Inflation and Inflation and UnemploymentUnemployment

Day 1 FocusDay 1 FocusInflation, its two measures – the

CPI and the GDP – and their limitations

Nominal and real incomes, both for individuals and the entire economy

Effects of InflationUnemployment continuing on Day 2

DefinitionsDefinitions

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 Consumer Price Index (CPI)(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

ExampleExample

1994 Prices Q per month $ per month Weights

Hamburgers $2.00 10 $20 20/50=0.4Milkshakes $1.00 30 $30 30/50=0.6

1995 1995 price x 1994 Q

Hamburgers $2.20 $2.20 x 10 = $22.00Milkshakes $1.05 $1.05 x 30 = $ 31.50

Total $ 22.00 + 31.50 = $53.50

CPI Example Con’dCPI 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 Nominal versus Real IncomeIncome

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 base-year dollars

Real income = nominal income CPI

Purchasing power is inversely related to CPI

ExampleExample A consumer’s income increased from $1000 to

$1050 at the same time the CPI is 1.10Real 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 CPILimitation of CPI

Consumer DifferencesChanges in Spending PatternsProduct Quality

GDP deflatorGDP 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 popularExample on page 312 and 313

Simple GDP DeflatorSimple GDP Deflator

Year Output of Microchips

Current Price

Output at current price

Output at 1994 Price

GDP Deflator

1994 1000 $ 0.20 $ 200 $ 200 1.0

1995 2000 $ 0.30 $ 600 $ 400 1.5

1996 2500 $ 0.40 $1000 $ 500 2.0

Finding Real Gross Finding Real Gross Domestic ProductDomestic Product

Year Nominal GDP (current $ billion)

GDP Deflator (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 GDPNominal 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 EffectsInflation Effects IncomeCost-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’dInflation Effects con’dBorrowing and LendingNominal interest rates : the interest rate expressed in

money termsReal interest rates : the nominal interest rate minus the

rate of inflationReal interest rates = nominal interest rate – inflation rateInflation premium : a percentage built into a nominal

interest rate to anticipate the rate of inflation of the loan period

ExampleExample1. 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 QuestionsReview Questions1. 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 2Review 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 FocusDay 2 FocusLabour force and unemploymentLimitations of the official

unemployment rateFrictional, structural, cyclical, and

seasonal unemploymentFull employment, the reasons for

changes in unemployment, and the costs of unemployment

What Causes What Causes Unemployment?Unemployment?

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

UnemploymentUnemployment 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 The Labour Force SurveySurvey

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 The Labour Force Survey (cont’d)(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 RatesParticipation Rates

The Official The Official Unemployment RateUnemployment 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 The Canadian Labour ForceForce

Drawbacks of the Official Drawbacks of the Official Unemployment RateUnemployment 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 Types of UnemploymentUnemployment

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 Types of Unemployment Unemployment

Continued…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 EmploymentFull 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 Factors That Influence Natural Unemployment RatesUnemployment 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 Factors That Influence Unemployment Rates (cont’d)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 UnemploymentThe Costs of Unemployment 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 What are some ways that can help lower can help lower

unemployment?unemployment?Early RetirementJob SecurityJob Training/RetrainingWork-Sharing ProgramsUnemployment Insurance

ReviewReview1. Which people in Canada are not considered

as part of the Labour Force Population?2. What are the formulas of the Population and

Official Unemployment Rates?3. What are the three drawbacks of the Official

Unemployment Rate?4. What are the four different types of

Unemployment found in Canada?5. What are the four trends/factors that

influence the unemployment rate?6. What indicates the cost of unemployment for

the economy?