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ECO102H1 Study Guide - Deflation, Fallacy, Nominal Interest Rate

Course Code
James Pesando

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Labor force activity
Labour force = Number of employed + Number of unemployed
Unemployment rate = Number of unemployed/ labor force * 100
Participation rate = Labour Force/ adult population * 100
Suppose if number of jobs = number of workers, would the unemployment rate be
Frictional unemployment: mismatch reflects normal labor turnover
Structural unemployment: mismatch in skill level, occupation, or region
*Cyclical unemployment related to business cycle
*Macroeconomic in origin
(Lipsey- Ragan: NAIRU)
Cyclical unemployment is zero unemployment is frictional or structural
When the economy is t the natural rate of unemployment (NAIRU):
Real GDP = Potential GDP
Recessionary gap is zero
Unemployment Rates February 2010 February
Canada: 8.2% 7.8%
U.S.: 9.7% 8.9%
Natural Rate of unemployment (estimated by economists)
Canada: 6.0%
U.S.: 4.5%
Monetary Policy
Bank of Canada controls money supply/ interest rate to influence aggregate demand
Fiscal Policy
Government uses expenditures/ taxes to influence aggregate demand
March 2009 Deep Recession
Centeral bank’s target Interest rate Implication
Canada 0.5% (almost) no potential for further stimulus to A.D. from interest rate
U.S. 0.5%
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Potential to use money policy very limited
Result: U.S. and Canada adopt expansionary fiscal policy
Government Budget
1. Government expenditures
2. Transfer payments to households (unemployment insurance, social
assistance, public pensions, etc.)
3. Interest on public debt
Revenues outlays = 0 Balanced budget
Revenues outlays > 0 Budget surplus
Revenues outlays < 0 Budget deficit
Budget deficit => future outlays must be reduced and/or future revenues
(taxes) increased
Large budget deficits => higher (effective) tax burden on future generations
Determinants of Natural Rate
Demographics (composition of labor force)
%young, unskilled natural rate
Technological Change
rapidity natural rate
Employment Insurance
Generosity opportunity cost of job search
unemployed workers less willing to accept job offers
natural rate
Minimum Wage Laws
Minimum wage natural rate
Question: Should the government make unemployment benefits more generous
(easier to qualify; longer period of benefits) in regions where unemployment is
Insight: What incentives would this create?
Answer: would increase unemployment, by discouraging the unemployed
from leaving high unemplyment regions. Ie) Newfoundland
Inflation: the rate at which the price level is rising
Repeated increases in the money supply produce repeated increases in the price
level and thus create inflation.
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