the Northwest Territories, Yukon and Nunavut. Also, it
excludes residents of institutions and Native reserves.
The Labour Force Survey
(cont’d)

The labour force is all the people who either
have a job or are actively seeking employment.
 The participation rate is the percentage of the
entire labour force population that makes up
the labour force.
 PR =

Labour Force
x 100
Labour Force Population
Statistics Canada also examines the
participation of specific groups of people. Ex)
women, men, people over and under 25
Participation Rates
The Official
Unemployment Rate

The official unemployment rate is the number
of unemployed people in the labour force as a
percentage of the entire labour force.
– Unemployment rate = unemployed in labour force
divided by the labour force, times 100.
– In 1993, the labour force was 13.946 million people
composed of 12.383 million with jobs and 1.562
without. This means that Canada’s unemployment
rate in 1993 was 11.2%.
The Canadian Labour
Force
Drawbacks of the Official
Unemployment Rate

Underemployment
– The problem of workers being underutilize, either as part-
time workers or by working at jobs not appropriate to their
skills or education
– It is argued that the official rate understates unemployment
by ignoring underemployed workers.

Discouraged Workers
– These are unemployed workers who have given up looking
for work and are not taken into account, which causes the
understating of unemployment.

Dishonesty
– People may state that they are actively looking for work
when, in fact, they are not. This can make it possible to
overstate the official unemployment rate.
Types of Unemployment

Frictional Unemployment
– It is unemployment due to being temporarily between
jobs or looking for a first job.
– An example would be a dental assistant who has left
one job voluntarily to look for another or a recent
university graduate looking for his or her first job.

Structural Unemployment
– This unemployment is due to a mismatch between
people and jobs.
– It also occurs primarily because of gradual changes in
the country’s economy.
– Examples are workers who lose their job because of the
shift from goods to services and some of these workers
do not have the skills to find another job that quickly.
Types of Unemployment
Continued…

Cyclical Unemployment
 It is unemployment due to the ups and downs of
economies and businesses.
 An auto worker, for example, may work overtime in
periods of strong consumer demand for cars, but be laid
off in leaner times.

Seasonal Unemployment
 It is unemployment due to the seasonal nature of some
occupations and industries.
 Seasonal unemployment is particularly significant in
Canada, given its climate and the importance of its
primary resource industries.
 Some examples are agriculture, construction and
tourism, which have lower employment for certain
seasons.
Full Employment
Def’n: the highest reasonable expectation of
employment for the economy as a whole
 Defined in terms of a natural unemployment
rate

 Includes frictional unemployment
 Excludes seasonal unemployment and cyclical
unemployment

In 1950s and 1960s, full employment occurred
when the natural unemployment rate was 3
percent or less
 Full employment was occasionally achieved

Today, full employment varies between 6 and 8
percent
Factors That Influence Natural
Unemployment Rates

Structural Change
 Occurs when there are structural adjustments in an economy


e.g. changes in what products are produced, how and where
they are produced
Unemployment Insurance
 UI increases frictional unemployment by allowing job seekers
to devote more time and effort to search for employment
 Reforms in early 1970s to UI has made it easier for those
experiencing seasonal and structural unemployment to claim
benefits
 UI has added between 0.5 percent and 2.0 percent to the
unemployment rate since the 1970s
Factors That Influence
Unemployment Rates (cont’d)

Changing Participation Rates
 Young workers add to the supply of unskilled labour
when they first enter the labour force
 As they struggle to acquire skills and more work
experience, they suffer greater frictional
unemployment than more experience workers

Minimum Wage
 An increase in minimum wage, increases the amount
of people looking for work
 Hence, the demand for employment cannot be met
by the supply because employers do not want to hire
more for workers at higher wages
The Costs of Unemployment
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Unemployment, especially for extended periods can
cause stress, discouragement, disrupt family life, lower
self-esteem, and cause financial hardship
The economy as a whole loses the output the worker
could have produced
The cost of unemployment for the economy is indicated
by the GDP gap, which is the dollar value by which
potential output, or the real output associated with full
employment, exceeds actual real output
Okun’s Law: for every percentage point that the
unemployment rate exceeds the natural unemployment
rate, the GDP gap is 2.5 percent
– Represents the relationship between an economy’s GDP gap
and natural unemployment
What are some ways that
can help lower
unemployment?

Early Retirement
 Job Security
 Job Training/Retraining
 Work-Sharing Programs
 Unemployment Insurance
Review
1.
2.
3.
4.
5.
6.
Which people in Canada are not considered
as part of the Labour Force Population?
What are the formulas of the Population and
Official Unemployment Rates?
What are the three drawbacks of the Official
Unemployment Rate?
What are the four different types of
Unemployment found in Canada?
What are the four trends/factors that
influence the unemployment rate?
What indicates the cost of unemployment for
the economy?