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Chapter 21

Economics 1022A/B Chapter Notes - Chapter 21: Output Gap, Gdp Deflator, Potential Output

Course Code
ECON 1022A/B
Desmond Mc Keon

of 3
Chapter 21
Unemployment results in:
-lost incomes and production and lost human capital
The population is divided into two groups:
1. The working-age population- there number of people aged 15 years and older
who are not in institutional care
2. People too young to work (under 15 years of age) or in institutional care
And the working age population is divided into two groups:
1. People in the labor force
2. People not in the labor force
-the labour force is the sum of employed and unemployed workers
-a marginally attached worker is a person who currently is neither working nor
looking for work but has indicated that he or she wants a job and is available and
has looked for work sometime in the recent past
-to be counted as unemployed, a person must be available for work and must be in
one of three categories:
1. Without work but has made specific efforts to find a job within the previous
four weeks
2. Laid off from a job and waiting to be called back to work
3. Waiting to start a new job within four weeks
The unemployment rate is the percentage of the labour force that is unemployed
-(# of people unemployed/labour force) x100
The involuntary part-time rate is the percentage of the labour force who work part
time but want full-time jobs
-(# of involuntary part-time workers/labour force) x100
The labour force participation rate is the percentage of the working-age population
who are members of the labour force
-(labour force/working-age population) x100
-frictional unemployment is unemployment that arises from normal labour market
turnover (creation and destruction of jobs requires that unemployed workers
search for new jobs)
-structural unemployment is unemployment created by changes in technology and
foreign competition that change the skills needed to perform jobs or the locations of
-cyclical unemployment is higher than normal unemployment at a business cycle
trough and lower than normal unemployment at a business cycle peak (firing during
recession, hiring back after)
-“natural” unemployment is the unemployment that arises from frictions and
structural change when there is no cyclical unemployment (all frictional and
structural unemployment)
-full employment is defined as the situation in which the unemployment rate equals
the natural unemployment rate (no cyclical unemployment)
-potential GDP is the quantity of real GDP produced at full employment
and real GDP-potential GDP is the output gap
the output gap fluctuates and the unemployment rate fluctuates around the natural
unemployment rate
when the unemployment rate is greater than the natural unemployment rate, real
GDP is less than potential GDP and the output gap is negative (vice versa)
-the price level is the average level of prices and the value of money
persistently rising level is inflation and the inverse is deflation
unpredictable inflation or deflation is a problem because it redistributes income and
wealth, lowers real GDP and employment, diverts resources from production
hyperinflation is an extremely rapid inflation rate
CPI measures the average of the prices paid by urban consumers for a “fixed” basket
of consumer goods and services
CPI is defined to equal 100 for the reference base period
Constructing the CPI involves: selecting the basket, monthly price survey then
calculating the CPI:
1. find the cost of CPI basket at base period
2. find cost of CPI basket at current prices
3. calculate the CPI for current period
ie. 100 at base period, 140 at current period and therefore, 40% inflation rate
biased CPI:
-new goods bias: not available in base year and if more expensive than goods at base
year, upward bias
-quality change bias: payment made for improved quality and not inflation
-commodity substitution bias: does not take in consumers’ substitutions away from
goods whose relative prices increase
-outlet substitution bias: people switch to buying from cheaper sources as retail
-the magnitude of bias say that CPI overstates inflation by 1.1 percentage points a
-consequences? Distorts private contracts, increases government outlays
-GDP deflator equals
(nominal GDP/real GDP) x100
-broader measure of the price level than the CPI because it includes all consumption
expenditure, investment, government expenditure on goods and services, and net
-CPIC is an index of the prices of all the items included in the consumption
expenditure in GDP
CPIC= (nominal consumption expenditure/real consumption expenditure) x100
~because both use current period and previous period quantities rather than fixed
quantites from an earlier period, they incorporate substitution effects and new
goods and overcomes the sources of bias in the CPI