Unemployment and Inflation

Unemployment and Inflation

ECON 101 - Macroeconomics

Instructor: Muhebullah Karimzada

Winter 2026

Chapter Outline

• 5.1 Measuring the Unemployment Rate and the Labour Force Participation Rate
• 5.2 Types of Unemployment
• 5.3 Explaining Unemployment
• 5.4 Measuring Inflation
• 5.5 Using Price Indexes to Adjust for the Effects of Inflation
• 5.6 Real versus Nominal Interest Rates
• 5.7 Does Inflation Impose Costs on the Economy?

Measuring Unemployment and Inflation

• Previous topics included measuring total output (GDP).
• This chapter focuses on:
  • Measurement of unemployment in the labour market.
  • Measurement of inflation in the goods and services market.
• Importance of these measurements:
  • Central for macroeconomic policy.
  • Evaluating economic performance.
  • Everyday decision-making of households and firms.

5.1 Learning Objectives

• Goal: Understand how unemployment, labour force participation, and employment rates are measured.
• Canada's economy is large and dynamic:
  • Millions of people constantly changing jobs.
• Statistical Method: Statistics Canada uses surveys to estimate key metrics:
  • Employment
  • Unemployment
  • Labour force participation
  • Employment-population ratio

The Labour Force and Unemployment

• Labour Force: Sum of employed and unemployed individuals in the economy.
• Unemployment Rate:
  • Formula: \text{Unemployment Rate} = \left( \frac{\text{Number of Unemployed}}{\text{Labour Force}} \right) \times 100
  • Often reported monthly in the news.

The Labour Force Survey (LFS)

• Conducted monthly by Statistics Canada with roughly 56,000 representative households.
• Participants (15 years and older) are asked about:
  • Employment status
  • Recent job search activities
• Classifications based on responses:
  • Employed
  • Unemployed
  • Not in the Labour Force

Definitions

Employed:

• Individual who:
  • Did paid work
  • Did unpaid work for family business
  • Worked for themselves
  • Was temporarily away from their job (vacation, illness, strike)

Unemployed:

• Not currently at work, but available for work and actively looking for a job in the previous four weeks.

Not in the Labour Force:

• Individuals who are neither employed nor unemployed (e.g., students not seeking work, retirees).

Labour Force Participation Rate

• Labour Force Participation Rate (LFPR):
  • Formula: \text{LFPR} = \left( \frac{\text{Labour Force}}{\text{Working-Age Population}} \right) \times 100
• Indicates fraction of working-age individuals actively in the labour market.
• Helps distinguish:
  • Low unemployment due to many people having jobs vs.
  • Low unemployment due to many giving up looking for work.

Employment-Population Ratio

• Employment-Population Ratio:
  • Formula: \text{Employment-Population Ratio} = \left( \frac{\text{Number Employed}}{\text{Working-Age Population}} \right) \times 100
• Provides insight into the health of the labour market during expansions and recessions.

Problems with Measuring the Unemployment Rate

• The measured unemployment rate can:
  • Understate true unemployment:
  • Difficult to distinguish between unemployed and not in the labour force.
  • Discouraged Workers: Individuals who have stopped looking for work but would accept a job if offered.
  • Does not account for job intensity (part-time vs. full-time, underemployment).
  • Overstate unemployment:
  • Individuals may falsely claim unemployment status to access benefits or evade taxes.

Job Creation and Job Destruction

• The labour market is dynamic:
  • Constant creation and destruction of jobs.
• Example:
  • In January 2022, there were 890,500 more people employed compared to January 2021.
  • The total number of jobs created was higher because many jobs were also lost.
  • Month-to-month provincial job losses can occur even in a nationally improving economy.

5.2 Learning Objectives

• Goal: Identify and understand the four types of unemployment.
• Unemployment is complex and categorized into:
  • Frictional Unemployment
  • Structural Unemployment
  • Cyclical Unemployment
  • Seasonal Unemployment

Types of Unemployment

• Frictional Unemployment: Short-term unemployment from the job matching process; arises from job search as individuals enter/re-enter the labour force or transition between jobs.
  • Some frictional unemployment can enhance economic efficiency by helping workers find better job matches.

Example: Frictional Unemployment

• A recent university graduate searching for a job in their field for three months represents frictional unemployment. It is beneficial for them to find a suitable job rather than settling for the first offer.

• Structural Unemployment: Long-term unemployment arising from skill mismatches and changes in industry demands; often requires retraining or relocation.

Example: Structural Unemployment

• A manufacturing worker whose skills do not transfer to new sectors, such as IT, after losing their job due to automation may remain jobless without retraining.

• Cyclical Unemployment: Results from economic downturns; when aggregate demand decreases, firms cut back on output and lay off workers, regardless of their skills.

Example: Cyclical Unemployment

• In February 2009, Chrysler closed a plant due to low sales, leading to layoffs reflecting cyclical unemployment.

• Seasonal Unemployment: Occurs due to seasonal variations in industries such as construction, tourism, and agriculture; may cause measured unemployment to appear artificially high in winter and low in summer.

• Statistics Canada accounts for this with:

  • Seasonally adjusted series (removing seasonal effects)
  • Unadjusted series (including seasonal effects)

Full Employment and the Natural Rate of Unemployment

• Full employment exists even in good times, as some unemployment is inevitable (comprising frictional and structural factors).
• Natural Rate of Unemployment: Rate representing frictional and structural unemployment; recent estimates for Canada hover around 5.6–6.7%.

5.3 Learning Objectives

• Goal: Explain determinants of the unemployment rate and the impact of policy on it.
• Governments can influence unemployment:
  • Some policies reduce frictional or structural unemployment.
  • Others may inadvertently increase unemployment.

Government Policies and Unemployment

• Policies that Reduce Unemployment:

  • Retraining programs (e.g., Ontario’s “Better Jobs Ontario”) targeting structural unemployment.
  • Hiring subsidies/job search assistance for reducing frictional unemployment.

• Policies that Might Increase Unemployment:

  • Employment Insurance (EI): If too generous, it may extend unemployment duration.
  • Minimum Wage Laws: Higher hiring costs may reduce labour demand.
  • Labour market regulations that restrict hiring/firing.

Employment Insurance (EI)

• If job loss occurs, an individual can either:
  • Take an immediately available but lower-paying job.
  • Search for a job that aligns better with their skills, facilitated by EI payments.
• EI replaces approximately 55% of earnings, with a cap (e.g., $595/week in 2021).
• Effects:
  • Provides extended job search time leading to better job matches and higher productivity.
  • However, it may also extend the average unemployment duration.

Minimum Wage Laws

• Designed to assist low-income earners by setting a wage floor.
• Increasing the minimum wage raises labour costs leading to:
  • Fewer workers hired
  • Capital substitution for labour
  • Reduced hours of current workers
• Example Minimum Wages (June 2022):
  • Nunavut: $16.00/hour
  • New Brunswick: $12.75/hour
• Studies suggest a 10% increase in minimum wage may decrease teenage employment by around 2%. Overall unemployment impact is minor.

Labour Unions

• Unions are worker organizations that negotiate with employers for:
  • Higher wages
  • Better working conditions
• Approximately 30.9% of Canadian workers were unionized by the end of 2021:
  • 77.2% of government workers are unionized.
  • Only 15.3% of private sector workers are unionized.
• Overall impact of unions on total unemployment in Canada is likely limited.

Efficiency Wages

• Efficiency Wage: A wage set above the market-clearing rate to enhance productivity.
• Reasons to Pay Higher Wages:
  • Reducing worker turnover
  • Increasing employee effort and reducing shirking
  • Attracting higher-quality job applicants
• However, this may:
  • Lead to fewer hires than desired
  • Cause persistent unemployment despite a healthy economy.

5.4 Learning Objectives

• Goal: Define price level and inflation rate, and understand their calculations.
• Previous chapters introduced price levels through the GDP deflator; this chapter elaborates on specific measures like the:
  • Consumer Price Index (CPI)
  • Producer Price Index (PPI)

Price Level and Inflation Rate

• Price Level: An average measure of prices for goods and services across the economy.
• Inflation Rate:
  • Formula: \text{Inflation Rate} = \left( \frac{\text{Price Level}t - \text{Price Level}{t-1}}{\text{Price Level}_{t-1}} \right) \times 100
• The GDP deflator measures price levels for final goods and services; the CPI focuses on household-specific goods.

The Consumer Price Index (CPI)

• CPI: Measures average price changes paid by a typical household over time for specific goods/services.
• Typical categories include:
  • Food, shelter, transportation, clothing, recreation, etc.
• CPI usage includes:
  • Adjusting wages, pensions, and benefits
  • Cost-of-living comparisons over time.

Calculating the CPI

• To compute CPI, the following information is needed:
  • A fixed basket of goods and services (quantities from a base year)
  • Cost of the basket in the base year
  • Cost of the basket in the current year
• CPI Calculation:
  • Formula: \text{CPI}_t = \left( \frac{\text{Cost of Basket in Year } t}{\text{Cost of Basket in Base Year}} \right) \times 100
  • CPI of the base year is conventionally set to 100.

A Simple CPI Calculation

Example:

• The CPI basket includes:
  • 10 units of A, 5 units of B, 2 units of C.
• Cost of Basket 2002:
  • \text{Cost}{2002} = 10P{2002}^A + 5P{2002}^B + 2P{2002}^C
• Cost of Basket 2022:
  • \text{Cost}{2022} = 10P{2022}^A + 5P{2022}^B + 2P{2022}^C
• CPI 2022:
  • Formula: \text{CPI}{2022} = \left( \frac{\text{Cost}{2022}}{\text{Cost}_{2002}} \right) \times 100
• Inflation Calculation from 2022 to 2023:
  • Formula: \text{Inflation} = \left( \frac{\text{CPI}{2023} - \text{CPI}{2022}}{\text{CPI}_{2022}} \right) \times 100

Historical Pricing Perspective

Example:

• Cost comparison:
  • A pair of cashmere socks cost $0.35 in 1915 and $39.00 in 2021.
  • CPI adjustment: $0.35 (1915) corresponds to about $8.13 in 2021 dollars.
  • While nominally more expensive today, adjusted for income, households can afford more than in the past.

CPI Accuracy and Biases

• The CPI is widely utilized but contains four primary biases that may overstate the increase in living costs (by about 0.5 to 1 percentage point annually):
  • Substitution Bias: Fixed basket fails to account for consumer shifts toward cheaper goods.
  • Quality Change Bias: Price increases may reflect improved product quality.
  • New Product Bias: Delayed inclusion of new products in the basket.
  • Outlet Bias: Shift to discount retailers not fully captured in CPI data.

Producer Price Index (PPI)

• PPI: Average prices received by producers of goods and services throughout various production stages.
• Composed of:
  • Raw materials
  • Intermediate goods
  • Wholesale goods
• Changes in PPI signal potential future consumer price changes due to input cost fluctuations.

5.5 Learning Objectives

• Goal: Use price indexes for adjusting nominal values for inflation to compare purchasing power over time.

Adjusting Nominal Values for Inflation

• To express a past value (e.g., $30,000 in 1993) in terms of today's dollars:
  • Formula: \text{Value in 2021 dollars} = \text{Value in 1993 dollars} \times \left( \frac{\text{CPI}{2021}}{\text{CPI}{1993}} \right)
  • Real equivalent of $30,000 in 1993 is approximately $49,626 in 2021 using actual CPI data.

Practical Application: Cost-of-Living Adjustments

• Cost-of-living adjustments (COLAs) through negotiations help maintain purchasing power.
• Many government benefits (e.g., pensions) are indexed to CPI, thus protecting real purchasing power during inflationary periods.

5.6 Learning Objectives

• Goal: Differentiate between nominal and real interest rates.
• Interest rates are critical for:
  • Saving and borrowing decisions
  • Investment strategy
  • Monetary policy implementation

Inflation and Interest Rates

• When lending, borrowers repay with interest. For example, a nominal interest rate of 6% on a $1,000 loan results in a total repayment of:
  • 1,000 \times (1 + 0.06) = 1,060
• Inflation can erode the real value of money over time, necessitating the understanding of real interest rates.

Nominal vs. Real Interest Rate

• Nominal Interest Rate: Stated rate on loans.
• Real Interest Rate: Adjusts for inflation:
  • Formula: \text{Real Interest Rate} \approx \text{Nominal Interest Rate} - \text{Inflation Rate}
• Example:
  • If nominal rate is 6% and inflation is 2%, the calculated real interest rate is approximately 4%.

5.7 Learning Objectives

• Goal: Discuss the problems inflation causes, especially when unanticipated.
• While inflation may appear benign if prices rise uniformly, it presents real economic challenges.

Is Inflation a Problem?

• Ideal scenario: Prices rise uniformly; however:
  • Price adjustments are asynchronous and uneven.
  • Some wages can lag due to fixed contracts.
  • Certain assets, like cash, may devalue.
• Consequences include:
  • Redistribution of income and wealth.
  • Altered incentives affecting saving, borrowing, and investment behaviors.

Problems with Anticipated Inflation

• Anticipated inflation can still create economic costs:
  • Redistribution of income disparity (some wages keep pace while others do not).
  • Real value diminishes for cash-held assets.
  • Menu Costs: Cost of changing prices incurred by firms (e.g., re-tagging products).
  • Tax implications, where nominal returns are taxed, resulting in higher tax burdens despite unchanged real returns.

Problems with Unanticipated Inflation

• Conflicts arise when inflation deviates from expectations, affecting long-term contracts:
  • Higher than expected inflation benefits borrowers (repayment in cheaper dollars) but harms lenders (returning less valuable money).
  • Conversely, lower than expected inflation harms borrowers (paying more than anticipated) while benefiting lenders.
• Volatile inflation discourages savings and long-term investments.

Example: High and Uncertain Inflation

• Historical perspective:
  • In the late 1970s to early 1980s, mortgage interest rates surged past 18% as banks sought to mitigate uncertain inflation impacts.
  • Households with high nominal rates suffered when inflation subsided while their rates remained high, emphasizing the need for stable inflation management by central banks.

Summary

• Key labor market indicators include:
  • Unemployment rate
  • Labour force participation rate
  • Employment-population ratio.
• Four primary types of unemployment:
  • Frictional
  • Structural
  • Cyclical
  • Seasonal.
• Various policies (EI, minimum wage laws, unions, efficiency wages) influence unemployment.
• Inflation measurements utilize various price indexes (CPI, PPI, GDP deflator):
• CPI serves as a cost-of-living index but has inherent biases affecting its accuracy.
• Price indexes are essential for converting nominal values to real values, impacting financial decisions.
• Real interest rates are significant for assessing returns on saving, borrowing, and overall investment strategies.
• Inflation, especially when unanticipated, poses substantial risks and economic costs.

Acknowledgment

• Thank you!

Muhebullah Karimzada

Unemployment and Inflation

Winter 2026