ECON 102 - Chapter 4

Chapter 4: Measuring the Economy 2: Unemployment and Inflation

Learning Objectives

• Describe what unemployment is and how it is measured.

• Explain the different types of unemployment and the costs of unemployment.

• Explain what inflation is and understand how it is measured.

• Describe the costs and the two causes of inflation.

LO1: Unemployment

• The concept of Unemployment applies to any of the three factor markets: labour, land, or capital.

  • It occurs when some of these factors are idle.

• In the Labour market, unemployment is defined as:

  • The number of persons fifteen years of age and older who are not in gainful employment but are actively seeking employment.

Population and Unemployment, Canada 2022

Table 4.1: Population and Employment in Canada (millions)

• Total population: 38.93

• Working-age population: 31.77

• Labour force: 20.79

• Employed: 19.69

• Unemployed: 1.10

Working-Age Population

• Defined as the total population excluding:

  • Those under 15 years of age

  • Those in the 3 territories or on Aboriginal (First Nations, Métis, Inuit) reserves

  • Full-time residents of mental or penal institutions, hospitals, or the armed forces.

Measuring Unemployment

• Labour Force: Members of the working-age population who are either employed or unemployed.

• Employed: Those in the labour force who hold paid employment.

• Unemployed: Those in the labour force who are actively seeking employment but do not hold paid employment.

Visual Representation: Table 4.1

• Employed: 19.69 million

• Working-age population: 31.77 million

• Labour force: 20.79 million

• Unemployed: 1.10 million

• Not in labour force: 10.98 million

• Not in working-age population: 7.16 million

Participation Rate

• The percentage of the working-age population who are in the labour force (either employed or unemployed).

• Labour Force Participation Rate 2022:

  • Calculation: $Participation \, Rate = \frac{Labour \, Force}{Working \, Age \, Population} \times 100 = \frac{20.79}{31.77} \times 100 = 65.4\%$

Unemployment Rate

• Percentage of those in the labour force who do not hold paid employment.

• Canada’s unemployment rate for 2022:

  • Calculation: $Unemployment \, Rate = \frac{Number \, of \, Unemployed}{Labour \, Force} \times 100 = \frac{1.10}{20.79} \times 100 = 5.9\%$

Unemployment Rates Trends

• Unemployment Rates in Canada (1990-2022)

  • Shows fluctuations in unemployment rates across different years (no detailed values provided).

• Unemployment Rates by Province (2022)

  • Different provinces show varied unemployment rates (no specific values provided).

Test Your Understanding

1. Given the following parameters: Population of 20 million, Working-age population of 15 million, Employed: 9 million, Unemployed: 1 million.

   • Labour force: $Labour \, Force = Employed + Unemployed = 9m + 1m = 10m$

   • Participation rate: $Participation \, Rate = \frac{Labour \, Force}{Working \, Age \, Population} \times 100 = \frac{10}{15} \times 100 = 66.7\%$

   • Unemployment rate: $Unemployment \, Rate = \frac{Unemployed}{Labour \, Force} \times 100 = \frac{1}{10} \times 100 = 10.0\%$

LO2: The Different Types of Unemployment

• Frictional Unemployment: Unemployment related to the time it takes individuals to find their first job or to transition between jobs.

• Structural Unemployment: Results from a mismatch in the skills or locations of jobs available and those looking for work.

• Cyclical Unemployment: Occurs as a result of the recessionary phase of the business cycle, where the economy is at or near full employment at its peak.

• Natural Rate of Unemployment: Characterizes the level of unemployment when there is no cyclical unemployment, indicative of full employment. It can change due to shifts in:

  • Employment insurance benefits

  • Average job search time

  • Labour-force participation rate.

Charting Unemployment

• Visual categorization of unemployed individuals (no specific diagram provided):

  • Categories include: Homemaker entry, student and discouraged worker entry, new hires, layoffs, dismissals, quits.

Test Your Understanding

• Categorize unemployment cases as frictional, structural, or cyclical:

  • Sanjit: Laid off due to high inventories - Cyclical

  • Alison: Left an unappealing job and still searching - Frictional

  • Tomiko: Sold her fishing boat after a lack of returns - Structural.

Criticisms of the Official Unemployment Rate

• Understatements:

  • Part-time workers counted as full-time.

  • Exclusion of discouraged workers (those who have stopped seeking work).

• Overstatements:

  • False information from EI recipients or those working in the underground economy.

Costs of Unemployment

• GDP Gap: The difference between potential GDP and actual GDP.

  • Calculation: $GDP \, Gap = Potential \, GDP - Actual \, GDP$

• Okun’s Law: Associate cyclical unemployment with GDP loss.

  • For every 1% of cyclical unemployment, GDP is 2.5% below potential.

  • Calculation: $GDP \, Gap = 2.5 imes cyclical \, unemployment \,$

Test Your Understanding

• Given parameters for natural rate of unemployment(8%), actual rate(10%), and real GDP ( extdollar800 billion):

  • GDP Gap calculation:

  • GDP \, Gap = 2.5 \times 2\% \times 800 \, billion = \textdollar40 \, billion

  • Potential GDP: Potential \, GDP = Actual \, GDP + GDP \, Gap = 800 + 40 = \textdollar840 \, billion

LO3: Inflation

• Defined as an increase in the general level of prices sustained over a period in an economy.

• Measured using price indices such as:

  • Consumer Price Index (CPI)

  • GDP Deflator

Consumer Price Index (CPI)

• A measure of the average level of prices for typical household goods and services.

  • CPI Calculation: $(CPI = \frac{Cost \, of \, basket \, in \, given \, year}{Cost \, of \, basket \, in \, base \, year} \times 100)$

• Inflation Rate Calculation using CPI:

  • $(Inflation \, Rate = \frac{CPI<em>{year \, 2} - CPI</em>{year \, 1}}{CPI_{year \, 1}} \times 100)$

Example: Measuring Inflation Using CPI

• Example calculation for CPI in 2022:

  • $CPI_{2022} = \frac{1300}{1250} \times 100 = 104$

  • Inflation Rate 2022: $Inflation \, Rate_{2022} = \frac{(104 - 100)}{100} \times 100 = 4\%$

CPI and Inflation Rates in Canada (2012-2022)

• Table highlights changes in CPI and inflation rates across the years.

Core CPI

• Excludes volatile items like:

  • Fruits and vegetables

  • Gas

  • Fuel oil

  • Mortgage interest

  • Tobacco

• Provides a better long-term inflation rate indication.

GDP Deflator

• A measure of the price level of goods and services within the GDP.

  • GDP Deflator Calculation: $GDP \, Deflator = \frac{Nominal \, GDP}{Real \, GDP} \times 100$

Example: GDP Deflator Calculation

• Example calculations provided for two consecutive years with resultant inflation rate.

Measuring Inflation: Summary

• CPI vs GDP Deflator Differences:

  • CPI: Explicit index based on a constant bundle.

  • GDP Deflator: Implicit metric measuring nominal vs real GDP, includes capital and government goods.

Relationship among Nominal GDP, Real GDP, and GDP Deflator

• Expressed as:

  • $Real \, GDP = \frac{Nominal \, GDP}{GDP \, Deflator} \times 100$

  • $Nominal \, GDP = Real \, GDP \times \frac{GDP \, Deflator}{100}$

Test Your Understanding: Fill in the Blanks Exercise

• Provided values to calculate the GDP characteristics across the specified years.

Benefits of Price Index

• Allows comparison of past values with present values.

• Enables evaluation of past incomes against current figures by normalizing to a common price index.

Nominal vs Real Income

• Nominal Income: Actual dollar value of a person’s income at the time.

• Real Income: Purchasing power of income, determined by dividing nominal income by the price level.

Test Your Understanding: Example of Nominal vs Real GDP Growth

• Example calculations on the increase of GDP and adjustments based on inflation.

Rule of 70

• Used to estimate the time needed for a value to double given a specific growth rate.

• Calculation: $Years \, to \, Double = \frac{70}{Growth \, Rate}$

Example: Investment Doubling

• If $1000 is invested at 10%, it will double in 7 years: $Years \, to \, Double = \frac{70}{10} = 7 \, years$

Test Your Understanding: Inflation Rate Doubling

• Example calculation to determine time for prices to double given a 7% inflation rate.

LO4: The Costs and Causes of Inflation

• Redistributive Costs: Shifts income from low-income individuals to high-income individuals and from lenders to borrowers.

• Output Costs: Reduction in investment and economic growth, alongside increased menu costs related to price changes.

• Real Interest Rate: Calculated as the nominal rate minus the inflation rate.

• Demand-side Inflation: Occurs when overall demand exceeds production capacity, driving prices up.

• Supply-side Inflation: Results from increased production costs due to various factors, such as wage increases or supply chain disruptions.

Galloping Inflation

• Extremely high rates of inflation, exemplified by historical cases:

  • Post-WWI Germany: Prices rose dramatically.

  • Zimbabwe in 2008: Prices doubled every 24 hours.

Test Your Understanding: Real Interest Rate Example

• Calculation of the real interest rate based on provided nominal rate and inflation rate values.

Summary Key Concepts

• Understanding unemployment and its measurement.

• Recognizing different types of unemployment.

• Evaluating costs associated with unemployment.

• Comprehending inflation and its measurement methodologies.

• Identifying costs of inflation and distinguishing between its causes.