Textbook Notes (280,000)
CA (170,000)
York (10,000)
ECON (800)
ECON 1010 (200)
Chapter 21

ECON 1010 Chapter Notes - Chapter 21: Underemployment, Intelius, Hyperinflation


Department
Economics
Course Code
ECON 1010
Professor
Simin Seury
Chapter
21

This preview shows pages 1-3. to view the full 17 pages of the document.
Employment*and*Unemployment
Why*Unemployment*is*a*Problem
Unemployment*is*a*serious*personal*and*social*economic*problem*for*two*
main*reasons,*it*results*in:
Lost*Incomes*and*Production
The*loss*of*jobs*brings*loss*of*income*and*lost*production
These*losses*are*devastating*for*the*people*who*bear*them*
and*them*unemployment*a*frightening*prospect*for*everyone
Unemployment*benefits*create*a*safety*net,*but*they*do*not*
fully*replace*lost*earnings
Lost*production*means*lower*consumption*and*a*lower*
investment*in*capital,*which*lowers*living*standard*in*both*
present*and*the*future
§
Prolonged*unemployment*permanently*damages*a*person's*
job*prospects*by*destroying*human*capital
Example:*Think*about*a*manager*who*loses*his*job*when*his*
company*downsizes,*and*the*only*work*he*can*find*is*driving*a*
taxi
After*a*year*in*this*work,*he*discovers*that*he*can't*
compete*with*new*MBA*graduates
®
Eventually*he*gets*hired*as*a*manager*but*in*a*small*
firm*and*at*a*lower*wage*than*before
®
He*has*lost*some*his*human*capital
®
The*cost*of*lost*human*capital*is*particularly*acute*for*older*
workers
§
-
Labour*Force*Survey
Every*month*Statistics*Canada*conducts*a*Labour*Force*Survey*in*which*it*
asks*54,000*households*a*series*of*questions*about*the*age*and*job*
market*status*of*members*of*each*household*during*a*previous*week*
called*reference*week*
The*population*divides*into*two*bold*groups:*the*working*age*population*
and*those*who*are*too*young*to*work*or*who*live*in*institutions*and*are*
unable*to*work
The*Working*Age*Population*is*the*total*number*of*people*aged*15*and*
up
The*working*age*population*is*also*divided*into*groups:*those*in*the*
labour*force*and*those*who*are*not*in*the*labour*force
§
Members*of*the*labour*force*are*either*employed*or*unemployed
The*employed*are*either*full-time*or*part-time*workers:
And*part*time*workers*either*want*part-time*or*are*
looking*for*part*time*work
®
Involuntary*part-time*workers*and*voluntary*part-time*
workers
®
To*be*counted*as*employed*in*the*labour*force*survey,*a*
person*must*have*either*a*full*time*job*or*a*part*time*job
To*be*counted*as*unemployed,*a*person*must*be*available'for'
work'and*must*be*in*one*of*three*categories:
On*temporary*layoff*with*expectation*of*recall
®
Without*work*but*has*looked*for*work*in*the*past*four*
weeks
®
Has*a*new*job*to*start*within*four*weeks
®
People*who*satisfy*one*of*these*three*criteria*are*counted*as*
unemployed
People*in*the*working*age*population*who*are*neither*
employed*or*unemployed*are*classified*as*not*in*the*labor*
force*
§
-
The*unemployment*rate
The*amount*of*unemployment*is*an*indicator*of*the*extent*to*which*
people*who*want*jobs*but*cannot*find*them
The*unemployment*rate*is*the*percentage*of*the*people*in*the*labour*
force*who*are*unemployed
Unemployment*Rate*=*Number*of*people*Unemployed*/*labour*
force*x*100
§
People*in*the*labour*force*are*either*unemployed*or*employed
Labour*Force*=*Number*of*people*employed*+*number*of*people*
unemployed
§
For*example:*in*2013*number*of*people*employed*was*17.73*million*and*
number*of*people*unemployed*was*1.35*million
Therefore*the*labour*force*is*19.08*million
§
Unemployment*rate*=*1.35/19.08*x*100*=*7.6*percent*(always*round*
up*to*nearest*decimal*place)
§
The*unemployment*rate*fluctuates*over*the*business*cycle
It*increases*as*a*recession*deepens,*reaches*a*peak*value*after*the*
recession*ends*and*decreases*once*expansion*gets*underway
§
-
Involuntary*Part-time*Rate
Many*part-time*workers*want*actually*want*part*time*work,*but*some*
want*full*time*work*and*are*unable*to*get*a*full*time*job
The*involuntary*part-time*rate*is*a*percentage*of*the*people*in*the*labour*
force*who*work*part*time*but*want*full*time*work
Involuntary*Part-time*rate*=*Number*of*Involuntary*workers/*
Labour*force*x*100
§
For*example:*in*2013,*913,600*involuntary*part-time*workers*and*a*labour*
force*of*19.08*million*
Involuntary*Part-time*Rate*=*913,600*/*19.08*million*x*100*=*4.8*
percent
§
-
The*Labour*Force*Participation*Rate
Statistics*Canada*measure*the*labour*force*participation*rate*as*the*
percentage*of*the*working*age*population*who*are*members*of*the*labour*
force
Labour*Force*Participation*Rate*=*Labour*Force*/*Working*Age*
Population*x*100
§
For*Example:*in*2013,*the*labour*force*was*19.08*million*and*the*working*
age*population*was*28.67*million
Labour*Force*Participation*Rate*=*19.08*/*28.67*x*100*=*66.5*percent
§
-
The*Employment*to*Population*Ratio
The*number*of*people*working*who*have*jobs*is*an*indicator*of*the*
availability*of*jobs*and*the*match*of*skills*to*jobs
The*employment*to*population*ratio*is*the*percentage*of*people*of*
working*age*who*have*jobs
Employment*to*population*ratio*=*Number*of*people*employed*/*
working*age*population*x*100
§
For*example:*In*2013,*the*number*of*working*people*was*17.73*million*
and*the*working*age*population*was*28.67*million
Employment*to*population*ratio*=*17.73*/*28.67*x*100*=*61.8*
percent
§
The*employment*to*population*rate*fluctuates*with*the*business*cycle
It*falls*in*recession*and*rises*in*expansion
§
The*labour*force*participation*rate*has*milder*business*cycle*swing*that*
reflect*movements*in*and*out*of*the*labour*force
-
Other*Definitions*of*Unemployment
To*be*counted*as*unemployed,*a*person*must*be*available*for*work*and*
either*be*on*temporary*lay*off*with*an*expectation*of*recall,* or*be*without*
work*and*have*looked*for*work*in*the*past*four*weeks,*or*a*have*a*job*to*
start*within*four*weeks
Some*people*without*a*job*might*want*one*but*not*meet*the*strict*criteria*
for*being*counted*as*unemployed
Also*people*who*have*part-time*jobs*but*want*full*time*jobs*may*be*
regarded*as*part-time*unemployed*
Statistics*Canada*believes*that*the*official*definition*of*unemployment*is*
the*correct*measure,*but*recognizes*other*wider*definitions*that*bring*in*
three*types*of*underemployed*labour*excluded*from*the*official*measure
Discouraged*Searchers
A*discouraged*searcher*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*for*work,*and*has*looked*for*work*
sometime*in*the*recent*past*but*has*stopped*because*of*
repeated*failure
The*official*unemployment*measure*excludes*discouraged*
searchers*because*they*have*not*made*specific*efforts*to*a*
find*a*job*within*the*last*four*weeks
In*all*other*respects*they*are*unemployed
§
Long-term*future*starts
Someone*with*a*job*that*starts*in*more*than*four*weeks*in*the*
future*is*classified*as*not*in*the*labour*force
The*economic*difference*between*someone*who*starts*within*
four*weeks*and*someone*who*starts*farther*in*the*future*is*
slight*potential*source*of*underestimating*the*true*amount*of*
unemployment
§
Involuntary*Part-timers
Part-time*workers*who*would*like*full-time*jobs*and*can't*find*
them*are*part-time*unemployed*but*not*counted*as*such*in*
the*official*measure
§
-
Most*Costly*Unemployment
All*unemployment*is*costly,*but*the*most*costly*is*long*term*
unemployment*that*results*from*job*loss*
People*who*unemployed*for*a*few*weeks*and*then*find*another*job*bear*
some*costs*of*unemployment,*but*these*costs*are*low*compared*to*those*
who*bear*costs*due*to*long*term*unemployment
The*unemployment*rate*does*not*distinguish*among*the*different*lengths*
of*unemployment*spells
If*most*unemployment*is*long*term,*the*situation*is*worse*than*if*most*are*
short*-term*job*searchers
-
Alternative*Measures*of*Unemployment*-not*included*on*Term*tests*
To*provide*specific*information*about*the*aspects*of*unemployment*we*
have*just*discussed,*Statistics*Canada*reports*8*alternative*measures*of*
unemployment
Three*that*are*narrower*than*the*official*rate*and*four*that*are*
broader*than*the*official*rate
§
The*narrower*measures*focus*on*the*personal*cost*of*
unemployment*and*the*broader*measures*focus*on*assessing*the*
full*amount*of*underemployed*labour*resources
§
The*narrower*measures,*R*-1*and*R*-2,*focus*on*the*personal*cost*of*
unemployment
R-4*is*the*official*unemployment*rate,*R-3*is*comparable*to*the*U.S*rate
The*broader*measures,*R-4,*R-5*and*R-6*,*focus*on*assessing*the*full*
amount*of*underemployed*labour*resources
-
Underemployment*and*Full*Employment
-There*is*always*someone*without*a*job*who*is*searching*for*one,*so*there*is*
always*some*unemployment
-The*key*reason*for*that*is*because*the*economy*is*complex*mechanism*that*is*
always*changing*-it*experiences*frictions,*structural*changes*and*cycles
-Frictional*Unemployment
There*is*an*unending*flow*of*people*in*and*out*of*the*labour*force*as*
people*move*through*stages*of*life*-from*being*in*school,*to*finding*a*job,*
to*working*and*perhaps*becoming*unhappy*with*a*job*and*searching*for*a*
new*one*and*then*finally*retiring*from*full*time*work
There*is*also*an*unending*process*of*job*creation*and*destruction*as*new*
firms*close,*new*firms*are*born,*firms*expand*and*contract,*and*some*
firms*fail*and*go*out*of*business
The*flows*in*and*out*of*the*labour*force*and*the*process*of*job*creation*/*
destruction*create*the*need*for*people*to*search*for*jobs,*and*for*
businesses*to*search*for*workers
The*unemployment*that*arises*from*normal*labour*turnover*as*discussed*
above*-from*people*entering*and*leaving*the*labour*force,*to*the*creation*
and*destruction*of*jobs*-is*called*frictional*unemployment*
§Frictional*unemployment*is*a*permanent*and*healthy*phenomenon*
is*a*dynamic*growing*economy
Part*of*Natural*Unemployment
-Structural*Unemployment
The*unemployment*that*arises*when*changes*in*technology*of*
international*competition*change*the*skills*needed*to*perform*jobs*or*
change*the*location*of*jobs*is*called*structural*unemployment*
§Structural*unemployment*usually*last*longer*that*frictional*
unemployment*because*worker*must*retrain*and*possibly*relocate*
to*find*a*new*job
§Especially*painful*for*older*workers
Part*of*Natural*unemployment
-Cyclical*Unemployment
The*higher*than*normal*unemployment*at*a*business*cycle*trough*and*
lower*than*normal*unemployment*at*a*business*cycle*peak*is*called*
cyclical*unemployment*
§A*worker*who*is*laid*off*because*the*economy*is*in*recession*and*
who*gets*rehired*some*months*later*when*the*expansion*begins*has*
experienced* cyclical*unemployment
-'Natural'*Unemployment
Is*the*employment*that*arises*from frictional and*structural change*when*
there*is*no*cyclical*unemployment*-when*all*unemployment*is*frictional*
and*structural
§Only*frictional*and*structural*unemployment*,*no*recession*or*
expansion*causing*cyclical*unemployment*can*be*happening
Natural*unemployment*as*a*percentage*of*the*labour*force*is*called*the*
natural*unemployment*rate
§Natural*Unemployment*Rate*=*(Natural*Unemployment*/*labour*
force)*x*100
Full*employment*is*defined*as*the*situation*in*which*the*unemployment*
rate*=*the*natural*unemployment*rate
What*determines*the*natural*unemployment*rate?*Is*it*constant*or*does*it*
change*over*time?
§Natural*unemployment*rate*is*influenced*by*many*factors*but*the*
most*important*are:
The*Age*Distribution*of*Population
The*Scale*of*Structural*Change
The*Real*Wage*Rate
Unemployment*Benefits
The*Age*Distribution*of*Population
§An*economy*with*a*young*population*has*a*large*number*of*new*job*
seekers*every*year*and*has*a*high*level*of*frictional*unemployment
§An*economy*with*an*aging*population*has*fewer*new*job*seekers*
and*a*low*level*of*frictional*unemployment
The*Scale*of*Structural*Change
§The*scale*of*structural*change*is*sometimes*small
§The*same*jobs*using*the*same*machines*remain*in*place*for*many*
years,*but*sometimes*there*is*technological*upheaval
§The*amount*of*structural*unemployment*fluctuates*with*the*pace*
and*volume*of*technological*change*and*the*change*driven*by*fierce*
international*competition,*especially*from*fast-changing*Asian*
Economies
The*Real*Wage*Rate
§The*natural*unemployment*rate*is*influenced*by*the*level*of*the*real*
wage*rate
§Real*wage*rates*that*bring*up*unemployment*are*minimum*wages*
and*efficiency*wages*
§An*efficiency*wage*is*a*wage*set*above*the*going*market*wage*to*
enable*firms*to*work*hard,*and*discourage*them*from*quitting
Unemployment*Benefits
§Unemployment*benefits*increase*the*natural*unemployment*rate*
by*lowering*the*opportunity*cost*of*job*searching
§Canada*and*European*countries*have*more*generous*
unemployment*benefits*and*higher*natural*unemployment*rates*
than*the*United*States
§Extending*unemployment*benefits*increases*the*unemployment*
rate
§Unemployed*people*opportunity*cost*of*job*searching*is*lowered*
because*they*are*given*monetary*benefits*
-Real*GDP*and*Unemployment*over*the*Cycle
The*quantity*of*real*GDP*at*full*employment*is*potential*GDP*(review*
chapter*20*,472)
Over*the*business*cycle,*Real*GDP*fluctuates*around*potential*GDP*
§The*gap*between*real*and*potential*GDP*is*called* the*output*gap*
As*the*output*gap*fluctuates*over*the*business*cycle,*the*unemployment*
rate*fluctuates*around*the*natural*unemployment*rate
When*the*economy*is*at*full*employment,*the*unemployment*rate*equals*
the*natural*unemployment*rate
§And*real*GDP*equals*potential*GDP,*so*the*output*gap*is*zero*
When*the*unemployment*rate*is*less*than*the*natural*unemployment*rate
§Real*GDP*is*greater*than*potential*GDP*and*the*output*gap*is*
positive*
When*the*unemployment*rate*is*greater*than*the*natural*unemployment*
rate
§Real*GDP*is*less*than*potential*GDP*and*the*output*gap*is*negative
The*Price*Level,*Inflation*and*Deflation
-What*will*it*really* cost*you*to*pay*off*your*student*debt*loan?*What*will*you*
parents*life*savings*buy*when*they*retire?*The*answers*depends*on*what*
happens*to*the*price*level*,*the*average*level*of*prices*and*the*value*of*money
A*persistently*rising*price*level*is*called*inflation
A*persistently*falling*price*level*is*called*deflation
-We*are*interested*in*the*price*level,*inflation*and*deflation*for*two*reasons:
First,*we*want*to*measure*the*annual*percentage*change*of*the*price*level*
§Inflation*rate*or*deflation*rate
Second,*we*want*distinguish*between*the*money*values*and*real*
economic*variables*such*as*your*student*loans*and*parents*life*savings
-Why*Inflation*and*Deflation*are*Problems
Low,*steady*and*anticipated*inflation/deflation*is*not*a*problem,*but*
unexpected*burst*of*inflation/deflation*brings*big*problems*and*costs
An*unexpected*inflation*or*deflation:
§Redistributes*Income
Workers*and*employers*sign*wage*contracts*that*last*a*year*
or*more
An*unexpected*burst*of*inflation*raises*prices*but*does*not*
immediately*raise*wages
®Workers*are*worse*off*because*their*wages*buy*less*
than*they*bargained*for
®Prices*have*gone*up,*but*wages*have*not
An*unexpected*burst*of*deflation*has*the*opposite*effect
®Workers*are*better*off*because*their*fixed*wages*buy*
more*than*what*they*had*bargained*for*and*employers*
are*worse*off*with*less*profits
®Prices*go*down,*wages*stay*the*same
§Redistributes*Wealth
People*enter*into*loan*contracts*that*are*fixed*in*money*
terms*and*that*pay*an*interest*rate*agreed*as*a*percentage*of*
the*money*borrowed*and*lent
With*an*unexpected*burst*of*inflation,*the*money*the*
borrower*repays*to*the*lender*buys*less*than*the*money*
originally*loaned
®The*borrower*wins*and*the*lender*loses
®The*interest*paid*does*not*compensate*the*lender*for*
the*loss*in*the*value*of*the*money*loaned
With*an*unexpected*deflation,*the*money*that*the*borrower*
repays*to*the*lender*buys*more*than*the*money*originally*
loaned
®The*borrower*loses,*and*the*lender*wins
§Lowers*Real*GDP*and*employment
Unexpected*inflation*that*raises*firm's*profits*bring*in*a*rise*in*
investment*and*a*boom*in*production*and*employment
®Real*GDP*rises*above*potential*GDP*and*the*
unemployment*rate*falls*below*the*natural*rate
®But*the*situation*is*temporary'
®Profitable*investments*dries*up,*spending*falls,*real*GDP*
falls*below*potential*GDP,*and*the*unemployment*rate*
rises
®Avoiding*these*swings*in*production*and*jobs*means*
avoiding*unexpected*swings*in*the*inflation*rate
An*unexpected*deflation*rate*has*even*greater*consequences*
for*GDP*and*jobs
®Businesses*and*households*that*are*in*debt*(borrowers)*
are*worse*off*and*they*cut*their*spending
®A*fall*in*total*spending*brings*a*recession*and*rising*
unemployment
§Diverts*resources*from*production
Unpredictable*inflation*or*deflation*turns*the*economy*into*a*
casino*and*diverts*resources*from*productive*activities*to*
forecasting*inflation
®It*can*become*more*profitable*to*forecast*inflation*rate*
or*deflation*rate*correctly*than*to*invent*a*new*product
®Doctors,*lawyers*,*accountants,*farmers*-just*about*
everyone*-can*make*themselves*better*off*by*not*
specializing*in*their*profession*but*by*spending*more*
time*dabbling*as*an*amateur*economist*and*inflation*
forecasters*and*managing*their*investments
From*a*social*perspective,*the*diversion*of*talent*that*results*
from*unpredictable*inflation*is*like*throwing*a*scarce*resource*
into*the*garbage
®This*waste*of*resources*is*a*cost*of*inflation
As*its*worst,*inflation*becomes*hyperinflation*
®An*inflation*rate*of*50*percent*a*month*of*higher*that*
grinds*the*economy*to*a*halt*and*causes*society*to*
collapse
®Hyperinflation*is*rare
-The*Consumer*Price*Index
Every*month*Statistics*Canada*measure*the*price*level*by*calculating* the*
Consumer*Price*Index*(CPI)
§Which*is*a*measure*of*the*average*prices*paid*by*urban*consumers*
for*a*fixed*basket*of*consumer*goods*and*services
-Reading*the*CPI*numbers
The*CPI*is*defined*to*equal*100*for*a*period*called* the*reference*base*
period
§Currently*the*reference*base*period*is*2002,*that*is*the*average*of*
the*12*months*of*2002,*the*CPI*=*100
In*June*2014,*the*CPI*was*125.6*,*this*Number*tells*us*the*average*of*the*
prices*paid*by*urban*consumers*for*a*fixed*basket*of*goods*and*services*
was*25.6*percent*higher*in*June*2014*than*it*was*the*average*of*2002
-Constructing*the*CPI
Constructing*the*CPI*involves*three*stages:
§Selecting*CPI*Basket
The*First*Stage*in*constructing*the*CPI*is*to*select*what*is*
called*the*CPI*basket
®This*basket*contains*goods*and*services*represented*in*
the*index,*each*weighted*by*its*relative*importance
The*idea*is*to*make*the*relative*importance*of*the*items*in*
the*CPI*basket*the*same*as*that*in*the*budget*of*an*average*
urban*household
®Individual'household's*baskets*are*spread*around*the*
average
§Conducting*the*monthly*price*survey
Each*month,*statistics*Canada*employees*check*the*prices*of*
the*goods*and*services*in*the*CPI*basket*in*major*cities
Because*the*CPI*aims*to*measure*price* changes',*it*is*
important*that*the*prices*recorded*each*month*refer*exactly*
to*the*same*item
For*example:*suppose*the*price*of*a*box*of*jelly*beans*has*
increased,*but*a*box**now*contains*more*jelly*beans*.*.*.*Has*
the*price*of*jelly*beans*increased
§Calculating*the*CPI*
One*the*raw*price*data*is*on*hand,*the*next*task*is*to*calculate*
the*CPI
To*calculate* the*CPI*we:
1. Find*the*Cost*of*the*CPI*basket*at*base*period*prices
2. Find*the*cost*of*the*CPI*basket*at*current*prices
3. Calculate*the*CPI*for*the*base*period*and*the*current*
period*
For*example*page*500:*We'll* work*through*these*three*steps*
for*the*simple*artificial*economy*(review*table*21.1)*in*which*
the*base*year*is*2012,*and*the*current*year*is*2015
®The*table*shows*the*quantities*in*the*CPI*basket*and*the*
prices*in*these*two*years
®Part*A)*contains*the*data*of*the*base*period*-2012
In*that*period*consumers*bought*10*oranges*at*$1*
each*and*5*haircuts*at*$8*each
}To*find*the*cost*of*the*CPI*basket*multiply*
the*quantities*for*the*goods*and*services*by*
the*base*period*prices
}Oranges*=*10*x*$1*=*$10.00**and*Haircuts*=*
5*x*$8*=*$40.00*
$10*+*$40*=*$50.00*
®Part*B)*contains*the*price*data*for*the*current*period*-
2015
In*the*current*period*the*price*of*an*orange*went*
up*from*$1*-$2*which*is*a*100%*increase*($1*/*$1)*
x*100*=*100%********(2*-1*=*1*/*1)*x*100
The*price*of*a*haircut*increased*from*$8*to$*10*
which*is*25%*increase
}($2*/*$8)*x*100*=*25%
The*CPI*provides*a*way*of*averaging*these*price*
increases*by*comparing*the*cost*of*the*basket*
rather*than*price*of*them*(Comparing*cost*over*
price)
To*find*the*Cost*of*the*CPI*basket*in*current*
period*,*2015,*multiply*the*quantities*in*the*
baskets*by*their*2015*prices
Oranges*is*$20*(10*x*$2*=*$20.00*)*and*the*cost*of*
haircuts*is*$50*(5*x*$10*=*$50.00*)
}So*the*total*cost*of*the*fixed*CPI*basket*at*
current*period*prices*is*$70*($20*+*$50*=*
$70.00*)
®Step*Three)*uses*the*numbers*that*we*have*calculated*
in*parts*A*and*parts*B
CPI*=*Cost*of*basket*at*current*period*prices*/*cost*
of*basket*at*base*period*prices
}CPI*=**$70*/*$50
No*we*have*established*that*in*2012*(base*period)*
the*cost*of*a*CPI*basket*is*$50*and*in*2015*
(current*period)*it*was*$70
}If*we*use*these*numbers*in*the CPI*Formula*
we*can*find*the*CPI*for*2012*and*2015
CPI*IN*2012*=*$50/$50*x*100*=*100
CPI*IN*2015*=*$70/$50*X*100*=*140*
-Measuring*the*Inflation*Rate
A*major*purpose*of*the*CPI*is*to*measure*changes*in*the*Cost*of*living*and*
in*the*value*of*money
To*measure*those*changes*we*calculate* the*inflation*rate*as*the*annual*
percentage*change*in*CPI
§Inflation*Rate*Formula:*Inflation*rate*=*CPI*this*year*-CPI*last*year/*
CPI*last*year*x*100
§For*Example:*Lets*calculate*the*inflation*rate*for*2014
The*CPI*in*June*2014*was*125.6*and*in*the*CPI*in*June*2013*
was*122.9
Inflation*Rate*=*125.6*-122.9*/*122.9*x*100*=*2.2*%
-Distinguishing*High*Inflation*from*a*High*Price*Level
Refer*to*page*501*,*figure*21.7
Figure*21.7*shows*the*CPI*and*inflation*rate*in*Canada*between*1970*and*
2014,*the*two*parts*the*figure*are*related*and*emphasize*distinction*
between*high*inflation*and*high*prices
§When*the*price*level*in*part*a)*rises'rapidly' (1970*-1982)*,*the*
inflation*rate*in*part*b)*is*high
§When*the*price*level*in*part*a)*rise'slowly'(after*1982)*,*the*inflation*
rate*in*part*b)*is*low'
A*high*inflation*rate*means*the*price*level*is*rising*rapidly
§A*high*price*level*means*that*there*has*been*a*sustained*period*in*
rising*prices
When*the*price*level*in*in*part*a)*falls'(2009),*the*inflation*rate*in*part*b)*is*
negative'-deflation*
The*CPI*is*not*a*perfect*measure*of*the*price*level*and*changes*in*the*CPI*
probably*overstate*the*inflation*rate,*there*are*sources*of*bias*in*the*CPI
-The*Biased*CPI
The*main*sources*of*bias*in*the*CPI*are:
§New*Good*Bias
If*you*want*to*compare*the*price*level*in*2014*to*that*of*1970,*
you*must*somehow*compare*a*computer*today*with*a*type*
writer*in*1970
Because*a*PC*is*more*expensive*than*a*typewriter*was,*the*
arrival*of*the*PC*but*an*upward*Bias*into*the*inflation*rate
§Quality*Change*Bias
Cars*and*many*other*goods*get*better*every*year
Part*of*the*rise*in*prices*of*these*goods*is*a*payment*for*
improved*quality*and*is*not*inflation
But*the*CPI*counts*the*entire*price*as*inflation*and*so*
overstates*inflation
§Commodity*Substitution*Bias
Changes*in*relative*prices*lead*consumers*to*change*the*items*
they*buy
For*example:*if*the*prices*of*beef*rises*and*the*price*of*
chicken*remains*the*same,*people*will*buy*more*chicken*and*
less*beef
®The*switch*from*beef*to*chicken*might*provide*the*
same*amount*of*meat*and*the*same*enjoyment*as*
before*and*the*previous*expenditure*is*the*same,*but*
The*CPI*ignores*the*substitution*of*chicken*for*beef,*and*
says*the*price*of*meat*has*increased
§Outlet*Substitution*Bias
When*confronted*with*higher*prices,*people*use*discount*
stores*more*frequently*and*convenience*stores*less*
frequently
This*phenomenon*is*called*outlet*substitution
The*CPI*surveys*do*not*monitor*outlet*substitutions
-The*Magnitude*of*The*Bias
We*know*the*sources*of*bias*in*the*CPI*but*how*big*is*the*bias?
This*question*is*addressed*periodically*and*the*most*recent*estimate*is*
provided*by*the*Bank*of*Canada*economist*James*Rossiter*at*about*0.6*
percent*a*year
-Some*consequences*of*the*Bias
The*bias*in*CPI*disports*private*contracts*and*increases*government*
outlays
Many*private*agreements,*such*as*wage*contracts,*are*linked*to*the*CPI
For*example:*When*a*firm*and*its*workers*might*agree*to*a*three-year*
wage*deal*that*increases*the*wage*rate*by*2*percent*a*year*plus*the*
percentage*increase*in*the*CPI
§Such*a*deal*ends*up*giving*the*workers*more*real*income*than*the*
firm*intended
-Alternative*Price*Indexes
The*CPI*is*just*one*of*many*alternative*price*level* index*numbers*and*
because*the*bias*in*the*CPI*other*measures*are*used*for*some*purposes
Two*Alternative*Price*Indexes:
§GDP*Deflator
Is*an*index*of*all*the*prices*of*all*items*included*in*GDP*and*is*
the*ratio*of*nominal*GDP*to*real*GDP
®GDP*deflator*=*Nominal*GDP*/*Real*GDP*x*100
Because*real*GDP*included*consumption*expenditure,*
investment*and*net*exports*the*GDP*deflator*is*an*index*of*
the*prices*of*all*these*items
Real*GDP*is*calculated* using*the*chained*dollar*method*
(chapter*20,*482-483)*,*which*means*that*the*weights*
attached*to*each*item*in*the*GDP*deflator*are*the*
components*of*GDP*in*both*the*current*year*and*preceding*
year
®Because*it*uses*current*period*and*previous*period*
quantities*rather*than*fixed*quantities*from*and*earlier*
period,*chained*dollar*price*index*incorporates*
substitution*effects*and*new*goods*and*over*comes*the*
source*of*bias*in*the*CPI
The*GDP*deflator*is*appropriate*for*macroeconomics*
because*,*like*GDP,*it*is*a*comprehensive*measure*of*the*cost*
of*the*real*GDP*goods*and*services*,*but*as*a*measure*of*cost*
of*living*is*too*broad
Using*the*GDP*deflator*we*can*deflate*any*nominal*variable*
and*find*its*corresponding*real*real*values
§Chained*Price*Index*for*Consumption
The*chained'Price'index'for'consumption'(CPIC)*is*an*index*of*
all*the*items*included*in*consumption*expenditure*in*GDP*and*
is*the*ratio*of*nominal*consumption*expenditure*to*real*
consumption*expenditure
®CPIC*=*Nominal*Consumption*Expenditure*/*Real*
Consumption*Expenditure*x*100
Like*the*GDP*deflator*,*because*CPIC*uses*current*period*and*
previous*period*quantities*rather*than*fixed*quantities*from*
an*earlier* period,*it*incorporates*substitution*effects*and*new*
goods*and*overcomes*the*sources*of*bias*in*the*CPI
-Core*Inflation*
No*matter*whether*we*calculate*the*inflation*rate*using*the*CPI*,*the*GDP*
deflator*or*the*CPIC*,*the*number*bounces*around*a*good*deal*from*
month*to*month*or*quarter*to*quarter
To*determine*whether*the*inflation*rate*is*trending*upward*or*downward,*
we*need*to*strip*a*few*numbers*of*their*volatility*
The*Core*Inflation*Rate*,*which*is*the*inflation*rate*excluding*volatile*
elements,*attempts*to*do*just*tat*and*reveal*the*underlying*inflation*trend
The*most*commonly*used*measure*of*core*inflation*is*the*Core*CPI*
Inflation*Rate*and*,*as*a*practical* matter*the*core*CPI*inflation*rate*is*
calculated*as*a*percentage*change*in*the*CPI*excluding*food*and*fuel
§CPI*including*food*and*fuel*-Core*CPI*/**Core*CPI**x*100
-The*Real*Variables*in*Macroeconomics
Another*name*for*a*money*price*is*nominal*price
In*macro*we*want*to*distinguish*between*a*real*variable*and*its*
corresponding*nominal*variable
We*want*distinguish*between*a*real*price*and*its*corresponding*nominal*
price*because*real*price*is*an*opportunity*cost*that*influence*choices
We*want*to*distinguish*between*a*real*quantity*(like*real*GDP)*from*a*
nominal*quantity*(like*nominal*GDP)*because*we*want*to*see*what*is*
really'happening*to*the*variables*that*influence*the*standard*of*living
There*is*one*variable*that*is*a*bit*different*-an*interest*rate
§A*real*interest*rate*is*not*a*nominal*interest*rate*divided*by*the*
price*level
But*all*other*real*variables*of*macroeconomics*are*calculated*by*dividing*a*
nominal*variable*by*the*price*level
Chapter(21:(Monitoring(Jobs(and(Inflation
Monday,*January*23,*2017
5:16*PM

Only pages 1-3 are available for preview. Some parts have been intentionally blurred.

Employment*and*Unemployment
Why*Unemployment*is*a*Problem
Unemployment*is*a*serious*personal*and*social*economic*problem*for*two*
main*reasons,*it*results*in:
Lost*Incomes*and*Production
The*loss*of*jobs*brings*loss*of*income*and*lost*production
These*losses*are*devastating*for*the*people*who*bear*them*
and*them*unemployment*a*frightening*prospect*for*everyone
Unemployment*benefits*create*a*safety*net,*but*they*do*not*
fully*replace*lost*earnings
Lost*production*means*lower*consumption*and*a*lower*
investment*in*capital,*which*lowers*living*standard*in*both*
present*and*the*future
§
Lost*Human*Capital
Prolonged*unemployment*permanently*damages*a*person's*
job*prospects*by*destroying*human*capital
Example:*Think*about*a*manager*who*loses*his*job*when*his*
company*downsizes,*and*the*only*work*he*can*find*is*driving*a*
taxi
After*a*year*in*this*work,*he*discovers*that*he*can't*
compete*with*new*MBA*graduates
®
Eventually*he*gets*hired*as*a*manager*but*in*a*small*
firm*and*at*a*lower*wage*than*before
®
He*has*lost*some*his*human*capital
®
The*cost*of*lost*human*capital*is*particularly*acute*for*older*
workers
§
-
Labour*Force*Survey
Every*month*Statistics*Canada*conducts*a*Labour*Force*Survey*in*which*it*
asks*54,000*households*a*series*of*questions*about*the*age*and*job*
market*status*of*members*of*each*household*during*a*previous*week*
called*reference*week*
The*population*divides*into*two*bold*groups:*the*working*age*population*
and*those*who*are*too*young*to*work*or*who*live*in*institutions*and*are*
unable*to*work
The*Working*Age*Population*is*the*total*number*of*people*aged*15*and*
up
The*working*age*population*is*also*divided*into*groups:*those*in*the*
labour*force*and*those*who*are*not*in*the*labour*force
§
Members*of*the*labour*force*are*either*employed*or*unemployed
The*employed*are*either*full-time*or*part-time*workers:
And*part*time*workers*either*want*part-time*or*are*
looking*for*part*time*work
®
Involuntary*part-time*workers*and*voluntary*part-time*
workers
®
To*be*counted*as*employed*in*the*labour*force*survey,*a*
person*must*have*either*a*full*time*job*or*a*part*time*job
To*be*counted*as*unemployed,*a*person*must*be*available'for'
work'and*must*be*in*one*of*three*categories:
On*temporary*layoff*with*expectation*of*recall
®
Without*work*but*has*looked*for*work*in*the*past*four*
weeks
®
Has*a*new*job*to*start*within*four*weeks
®
People*who*satisfy*one*of*these*three*criteria*are*counted*as*
unemployed
People*in*the*working*age*population*who*are*neither*
employed*or*unemployed*are*classified*as*not*in*the*labor*
force*
§
-
The*unemployment*rate
The*amount*of*unemployment*is*an*indicator*of*the*extent*to*which*
people*who*want*jobs*but*cannot*find*them
The*unemployment*rate*is*the*percentage*of*the*people*in*the*labour*
force*who*are*unemployed
Unemployment*Rate*=*Number*of*people*Unemployed*/*labour*
force*x*100
§
People*in*the*labour*force*are*either*unemployed*or*employed
Labour*Force*=*Number*of*people*employed*+*number*of*people*
unemployed
§
For*example:*in*2013*number*of*people*employed*was*17.73*million*and*
number*of*people*unemployed*was*1.35*million
Therefore*the*labour*force*is*19.08*million
§
Unemployment*rate*=*1.35/19.08*x*100*=*7.6*percent*(always*round*
up*to*nearest*decimal*place)
§
The*unemployment*rate*fluctuates*over*the*business*cycle
It*increases*as*a*recession*deepens,*reaches*a*peak*value*after*the*
recession*ends*and*decreases*once*expansion*gets*underway
§
-
Involuntary*Part-time*Rate
Many*part-time*workers*want*actually*want*part*time*work,*but*some*
want*full*time*work*and*are*unable*to*get*a*full*time*job
The*involuntary*part-time*rate*is*a*percentage*of*the*people*in*the*labour*
force*who*work*part*time*but*want*full*time*work
Involuntary*Part-time*rate*=*Number*of*Involuntary*workers/*
Labour*force*x*100
§
For*example:*in*2013,*913,600*involuntary*part-time*workers*and*a*labour*
force*of*19.08*million*
Involuntary*Part-time*Rate*=*913,600*/*19.08*million*x*100*=*4.8*
percent
§
-
The*Labour*Force*Participation*Rate
Statistics*Canada*measure*the*labour*force*participation*rate*as*the*
percentage*of*the*working*age*population*who*are*members*of*the*labour*
force
Labour*Force*Participation*Rate*=*Labour*Force*/*Working*Age*
Population*x*100
§
For*Example:*in*2013,*the*labour*force*was*19.08*million*and*the*working*
age*population*was*28.67*million
Labour*Force*Participation*Rate*=*19.08*/*28.67*x*100*=*66.5*percent
§
-
The*Employment*to*Population*Ratio
The*number*of*people*working*who*have*jobs*is*an*indicator*of*the*
availability*of*jobs*and*the*match*of*skills*to*jobs
The*employment*to*population*ratio*is*the*percentage*of*people*of*
working*age*who*have*jobs
Employment*to*population*ratio*=*Number*of*people*employed*/*
working*age*population*x*100
§
For*example:*In*2013,*the*number*of*working*people*was*17.73*million*
and*the*working*age*population*was*28.67*million
Employment*to*population*ratio*=*17.73*/*28.67*x*100*=*61.8*
percent
§
The*employment*to*population*rate*fluctuates*with*the*business*cycle
It*falls*in*recession*and*rises*in*expansion
§
The*labour*force*participation*rate*has*milder*business*cycle*swing*that*
reflect*movements*in*and*out*of*the*labour*force
-
Other*Definitions*of*Unemployment
To*be*counted*as*unemployed,*a*person*must*be*available*for*work*and*
either*be*on*temporary*lay*off*with*an*expectation*of*recall,* or*be*without*
work*and*have*looked*for*work*in*the*past*four*weeks,*or*a*have*a*job*to*
start*within*four*weeks
Some*people*without*a*job*might*want*one*but*not*meet*the*strict*criteria*
for*being*counted*as*unemployed
Also*people*who*have*part-time*jobs*but*want*full*time*jobs*may*be*
regarded*as*part-time*unemployed*
Statistics*Canada*believes*that*the*official*definition*of*unemployment*is*
the*correct*measure,*but*recognizes*other*wider*definitions*that*bring*in*
three*types*of*underemployed*labour*excluded*from*the*official*measure
Discouraged*Searchers
A*discouraged*searcher*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*for*work,*and*has*looked*for*work*
sometime*in*the*recent*past*but*has*stopped*because*of*
repeated*failure
The*official*unemployment*measure*excludes*discouraged*
searchers*because*they*have*not*made*specific*efforts*to*a*
find*a*job*within*the*last*four*weeks
In*all*other*respects*they*are*unemployed
§
Long-term*future*starts
Someone*with*a*job*that*starts*in*more*than*four*weeks*in*the*
future*is*classified*as*not*in*the*labour*force
The*economic*difference*between*someone*who*starts*within*
four*weeks*and*someone*who*starts*farther*in*the*future*is*
slight*potential*source*of*underestimating*the*true*amount*of*
unemployment
§
Involuntary*Part-timers
Part-time*workers*who*would*like*full-time*jobs*and*can't*find*
them*are*part-time*unemployed*but*not*counted*as*such*in*
the*official*measure
§
-
Most*Costly*Unemployment
All*unemployment*is*costly,*but*the*most*costly*is*long*term*
unemployment*that*results*from*job*loss*
People*who*unemployed*for*a*few*weeks*and*then*find*another*job*bear*
some*costs*of*unemployment,*but*these*costs*are*low*compared*to*those*
who*bear*costs*due*to*long*term*unemployment
The*unemployment*rate*does*not*distinguish*among*the*different*lengths*
of*unemployment*spells
If*most*unemployment*is*long*term,*the*situation*is*worse*than*if*most*are*
short*-term*job*searchers
-
Alternative*Measures*of*Unemployment*-not*included*on*Term*tests*
To*provide*specific*information*about*the*aspects*of*unemployment*we*
have*just*discussed,*Statistics*Canada*reports*8*alternative*measures*of*
unemployment
Three*that*are*narrower*than*the*official*rate*and*four*that*are*
broader*than*the*official*rate
§
The*narrower*measures*focus*on*the*personal*cost*of*
unemployment*and*the*broader*measures*focus*on*assessing*the*
full*amount*of*underemployed*labour*resources
§
The*narrower*measures,*R*-1*and*R*-2,*focus*on*the*personal*cost*of*
unemployment
R-4*is*the*official*unemployment*rate,*R-3*is*comparable*to*the*U.S*rate
The*broader*measures,*R-4,*R-5*and*R-6*,*focus*on*assessing*the*full*
amount*of*underemployed*labour*resources
-
Underemployment*and*Full*Employment
-There*is*always*someone*without*a*job*who*is*searching*for*one,*so*there*is*
always*some*unemployment
-The*key*reason*for*that*is*because*the*economy*is*complex*mechanism*that*is*
always*changing*-it*experiences*frictions,*structural*changes*and*cycles
-Frictional*Unemployment
There*is*an*unending*flow*of*people*in*and*out*of*the*labour*force*as*
people*move*through*stages*of*life*-from*being*in*school,*to*finding*a*job,*
to*working*and*perhaps*becoming*unhappy*with*a*job*and*searching*for*a*
new*one*and*then*finally*retiring*from*full*time*work
There*is*also*an*unending*process*of*job*creation*and*destruction*as*new*
firms*close,*new*firms*are*born,*firms*expand*and*contract,*and*some*
firms*fail*and*go*out*of*business
The*flows*in*and*out*of*the*labour*force*and*the*process*of*job*creation*/*
destruction*create*the*need*for*people*to*search*for*jobs,*and*for*
businesses*to*search*for*workers
The*unemployment*that*arises*from*normal*labour*turnover*as*discussed*
above*-from*people*entering*and*leaving*the*labour*force,*to*the*creation*
and*destruction*of*jobs*-is*called*frictional*unemployment*
§Frictional*unemployment*is*a*permanent*and*healthy*phenomenon*
is*a*dynamic*growing*economy
Part*of*Natural*Unemployment
-Structural*Unemployment
The*unemployment*that*arises*when*changes*in*technology*of*
international*competition*change*the*skills*needed*to*perform*jobs*or*
change*the*location*of*jobs*is*called*structural*unemployment*
§Structural*unemployment*usually*last*longer*that*frictional*
unemployment*because*worker*must*retrain*and*possibly*relocate*
to*find*a*new*job
§Especially*painful*for*older*workers
Part*of*Natural*unemployment
-Cyclical*Unemployment
The*higher*than*normal*unemployment*at*a*business*cycle*trough*and*
lower*than*normal*unemployment*at*a*business*cycle*peak*is*called*
cyclical*unemployment*
§A*worker*who*is*laid*off*because*the*economy*is*in*recession*and*
who*gets*rehired*some*months*later*when*the*expansion*begins*has*
experienced* cyclical*unemployment
-'Natural'*Unemployment
Is*the*employment*that*arises*from frictional and*structural change*when*
there*is*no*cyclical*unemployment*-when*all*unemployment*is*frictional*
and*structural
§Only*frictional*and*structural*unemployment*,*no*recession*or*
expansion*causing*cyclical*unemployment*can*be*happening
Natural*unemployment*as*a*percentage*of*the*labour*force*is*called*the*
natural*unemployment*rate
§Natural*Unemployment*Rate*=*(Natural*Unemployment*/*labour*
force)*x*100
Full*employment*is*defined*as*the*situation*in*which*the*unemployment*
rate*=*the*natural*unemployment*rate
What*determines*the*natural*unemployment*rate?*Is*it*constant*or*does*it*
change*over*time?
§Natural*unemployment*rate*is*influenced*by*many*factors*but*the*
most*important*are:
The*Age*Distribution*of*Population
The*Scale*of*Structural*Change
The*Real*Wage*Rate
Unemployment*Benefits
The*Age*Distribution*of*Population
§An*economy*with*a*young*population*has*a*large*number*of*new*job*
seekers*every*year*and*has*a*high*level*of*frictional*unemployment
§An*economy*with*an*aging*population*has*fewer*new*job*seekers*
and*a*low*level*of*frictional*unemployment
The*Scale*of*Structural*Change
§The*scale*of*structural*change*is*sometimes*small
§The*same*jobs*using*the*same*machines*remain*in*place*for*many*
years,*but*sometimes*there*is*technological*upheaval
§The*amount*of*structural*unemployment*fluctuates*with*the*pace*
and*volume*of*technological*change*and*the*change*driven*by*fierce*
international*competition,*especially*from*fast-changing*Asian*
Economies
The*Real*Wage*Rate
§The*natural*unemployment*rate*is*influenced*by*the*level*of*the*real*
wage*rate
§Real*wage*rates*that*bring*up*unemployment*are*minimum*wages*
and*efficiency*wages*
§An*efficiency*wage*is*a*wage*set*above*the*going*market*wage*to*
enable*firms*to*work*hard,*and*discourage*them*from*quitting
Unemployment*Benefits
§Unemployment*benefits*increase*the*natural*unemployment*rate*
by*lowering*the*opportunity*cost*of*job*searching
§Canada*and*European*countries*have*more*generous*
unemployment*benefits*and*higher*natural*unemployment*rates*
than*the*United*States
§Extending*unemployment*benefits*increases*the*unemployment*
rate
§Unemployed*people*opportunity*cost*of*job*searching*is*lowered*
because*they*are*given*monetary*benefits*
-Real*GDP*and*Unemployment*over*the*Cycle
The*quantity*of*real*GDP*at*full*employment*is*potential*GDP*(review*
chapter*20*,472)
Over*the*business*cycle,*Real*GDP*fluctuates*around*potential*GDP*
§The*gap*between*real*and*potential*GDP*is*called* the*output*gap*
As*the*output*gap*fluctuates*over*the*business*cycle,*the*unemployment*
rate*fluctuates*around*the*natural*unemployment*rate
When*the*economy*is*at*full*employment,*the*unemployment*rate*equals*
the*natural*unemployment*rate
§And*real*GDP*equals*potential*GDP,*so*the*output*gap*is*zero*
When*the*unemployment*rate*is*less*than*the*natural*unemployment*rate
§Real*GDP*is*greater*than*potential*GDP*and*the*output*gap*is*
positive*
When*the*unemployment*rate*is*greater*than*the*natural*unemployment*
rate
§Real*GDP*is*less*than*potential*GDP*and*the*output*gap*is*negative
The*Price*Level,*Inflation*and*Deflation
-What*will*it*really* cost*you*to*pay*off*your*student*debt*loan?*What*will*you*
parents*life*savings*buy*when*they*retire?*The*answers*depends*on*what*
happens*to*the*price*level*,*the*average*level*of*prices*and*the*value*of*money
A*persistently*rising*price*level*is*called*inflation
A*persistently*falling*price*level*is*called*deflation
-We*are*interested*in*the*price*level,*inflation*and*deflation*for*two*reasons:
First,*we*want*to*measure*the*annual*percentage*change*of*the*price*level*
§Inflation*rate*or*deflation*rate
Second,*we*want*distinguish*between*the*money*values*and*real*
economic*variables*such*as*your*student*loans*and*parents*life*savings
-Why*Inflation*and*Deflation*are*Problems
Low,*steady*and*anticipated*inflation/deflation*is*not*a*problem,*but*
unexpected*burst*of*inflation/deflation*brings*big*problems*and*costs
An*unexpected*inflation*or*deflation:
§Redistributes*Income
Workers*and*employers*sign*wage*contracts*that*last*a*year*
or*more
An*unexpected*burst*of*inflation*raises*prices*but*does*not*
immediately*raise*wages
®Workers*are*worse*off*because*their*wages*buy*less*
than*they*bargained*for
®Prices*have*gone*up,*but*wages*have*not
An*unexpected*burst*of*deflation*has*the*opposite*effect
®Workers*are*better*off*because*their*fixed*wages*buy*
more*than*what*they*had*bargained*for*and*employers*
are*worse*off*with*less*profits
®Prices*go*down,*wages*stay*the*same
§Redistributes*Wealth
People*enter*into*loan*contracts*that*are*fixed*in*money*
terms*and*that*pay*an*interest*rate*agreed*as*a*percentage*of*
the*money*borrowed*and*lent
With*an*unexpected*burst*of*inflation,*the*money*the*
borrower*repays*to*the*lender*buys*less*than*the*money*
originally*loaned
®The*borrower*wins*and*the*lender*loses
®The*interest*paid*does*not*compensate*the*lender*for*
the*loss*in*the*value*of*the*money*loaned
With*an*unexpected*deflation,*the*money*that*the*borrower*
repays*to*the*lender*buys*more*than*the*money*originally*
loaned
®The*borrower*loses,*and*the*lender*wins
§Lowers*Real*GDP*and*employment
Unexpected*inflation*that*raises*firm's*profits*bring*in*a*rise*in*
investment*and*a*boom*in*production*and*employment
®Real*GDP*rises*above*potential*GDP*and*the*
unemployment*rate*falls*below*the*natural*rate
®But*the*situation*is*temporary'
®Profitable*investments*dries*up,*spending*falls,*real*GDP*
falls*below*potential*GDP,*and*the*unemployment*rate*
rises
®Avoiding*these*swings*in*production*and*jobs*means*
avoiding*unexpected*swings*in*the*inflation*rate
An*unexpected*deflation*rate*has*even*greater*consequences*
for*GDP*and*jobs
®Businesses*and*households*that*are*in*debt*(borrowers)*
are*worse*off*and*they*cut*their*spending
®A*fall*in*total*spending*brings*a*recession*and*rising*
unemployment
§Diverts*resources*from*production
Unpredictable*inflation*or*deflation*turns*the*economy*into*a*
casino*and*diverts*resources*from*productive*activities*to*
forecasting*inflation
®It*can*become*more*profitable*to*forecast*inflation*rate*
or*deflation*rate*correctly*than*to*invent*a*new*product
®Doctors,*lawyers*,*accountants,*farmers*-just*about*
everyone*-can*make*themselves*better*off*by*not*
specializing*in*their*profession*but*by*spending*more*
time*dabbling*as*an*amateur*economist*and*inflation*
forecasters*and*managing*their*investments
From*a*social*perspective,*the*diversion*of*talent*that*results*
from*unpredictable*inflation*is*like*throwing*a*scarce*resource*
into*the*garbage
®This*waste*of*resources*is*a*cost*of*inflation
As*its*worst,*inflation*becomes*hyperinflation*
®An*inflation*rate*of*50*percent*a*month*of*higher*that*
grinds*the*economy*to*a*halt*and*causes*society*to*
collapse
®Hyperinflation*is*rare
-The*Consumer*Price*Index
Every*month*Statistics*Canada*measure*the*price*level*by*calculating* the*
Consumer*Price*Index*(CPI)
§Which*is*a*measure*of*the*average*prices*paid*by*urban*consumers*
for*a*fixed*basket*of*consumer*goods*and*services
-Reading*the*CPI*numbers
The*CPI*is*defined*to*equal*100*for*a*period*called* the*reference*base*
period
§Currently*the*reference*base*period*is*2002,*that*is*the*average*of*
the*12*months*of*2002,*the*CPI*=*100
In*June*2014,*the*CPI*was*125.6*,*this*Number*tells*us*the*average*of*the*
prices*paid*by*urban*consumers*for*a*fixed*basket*of*goods*and*services*
was*25.6*percent*higher*in*June*2014*than*it*was*the*average*of*2002
-Constructing*the*CPI
Constructing*the*CPI*involves*three*stages:
§Selecting*CPI*Basket
The*First*Stage*in*constructing*the*CPI*is*to*select*what*is*
called*the*CPI*basket
®This*basket*contains*goods*and*services*represented*in*
the*index,*each*weighted*by*its*relative*importance
The*idea*is*to*make*the*relative*importance*of*the*items*in*
the*CPI*basket*the*same*as*that*in*the*budget*of*an*average*
urban*household
®Individual'household's*baskets*are*spread*around*the*
average
§Conducting*the*monthly*price*survey
Each*month,*statistics*Canada*employees*check*the*prices*of*
the*goods*and*services*in*the*CPI*basket*in*major*cities
Because*the*CPI*aims*to*measure*price* changes',*it*is*
important*that*the*prices*recorded*each*month*refer*exactly*
to*the*same*item
For*example:*suppose*the*price*of*a*box*of*jelly*beans*has*
increased,*but*a*box**now*contains*more*jelly*beans*.*.*.*Has*
the*price*of*jelly*beans*increased
§Calculating*the*CPI*
One*the*raw*price*data*is*on*hand,*the*next*task*is*to*calculate*
the*CPI
To*calculate* the*CPI*we:
1. Find*the*Cost*of*the*CPI*basket*at*base*period*prices
2. Find*the*cost*of*the*CPI*basket*at*current*prices
3. Calculate*the*CPI*for*the*base*period*and*the*current*
period*
For*example*page*500:*We'll* work*through*these*three*steps*
for*the*simple*artificial*economy*(review*table*21.1)*in*which*
the*base*year*is*2012,*and*the*current*year*is*2015
®The*table*shows*the*quantities*in*the*CPI*basket*and*the*
prices*in*these*two*years
®Part*A)*contains*the*data*of*the*base*period*-2012
In*that*period*consumers*bought*10*oranges*at*$1*
each*and*5*haircuts*at*$8*each
}To*find*the*cost*of*the*CPI*basket*multiply*
the*quantities*for*the*goods*and*services*by*
the*base*period*prices
}Oranges*=*10*x*$1*=*$10.00**and*Haircuts*=*
5*x*$8*=*$40.00*
$10*+*$40*=*$50.00*
®Part*B)*contains*the*price*data*for*the*current*period*-
2015
In*the*current*period*the*price*of*an*orange*went*
up*from*$1*-$2*which*is*a*100%*increase*($1*/*$1)*
x*100*=*100%********(2*-1*=*1*/*1)*x*100
The*price*of*a*haircut*increased*from*$8*to$*10*
which*is*25%*increase
}($2*/*$8)*x*100*=*25%
The*CPI*provides*a*way*of*averaging*these*price*
increases*by*comparing*the*cost*of*the*basket*
rather*than*price*of*them*(Comparing*cost*over*
price)
To*find*the*Cost*of*the*CPI*basket*in*current*
period*,*2015,*multiply*the*quantities*in*the*
baskets*by*their*2015*prices
Oranges*is*$20*(10*x*$2*=*$20.00*)*and*the*cost*of*
haircuts*is*$50*(5*x*$10*=*$50.00*)
}So*the*total*cost*of*the*fixed*CPI*basket*at*
current*period*prices*is*$70*($20*+*$50*=*
$70.00*)
®Step*Three)*uses*the*numbers*that*we*have*calculated*
in*parts*A*and*parts*B
CPI*=*Cost*of*basket*at*current*period*prices*/*cost*
of*basket*at*base*period*prices
}CPI*=**$70*/*$50
No*we*have*established*that*in*2012*(base*period)*
the*cost*of*a*CPI*basket*is*$50*and*in*2015*
(current*period)*it*was*$70
}If*we*use*these*numbers*in*the CPI*Formula*
we*can*find*the*CPI*for*2012*and*2015
CPI*IN*2012*=*$50/$50*x*100*=*100
CPI*IN*2015*=*$70/$50*X*100*=*140*
-Measuring*the*Inflation*Rate
A*major*purpose*of*the*CPI*is*to*measure*changes*in*the*Cost*of*living*and*
in*the*value*of*money
To*measure*those*changes*we*calculate* the*inflation*rate*as*the*annual*
percentage*change*in*CPI
§Inflation*Rate*Formula:*Inflation*rate*=*CPI*this*year*-CPI*last*year/*
CPI*last*year*x*100
§For*Example:*Lets*calculate*the*inflation*rate*for*2014
The*CPI*in*June*2014*was*125.6*and*in*the*CPI*in*June*2013*
was*122.9
Inflation*Rate*=*125.6*-122.9*/*122.9*x*100*=*2.2*%
-Distinguishing*High*Inflation*from*a*High*Price*Level
Refer*to*page*501*,*figure*21.7
Figure*21.7*shows*the*CPI*and*inflation*rate*in*Canada*between*1970*and*
2014,*the*two*parts*the*figure*are*related*and*emphasize*distinction*
between*high*inflation*and*high*prices
§When*the*price*level*in*part*a)*rises'rapidly' (1970*-1982)*,*the*
inflation*rate*in*part*b)*is*high
§When*the*price*level*in*part*a)*rise'slowly'(after*1982)*,*the*inflation*
rate*in*part*b)*is*low'
A*high*inflation*rate*means*the*price*level*is*rising*rapidly
§A*high*price*level*means*that*there*has*been*a*sustained*period*in*
rising*prices
When*the*price*level*in*in*part*a)*falls'(2009),*the*inflation*rate*in*part*b)*is*
negative'-deflation*
The*CPI*is*not*a*perfect*measure*of*the*price*level*and*changes*in*the*CPI*
probably*overstate*the*inflation*rate,*there*are*sources*of*bias*in*the*CPI
-The*Biased*CPI
The*main*sources*of*bias*in*the*CPI*are:
§New*Good*Bias
If*you*want*to*compare*the*price*level*in*2014*to*that*of*1970,*
you*must*somehow*compare*a*computer*today*with*a*type*
writer*in*1970
Because*a*PC*is*more*expensive*than*a*typewriter*was,*the*
arrival*of*the*PC*but*an*upward*Bias*into*the*inflation*rate
§Quality*Change*Bias
Cars*and*many*other*goods*get*better*every*year
Part*of*the*rise*in*prices*of*these*goods*is*a*payment*for*
improved*quality*and*is*not*inflation
But*the*CPI*counts*the*entire*price*as*inflation*and*so*
overstates*inflation
§Commodity*Substitution*Bias
Changes*in*relative*prices*lead*consumers*to*change*the*items*
they*buy
For*example:*if*the*prices*of*beef*rises*and*the*price*of*
chicken*remains*the*same,*people*will*buy*more*chicken*and*
less*beef
®The*switch*from*beef*to*chicken*might*provide*the*
same*amount*of*meat*and*the*same*enjoyment*as*
before*and*the*previous*expenditure*is*the*same,*but*
The*CPI*ignores*the*substitution*of*chicken*for*beef,*and*
says*the*price*of*meat*has*increased
§Outlet*Substitution*Bias
When*confronted*with*higher*prices,*people*use*discount*
stores*more*frequently*and*convenience*stores*less*
frequently
This*phenomenon*is*called*outlet*substitution
The*CPI*surveys*do*not*monitor*outlet*substitutions
-The*Magnitude*of*The*Bias
We*know*the*sources*of*bias*in*the*CPI*but*how*big*is*the*bias?
This*question*is*addressed*periodically*and*the*most*recent*estimate*is*
provided*by*the*Bank*of*Canada*economist*James*Rossiter*at*about*0.6*
percent*a*year
-Some*consequences*of*the*Bias
The*bias*in*CPI*disports*private*contracts*and*increases*government*
outlays
Many*private*agreements,*such*as*wage*contracts,*are*linked*to*the*CPI
For*example:*When*a*firm*and*its*workers*might*agree*to*a*three-year*
wage*deal*that*increases*the*wage*rate*by*2*percent*a*year*plus*the*
percentage*increase*in*the*CPI
§Such*a*deal*ends*up*giving*the*workers*more*real*income*than*the*
firm*intended
-Alternative*Price*Indexes
The*CPI*is*just*one*of*many*alternative*price*level* index*numbers*and*
because*the*bias*in*the*CPI*other*measures*are*used*for*some*purposes
Two*Alternative*Price*Indexes:
§GDP*Deflator
Is*an*index*of*all*the*prices*of*all*items*included*in*GDP*and*is*
the*ratio*of*nominal*GDP*to*real*GDP
®GDP*deflator*=*Nominal*GDP*/*Real*GDP*x*100
Because*real*GDP*included*consumption*expenditure,*
investment*and*net*exports*the*GDP*deflator*is*an*index*of*
the*prices*of*all*these*items
Real*GDP*is*calculated* using*the*chained*dollar*method*
(chapter*20,*482-483)*,*which*means*that*the*weights*
attached*to*each*item*in*the*GDP*deflator*are*the*
components*of*GDP*in*both*the*current*year*and*preceding*
year
®Because*it*uses*current*period*and*previous*period*
quantities*rather*than*fixed*quantities*from*and*earlier*
period,*chained*dollar*price*index*incorporates*
substitution*effects*and*new*goods*and*over*comes*the*
source*of*bias*in*the*CPI
The*GDP*deflator*is*appropriate*for*macroeconomics*
because*,*like*GDP,*it*is*a*comprehensive*measure*of*the*cost*
of*the*real*GDP*goods*and*services*,*but*as*a*measure*of*cost*
of*living*is*too*broad
Using*the*GDP*deflator*we*can*deflate*any*nominal*variable*
and*find*its*corresponding*real*real*values
§Chained*Price*Index*for*Consumption
The*chained'Price'index'for'consumption'(CPIC)*is*an*index*of*
all*the*items*included*in*consumption*expenditure*in*GDP*and*
is*the*ratio*of*nominal*consumption*expenditure*to*real*
consumption*expenditure
®CPIC*=*Nominal*Consumption*Expenditure*/*Real*
Consumption*Expenditure*x*100
Like*the*GDP*deflator*,*because*CPIC*uses*current*period*and*
previous*period*quantities*rather*than*fixed*quantities*from*
an*earlier* period,*it*incorporates*substitution*effects*and*new*
goods*and*overcomes*the*sources*of*bias*in*the*CPI
-Core*Inflation*
No*matter*whether*we*calculate*the*inflation*rate*using*the*CPI*,*the*GDP*
deflator*or*the*CPIC*,*the*number*bounces*around*a*good*deal*from*
month*to*month*or*quarter*to*quarter
To*determine*whether*the*inflation*rate*is*trending*upward*or*downward,*
we*need*to*strip*a*few*numbers*of*their*volatility*
The*Core*Inflation*Rate*,*which*is*the*inflation*rate*excluding*volatile*
elements,*attempts*to*do*just*tat*and*reveal*the*underlying*inflation*trend
The*most*commonly*used*measure*of*core*inflation*is*the*Core*CPI*
Inflation*Rate*and*,*as*a*practical* matter*the*core*CPI*inflation*rate*is*
calculated*as*a*percentage*change*in*the*CPI*excluding*food*and*fuel
§CPI*including*food*and*fuel*-Core*CPI*/**Core*CPI**x*100
-The*Real*Variables*in*Macroeconomics
Another*name*for*a*money*price*is*nominal*price
In*macro*we*want*to*distinguish*between*a*real*variable*and*its*
corresponding*nominal*variable
We*want*distinguish*between*a*real*price*and*its*corresponding*nominal*
price*because*real*price*is*an*opportunity*cost*that*influence*choices
We*want*to*distinguish*between*a*real*quantity*(like*real*GDP)*from*a*
nominal*quantity*(like*nominal*GDP)*because*we*want*to*see*what*is*
really'happening*to*the*variables*that*influence*the*standard*of*living
There*is*one*variable*that*is*a*bit*different*-an*interest*rate
§A*real*interest*rate*is*not*a*nominal*interest*rate*divided*by*the*
price*level
But*all*other*real*variables*of*macroeconomics*are*calculated*by*dividing*a*
nominal*variable*by*the*price*level
Chapter(21:(Monitoring(Jobs(and(Inflation
Monday,*January*23,*2017 5:16*PM

Only pages 1-3 are available for preview. Some parts have been intentionally blurred.

Employment*and*Unemployment
Why*Unemployment*is*a*Problem
Unemployment*is*a*serious*personal*and*social*economic*problem*for*two*
main*reasons,*it*results*in:
Lost*Incomes*and*Production
The*loss*of*jobs*brings*loss*of*income*and*lost*production
These*losses*are*devastating*for*the*people*who*bear*them*
and*them*unemployment*a*frightening*prospect*for*everyone
Unemployment*benefits*create*a*safety*net,*but*they*do*not*
fully*replace*lost*earnings
Lost*production*means*lower*consumption*and*a*lower*
investment*in*capital,*which*lowers*living*standard*in*both*
present*and*the*future
§
Lost*Human*Capital
Prolonged*unemployment*permanently*damages*a*person's*
job*prospects*by*destroying*human*capital
Example:*Think*about*a*manager*who*loses*his*job*when*his*
company*downsizes,*and*the*only*work*he*can*find*is*driving*a*
taxi
After*a*year*in*this*work,*he*discovers*that*he*can't*
compete*with*new*MBA*graduates
®
Eventually*he*gets*hired*as*a*manager*but*in*a*small*
firm*and*at*a*lower*wage*than*before
®
He*has*lost*some*his*human*capital
®
The*cost*of*lost*human*capital*is*particularly*acute*for*older*
workers
§
-
Labour*Force*Survey
Every*month*Statistics*Canada*conducts*a*Labour*Force*Survey*in*which*it*
asks*54,000*households*a*series*of*questions*about*the*age*and*job*
market*status*of*members*of*each*household*during*a*previous*week*
called*reference*week*
The*population*divides*into*two*bold*groups:*the*working*age*population*
and*those*who*are*too*young*to*work*or*who*live*in*institutions*and*are*
unable*to*work
The*Working*Age*Population*is*the*total*number*of*people*aged*15*and*
up
The*working*age*population*is*also*divided*into*groups:*those*in*the*
labour*force*and*those*who*are*not*in*the*labour*force
§
Members*of*the*labour*force*are*either*employed*or*unemployed
The*employed*are*either*full-time*or*part-time*workers:
And*part*time*workers*either*want*part-time*or*are*
looking*for*part*time*work
®
Involuntary*part-time*workers*and*voluntary*part-time*
workers
®
To*be*counted*as*employed*in*the*labour*force*survey,*a*
person*must*have*either*a*full*time*job*or*a*part*time*job
To*be*counted*as*unemployed,*a*person*must*be*available'for'
work'and*must*be*in*one*of*three*categories:
On*temporary*layoff*with*expectation*of*recall
®
Without*work*but*has*looked*for*work*in*the*past*four*
weeks
®
Has*a*new*job*to*start*within*four*weeks
®
People*who*satisfy*one*of*these*three*criteria*are*counted*as*
unemployed
People*in*the*working*age*population*who*are*neither*
employed*or*unemployed*are*classified*as*not*in*the*labo