Chapter 7 | Unemployment and Inflation

Question 1

Healthy & Unhealthy Unemployment

Answer 1

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

Question 2

There are four types of unemployment

Answer 2

• frictional
• structural
• seasonal
• cyclical

Question 3

Statistics Canada sorts working-age population (age 15 and over) into three categories

Answer 3

Employed

Unemployed

Not in labour force

Question 4

Employed

Answer 4

working full-time or part time at paid job

Question 5

Unemployed

Answer 5

not doing paid work and actively searching for job: on temporary layoff; about to start new job

Question 6

Not in labour force

Answer 6

not employed or unemployed (full-time student, homemaker, retiree)

Question 7

Labour Force

Answer 7

employed + unemployed

Question 8

Unemployment Rate

Answer 8

Percentage of people in labour force who are unemployed

Unemployment Rate = Unemployed / Labour Force (x100)

Question 9

Labour Force Participation Rate

Answer 9

Percentage of working-age population in the labour force (employed or unemployed)

Labour Force Participation Rate = Labour Force / Working-Age Population (x100)

Question 10

Unemployment rate misses

Answer 10

Involuntary part-time workers

Discouraged workers

Question 11

Involuntary part-time workers

Answer 11

employed part time, would rather have full-time jobs, but can’t find one

Question 12

Discouraged workers

Answer 12

want to work but have given up actively searching for jobs

Question 13

Labour Underutilization Rate

Answer 13

unemployment rate including unemployed, involuntary part-time workers, discouraged workers

Question 14

Healthy and unhealthy types of unemployment

Answer 14

Frictional Unemployment

Structural Unemployment

Seasonal Unemployment

Cyclical Unemployment

Question 15

Frictional unemployment

Answer 15

due to normal labour turnover and job search; healthy part of a changing economy; not a problem

Question 16

Structural unemployment

Answer 16

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

Question 17

Seasonal unemployment

Answer 17

due to seasonal changes in weathers healthy; not a problem

Question 18

Cyclical unemployment

Answer 18

due to business cycle fluctuations in economic activity; unhealthy part of changing economy; problem needs fixing

Question 19

Natural Rate of Unemployment

Answer 19

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.

Question 20

Natural Rate of Unemployment Def.

Answer 20

unemployment rate at full employment; includes frictional, structural, seasonal unemployment

Question 21

Full employment

Answer 21

not zero percent unemployment, but zero percent cyclical unemployment

Question 22

Relation between natural rate of unemployment and potential GDP

Answer 22

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

Question 23

Inflation

Answer 23

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.

Question 24

Inflation def.

Answer 24

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

Question 25

Consumer Price Index (CPI)

Answer 25

measure of average prices of fixed shopping basket of products and services CPI = 100 for the base year, currently 2002

Question 26

Inflation Rate

Answer 26

annual percentage change in Consumer Price Index Inflation Rate = CPI for current year - CPI for previous year / CPI for previous year (x100)

Question 27

Core Inflation Rate

Answer 27

inflation rate excluding volatile categories CPI-trim; CPI-median, CPI-common Better measure of underlying inflation trend

Question 28

Inflation is a worry because of falling value of money

Answer 28

Inflation reduces purchasing power of people with fixed (unchanged dollar) income or savings

Question 29

Inflation affects interest rates

Answer 29

Nominal Interest Rate Realized Interest Rate

Question 30

Nominal Interest Rate

Answer 30

- 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

Question 31

inflation is a worry because

Answer 31

Unpredictable prices create risk and discourage business investment Expectations of inflation can cause inflation

Question 32

Predictable inflation rates between 1 and 3 percent are Bank of Canada’s aim

Answer 32

Predictable inflation rates between 1 and 3 percent are Bank of Canada’s aim

Question 33

Deflation

Answer 33

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

Question 34

CPI fixes quantities in the shopping basket to isolate impact of changing prices only on cost of living

Answer 34

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

Question 35

For any economy with money, M x V = P x Q, where

Answer 35

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

Question 36

There must be enough money, multiplied by velocity, to allow sales of all output produced (nominal GDP)

Answer 36

There must be enough money, multiplied by velocity, to allow sales of all output produced (nominal GDP)

Question 37

Quantity Theory of Money

Answer 37

- 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”

Question 38

Inflation is always accompanied by increases in quantity of money

Answer 38

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

Question 39

Unemployment-Inflation Trade-Offs

Answer 39

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.

Question 40

Phillips Curve

Answer 40

- graph showing inverse relation between unemployment and inflation

Question 41

Demand-pull Inflation

Answer 41

- 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

Question 42

Cost-push inflation

Answer 42

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

Question 43

supply shocks

Answer 43

events directly affecting buusinessess’s costs, prices, and supply

Question 44

stagflation

Answer 44

combination of recession (unemployment) and inflation

Question 45

Both demand-pull and cost-push inflation require and accompanying increase in the quantity of money

Answer 45

Both demand-pull and cost-push inflation require and accompanying increase in the quantity of money

Question 46

Over time, trade-offs between unemployment and inflation of the original Phillips Curve become complicated due to changes in

Answer 46

Expectations of inflation Natural rate of unemployment