16 January 2013
CHAPTER 19: INFLATION AND UNEMPLOYMENT [CONT’D] SUPPLEMENTARY B
If we multiply 1.9% by 20 years, we got 38% without compounding; prices would have only risen by 38%
not 44.8%. This shows the “power” of compounding. There is a simple rule known as the rule of 72.
# OF YEARS NEEDED FOR A NUMBER TO DOUBLE = 72 / X %
72 / 1.9 = 37.9 which means it take 37.9 years for prices to double
Should we worry about inflation? Why inflation is bad?
Inflation rate was relatively low and stable in recent years (due to the 2% inflation target set by the Bank
of Canada, and the inflation target has been extended to 2016). In the 1970s and early 80s, Canada
experienced high inflation and it caused problem.
What are the issues with inflation?
It reduces the purchasing power of money, the amount of goods and services that can be
purchased with a unit of money (IE: If a hamburger costs 39 cents in 1967 you can buy 13
hamburgers with $5. In 2013, it costs $1.39. The same $5 will only be able to buy 3. The fact that
the same $5 buys fewer hamburgers means there is a reduction in purchasing power)
It reduces the real value of anything whose price is fixed in money terms (IE: If an individual
receives and allowance from their parents but with inflation, the individual may ask their
parents for a raise because if they give the same amount they buy less)
There is redistribution of wealth; unexpected inflation would redistribute wealth arbitrarily (IE:
After WW1, Germany experienced hyper inflation so people did not want to hold money
because it would make them suffer losses. Because they did not want to trade by exchanging
money they would use the barter system by exchanging goods)
There is inefficiency, erosion of money as medium of exchange
A solution to inflation, to make sure it does not pose these problems, is indexation which is increasing
the monthly dollar payment by the inflation rate.
Example #6 Compare Incomes in Different Years
Suppose you earned $80000 in 2011
CPI in 1991 = 82.8
CPI in 2011 = 119.9
What is your 2011 income measured in 1991 dollars?
To get income in year B into year A prices:
INCOME X PRICE INDEX / PRICE INDEX
B A B
$80000 X 82.8 / 119.9 = $55246.04. Those who earned $80000 in 2011, they earn $555246.04 in 1991.
Suppose you earned $45000 in 1991, what is your 1991 income measured in 2011 dollars?
$45000 X 119.9 / 82.8 = $65163.04. Those who earned $45000 in 1991 would earn $65163.04 in 2011. UNEMPLOYMENT
We conduct the “labour force survey” that classifies the adult population (age 15 or above) into 3
Employed (E) are those who get a paid job (E = LF – U)
Unemployed (U) are those who currently do not have a job but are looking for one
Not In The Labour Force (NILF) are those who do not have a job and are not looking for one (IE:
housewives, retired people, armed forces)
By classifying the adult populations in these 3 groups, we can calculate:
LABOUR FORCE (LF) = # OF EMPLOYED + # OF UNEMPLOYED