Chapter 7 | Unemployment and Inflation Flashcards
Healthy & Unhealthy Unemployment
The unemployment rate measures the percentage of the labour force who are out of work and actively searching for jobs, but misses involuntary part-time workers and discouraged workers
There are four types of unemployment
- frictional
- structural
- seasonal
- cyclical
Statistics Canada sorts working-age population (age 15 and over) into three categories
Employed
Unemployed
Not in labour force
Employed
working full-time or part time at paid job
Unemployed
not doing paid work and actively searching for job: on temporary layoff; about to start new job
Not in labour force
not employed or unemployed (full-time student, homemaker, retiree)
Labour Force
employed + unemployed
Unemployment Rate
Percentage of people in labour force who are unemployed
Unemployment Rate = Unemployed / Labour Force (x100)
Labour Force Participation Rate
Percentage of working-age population in the labour force (employed or unemployed)
Labour Force Participation Rate = Labour Force / Working-Age Population (x100)
Unemployment rate misses
Involuntary part-time workers
Discouraged workers
Involuntary part-time workers
employed part time, would rather have full-time jobs, but can’t find one
Discouraged workers
want to work but have given up actively searching for jobs
Labour Underutilization Rate
unemployment rate including unemployed, involuntary part-time workers, discouraged workers
Healthy and unhealthy types of unemployment
Frictional Unemployment
Structural Unemployment
Seasonal Unemployment
Cyclical Unemployment
Frictional unemployment
due to normal labour turnover and job search; healthy part of a changing economy; not a problem
Structural unemployment
due to technological change or international competition making workers’ skills obsolete; mismatch between skills workers have and skills new job require; healthy part of changing economy; problem requiring retraining
Seasonal unemployment
due to seasonal changes in weathers healthy; not a problem
Cyclical unemployment
due to business cycle fluctuations in economic activity; unhealthy part of changing economy; problem needs fixing
Natural Rate of Unemployment
The natural rate of unemployment occurs at full employment, when there is only healthy frictional, structural, and seasonal unemployment. Relative to the natural rate, the unemployment rate is higher in a recessionary gap and lower in an inflationary gap.
Natural Rate of Unemployment Def.
unemployment rate at full employment; includes frictional, structural, seasonal unemployment
Full employment
not zero percent unemployment, but zero percent cyclical unemployment
Relation between natural rate of unemployment and potential GDP
When unemployment = natural rate; real GDP = potential GDP; full employment
When unemployment > natural rate; real GDP < potential GDP; recessionary output gap; cyclical unemployment
When unemployment < natural rate; real GDP > potential GDP; inflationary output gap
Inflation
Inflation is measured by changes in the Consumer Price INdex, hurts those on fixed incomes, creates risk for business investment, and, through expectations, can create a vicious cycle of more inflation. The inflation rate overstates increases in the cost of living by missing switches to cheaper substitutes and new/improved products/services.
Inflation def.
persistent rise in average prices and fall in value of money
You must spend more to get same products and services as before
Your money is worth less
Consumer Price Index (CPI)
measure of average prices of fixed shopping basket of products and services
CPI = 100 for the base year, currently 2002
Inflation Rate
annual percentage change in Consumer Price Index
Inflation Rate = CPI for current year - CPI for previous year / CPI for previous year (x100)
Core Inflation Rate
inflation rate excluding volatile categories
CPI-trim; CPI-median, CPI-common
Better measure of underlying inflation trend
Inflation is a worry because of falling value of money
Inflation reduces purchasing power of people with fixed (unchanged dollar) income or savings
Inflation affects interest rates
Nominal Interest Rate
Realized Interest Rate
Nominal Interest Rate
- observed interest rate; dollars received per year in interest as percentage of dollars saved
- nominal interest rate adjusted for inflation = nominal interest rate – inflation rate
inflation is a worry because
Unpredictable prices create risk and discourage business investment
Expectations of inflation can cause inflation
Predictable inflation rates between 1 and 3 percent are Bank of Canada’s aim
Predictable inflation rates between 1 and 3 percent are Bank of Canada’s aim
Deflation
persistent fall in average prices and a rise in value of money
Consumers postpone spending, causing economic contraction and increasing unemployment
Deflation benefits savers but hurts borrowers
Deflation is worse than low inflation
CPI fixes quantities in the shopping basket to isolate impact of changing prices only on cost of living
When prices rise, CPI misses quantity switches to cheaper substitutes and new/improved products
Inflation rate based on the CPI overstates increases in cost of living
For any economy with money, M x V = P x Q, where
M quantity of money
V velocity of money
Number of times a unit of money changes hands during a year
P average prices – Consumer Price Index
Q aggregate quantity of real output
P x Q nominal GDP
There must be enough money, multiplied by velocity, to allow sales of all output produced (nominal GDP)
There must be enough money, multiplied by velocity, to allow sales of all output produced (nominal GDP)
Quantity Theory of Money
- increase in quantity of money causes an equal percentage increase in inflation rate
Takes equation M x V = P x Q, fixes V and fixes Q at potential GDP
“Printing money causes inflation”
Inflation is always accompanied by increases in quantity of money
But increase in quantity of money does not always cause inflation, especially when Q (real GDP) is below potential GDP
Not all inflation is caused by increases in quantity of money
Unemployment-Inflation Trade-Offs
The Phillips Curve shows an immediate trade-off between unemployment and inflation consistent with demand-pull stories on inflation.
Cost-push inflation (simultaneous unemployment and inflation) changes in expectations and changes in the natural rate of unemployment complicate the original Phillips Curve.
Phillips Curve
- graph showing inverse relation between unemployment and inflation
Demand-pull Inflation
- rising average prices caused by increases in demand - explains Phillips Curve’s trade-off between unemployment and inflation
During expansions, demand is key force causing shortages and pulling up prices for inputs (wages) and outputs
Cost-push inflation
rising average prices caused by decreases in supply
Does not fit Phillips Curve
Caused by supply shocks
Decrease in supply pushes up output prices, while pushing economy into contraction, increasing unemployment
Can cause stagflation
supply shocks
events directly affecting buusinessess’s costs, prices, and supply
stagflation
combination of recession (unemployment) and inflation
Both demand-pull and cost-push inflation require and accompanying increase in the quantity of money
Both demand-pull and cost-push inflation require and accompanying increase in the quantity of money
Over time, trade-offs between unemployment and inflation of the original Phillips Curve become complicated due to changes in
Expectations of inflation
Natural rate of unemployment
