Inflation and Unemployment Day 1 Focus l Inflation

Inflation and Unemployment

Day 1 Focus l Inflation, its two measures – the CPI and the GDP – and their limitations l Nominal and real incomes, both for individuals and the entire economy l Effects of Inflation l 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) l Most common tool to measure inflation l Measures price changes for a typical basket of consumer products l Base Year – the survey year used as a point of comparison in subsequent years l 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 $1. 00 10 30 20/50=0. 4 30/50=0. 6 Milkshakes 1995 $20 $30 1995 price x 1994 Q Hamburgers $2. 20 Milkshakes $1. 05 Total $2. 20 x 10 = $22. 00 $1. 05 x 30 = $ 31. 50 $ 22. 00 + 31. 50 = $53. 50

CPI Example Con’d l Inflation = total cost of the base year – total cost of the new year l In this example : $53. 50 - $50 = $3. 50 or 7% ($3. 50 / $50) l 1995 CPI is 1. 07

Nominal versus Real Income l Cost of living – the amount consumers must spend on the entire range of goods and services they buy l Nominal income – income expressed in current dollars l Real income – income expressed in baseyear dollars l Real income = nominal income CPI l Purchasing power is inversely related to CPI

Example l 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 l A higher income rate will allow consumers to battle inflation l

Limitation of CPI l Consumer Differences l Changes in Spending Patterns l Product Quality

GDP deflator l An indicator of price changes for all goods and services produced in the economy l Updated every year to increase accuracy, but takes time. l Since it takes time, CPI is more popular l Example on page 312 and 313

Simple GDP Deflator Year Output of Current Output at Output current Microchips Price at 1994 price Price 1994 1000 $ 0. 20 $ 200 GDP Deflator 1995 2000 $ 0. 30 $ 600 $ 400 1. 5 1996 2500 $ 0. 40 $1000 $ 500 2. 0 1. 0

Finding Real Gross Domestic Product Year Nominal 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 l Real GDP – Gross Domestic Product in base year dollars l Real GDP = Nominal GDP deflator l

Inflation Effects Income l Cost-of-living-adjustment clauses : provision for income adjustments to accommodate changes in price levels, which are included in wage contracts l Fully indexed incomes: nominal incomes that automatically increase by the rate of income l Partially indexed incomes: nominal incomes that increase by less than the rate of inflation l Fixed income: nominal incomes that remain fixed at some dollar amount regardless of the rate of inflation l

Inflation Effects con’d l Borrowing and Lending l Nominal interest rates : the interest rate expressed in money terms l Real interest rates : the nominal interest rate minus the rate of inflation l Real interest rates = nominal interest rate – inflation rate l 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 l Labour force and unemployment l Limitations of the official unemployment rate l Frictional, structural, cyclical, and seasonal unemployment l Full employment, the reasons for changes in unemployment, and the costs of unemployment

What Causes Unemployment? l l l l l 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. l To see why unemployment provokes considerable anxiety, we must: l – 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. l Labour force population is from which Statistics Canada takes a random sample for the labour force survey. l – 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. l The participation rate is the percentage of the entire labour force population that makes up the labour force. l Ø PR = l Labour Force x 100 Labour Force Population Statistics Canada also examines the participation of specific groups of people. Ex) women, people over and under 25

Participation Rates

The Official Unemployment Rate l 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 l 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. l 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. l 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 l 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. l 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… l Cyclical Unemployment Ø It is unemployment due to the ups and downs of economies and businesses. Ø An auto worker, for example, may work overtime in periods of strong consumer demand for cars, but be laid off in leaner times. l Seasonal Unemployment Ø It is unemployment due to the seasonal nature of some occupations and industries. Ø Seasonal unemployment is particularly significant in Canada, given its climate and the importance of its primary resource industries. Ø 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 l Defined in terms of a natural unemployment rate l Ø Includes frictional unemployment Ø Excludes seasonal unemployment and cyclical unemployment l In 1950 s and 1960 s, full employment occurred when the natural unemployment rate was 3 percent or less Ø Full employment was occasionally achieved l Today, full employment varies between 6 and 8 percent

Factors That Influence Natural Unemployment Rates l Structural Change Ø Occurs when there are structural adjustments in an economy Ø l e. g. changes in what products are produced, how and where they are produced Unemployment Insurance Ø UI increases frictional unemployment by allowing job seekers to devote more time and effort to search for employment Ø Reforms in early 1970 s to UI has made it easier for those experiencing seasonal and structural unemployment to claim benefits Ø UI has added between 0. 5 percent and 2. 0 percent to the unemployment rate since the 1970 s

Factors That Influence Unemployment Rates (cont’d) l Changing Participation Rates Ø Young workers add to the supply of unskilled labour when they first enter the labour force Ø As they struggle to acquire skills and more work experience, they suffer greater frictional unemployment than more experience workers l Minimum Wage Ø An increase in minimum wage, increases the amount of people looking for work Ø 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, especially for extended periods can cause stress, discouragement, disrupt family life, lower self-esteem, and cause financial hardship l The economy as a whole loses the output the worker could have produced l 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 l Okun’s Law: for every percentage point that the unemployment rate exceeds the natural unemployment rate, the GDP gap is 2. 5 percent l – Represents the relationship between an economy’s GDP gap and natural unemployment

What are some ways that can help lower unemployment? l Early Retirement l Job Security l Job Training/Retraining l Work-Sharing Programs l 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 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?