Chapter 8 - Unemployment and Inflation
Chapter Overview Chapter 8 covers the topics of Unemployment and Inflation. Learning Objectives
Understand how unemployment is measured and the calculation of the unemployment rate.
Significance of the unemployment rate for the economy.
Relationship between unemployment rate and economic growth.
Factors determining the natural rate of unemployment.
Impact of inflation and deflation on different economic agents (winners and losers).
Unemployment in Canada (1946-2020)
Unemployment typically increases during recessions.
Unemployment usually decreases during periods of economic expansion.
Reference: The Canadian unemployment rate graph (Figure 8-1).
Defining Unemployment
Employment: Total number of people currently employed (full time or part time).
Unemployment: Total number of people actively seeking work but not currently employed.
Labour Force: Sum of employed and unemployed individuals.
Measuring Unemployment
Labour Force Participation Rate: Percentage of adults (15 and older) in the labour force.
Unemployment Rate: Percentage of individuals in the labour force who are unemployed.
Formulas:
Labour force participation rate = (Labour force / Population age 15 and older) x 100
Unemployment rate = (Number of unemployed workers / Labour force) x 100
Practice Question 1 Scenario: Labour force: 24 million, Employed: 21.5 million. Unemployment Rate Calculation:
Unemployed = 24 million - 21.5 million = 2.5 million
Unemployment Rate = (2.5 million / 24 million) x 100 = 10.4%.
Categories of Unemployed Individuals
Job Loser: Involuntarily terminated or laid off.
Re-entrant: Previously employed but out of the labor force.
Job Leaver: Voluntarily ended employment.
New Entrant: Never worked a full-time job for more than two weeks.
Significance of the Unemployment Rate
Potential Overstatement: Counts individuals actively searching for jobs, even if it takes weeks.
The rate never falls to zero even in prosperous times.
Potential Understatement: Discouraged Workers: Gave up searching for jobs due to availability.
Marginally Attached Workers: Looked for work in the past year but not in the last month.
Underemployed: Workers preferring full-time work but only in part-time roles.
Alternative Measures of Unemployment (1996-2020)
Broader measures include discouraged, marginally attached, and underemployed individuals.
Figure 8-2 illustrates these measures.
Practice Question 2 Details: Adult population: 200 million, Labour force: 150 million, Employed: 138.75 million, Discouraged workers: 10.5 million. Choose from:
a) 7%; 60.4% (correct)
b) 0.7%; 99.3%
c) 5.6%; 69.4%
d) 7.5%; 75%.
Validity of Unemployment Rate
While informative, it doesn’t measure job quality or skill alignment.
Other indicators include labour force participation rate, number of full-time jobs, and average wages.
Regional and Group Variations in Unemployment
Higher unemployment rates for younger and nearing-retirement workers.
2008 recession and 2020 pandemic had significant impacts.
Resource-dependent regions experience fluctuating unemployment according to commodity prices.
Growth and Unemployment Relationship
Typically, unemployment rises during recessions and falls during economic expansions, although never consistently.
Early 1980s and 1990s experienced delayed unemployment reductions post-recession.
Job Creation and Structural Trends
Unemployment rate has never dropped below 3.6% historically.
Economic conditions lead to constant job creation and destruction.
Three main unemployment types: Frictional, Structural, Cyclical.
Frictional Unemployment
Arises from job search duration; often due to information gaps.
Transition time for finding suitable employment leads to frictional unemployment.
Structural Unemployment
Description: Occurs when job-seekers exceed job availability at the current wage.
Factors include skill surpluses, geographic mismatches.
Causes: Can be caused by persistently high wage rates due to minimum wages, union policies, efficiency wages, and government policies.
Minimum Wages
Defined as the legally mandated wage floor.
Binding minimum wages create a surplus in the labor market, potentially leading to structural unemployment.
Unions
Collective worker associations negotiating for better wages and conditions.
Some unions restrict entry into professions or safeguard against termination for full-time workers.
Efficiency Wages
Employers may pay above-equilibrium wages to motivate performance.
Higher wages encourage employees to exert more effort to avoid job loss.
Government Policy Effects
Benefits for unemployed workers can discourage prompt job-seeking.
Generous unemployment benefits can lead to persistent unemployment (Eurosclerosis).
Mismatches Between Employees and Employers
Shifts in the economy create discrepancies in employee skills and employer needs.
Can be caused by geographic or skills mismatching.
Practice Question 4 Scenario: Jasmine moved to a new state and is searching for a job, indicative of:
a) Frictional Unemployment (correct)
b) Cyclical Unemployment.
c) Structural Unemployment.
d) Underemployment.
Natural Rate of Unemployment
The sum of frictional and structural unemployment is termed the natural rate.
Cyclical unemployment represents fluctuations from this natural rate.
Formulas:
Natural unemployment = frictional + structural
Actual unemployment = natural + cyclical
Changes in the Canadian Labour Force (1946-2019)
Significant increase in female labor force participation in the 60s and 70s.
Decrease in workers under 25 due to declining birth rates.
Inflation and Deflation
Definitions: Inflation: Increase in price level affecting purchasing power.
Inflation can be misleading as incomes often rise concurrently, mitigating perceived poverty.
Price Levels vs. Inflation Rate
The real wage refers to the wage rate adjusted for price level changes.
Real income is income adjusted for inflation levels.
Historical increases in prices in Canada did not equate to decreased affluence since income levels also rose.
Importance of Inflation Rate
The inflation rate captures the change in price levels over time, which is crucial in economic analysis.
Example Calculation
If CPI ascends from 120 to 135:
Inflation Rate = (135 - 120) / 120 x 100 = 12.5%.
Winners and Losers from Inflation
Nominal Interest Rate: Stated rate of interest without inflation adjustment.
Real Interest Rate: Nominal less the inflation rate.
Impacts on Borrowers and Lenders
If inflation exceeds expectations, borrowers benefit; lenders lose.
If inflation falls short of expectations, lenders gain; borrowers lose.
Practice Question 6 Scenario: Mary and Joe's expectations about inflation and real interest rates, with actual inflation leading to different outcomes based on their agreements.
Correct answer: Mary is pleased as her real interest rate has declined.
Practice Question 7
Calculation of adjusted salary based on CPI change from 110 to 112.
Correct Answer for salary adjustment: $30,545.
Formulas
Labour force participation rate = (Labour force / Population age 15 and older) x 100
Unemployment rate = (Number of unemployed workers / Labour force) x 100
Natural unemployment = frictional + structural
Actual unemployment = natural + cyclical