Chapter 8: Unemployment and Inflation

Question 1

What is employment?

Answer 1

The total number of people currently employed, either full-time or part-time

Question 2

How is unemployment defined?

Answer 2

The total number of people aged 15 or older who are actively looking for work but aren’t currently employed

Question 3

What is a labour force?

Answer 3

A country’s labour force is the sum of employment and unemployment; that is, the number of people who are currently working plus the number of people who are currently looking for work

Question 4

How do you calculate the labour force participation rate?

Answer 4

Labour force participation rate = (Labour force/Population aged 15 or older) * 100

Question 5

What is the labour force participation rate?

Answer 5

The percentage of the population aged 15 or older that is in the labour force

Question 6

What is the unemployment rate?

Answer 6

The percentage of the total number of people in the labour force who are unemployed, calculated as unemployment/(unemployment + employment)

Question 7

How do you calculate the unemployment rate?

Answer 7

Unemployment rate = (Number of unemployed workers/Labour force) * 100

Question 8

What does the unemployment rate generally indicate?

Answer 8

It is an indicator of the overall labour market conditions, not as an exact measure of the percentage of people unable to find jobs

Question 9

Why does the unemployment rate never fall to zero?

Answer 9

If you’re searching for work, it’s normal to take a few weeks to find a suitable job. Yet a worker who is quite confident of finding a job, but has not yet accepted a job, is counted as unemployed. As a consequence, the unemployment rate never falls to zero, even in boom times when jobs are plentiful.

Question 10

Who is omitted from the unemployment rate calculation?

Answer 10

Discouraged workers, marginally attached workers, and underemployed workers (visible and invisible)

Question 11

Who is a discouraged worker?

Answer 11

Individuals who want to work but who have stated to government researchers that they aren’t currently searching for a job because they see little prospect of finding one given the state of the job market

Question 12

Who is a marginally attached worker?

Answer 12

Nonworking individuals who say they would like a job and have looked for work in the recent past but are currently not looking for a job, because they are waiting for employment to begin (i.e. waiting to be recalled after a layoff, or for a new job to start in a few weeks)

Question 13

Who is a visibly underemployed worker?

Answer 13

People who work, but not in the desired capacity. Visibly underemployed workers are people who have jobs in which they work fewer hours than they would like

Question 14

Who is an invisibly underemployed worker?

Answer 14

People who work, but not in the desired capacity. Invisibly underemployed workers have jobs that do not use their skills fully or that are considered to be substandard, owing to low wages or some other disadvantage

Question 15

What is the R8?

Answer 15

The sum of the three categories of frustrated workers, plus the unemployed, measured by Stats Canada

Question 16

How can the unemployment rate understate the true level of unemployment?

Answer 16

1. Does not include frustrated workers, 2. Employment varies drastically across demographic groups (i.e. young workers, people without post-secondary degrees, etc.), 3. Regional macroeconomic differences (i.e. Alberta more sensitive to changes in oil prices)

Question 17

Explain the relationship between changes in real GDP and changes in the unemployment rate

Answer 17

There is a negative relationship between changes in economic growth and changes in the unemployment rate. If real GDP rises, the unemployment rate typically falls. If real GDP falls, the unemployment rate typically rises.

Question 18

Explain why we might see an increase in the unemployment rate during periods of expansion

Answer 18

1. Real GDP might not be growing fast enough to reduce the unemployment rate, 2. Productivity/technology expansions may lead to fewer workers being necessary, 3. Workers who were previously discouraged may begin to look for a job again during expansions, 4. Workers may quit their job to find a better one, increasing the unemployment rate

Question 19

Explain why we might see a decrease in the unemployment rate during periods of recession

Answer 19

1. People may become discouraged workers and give up looking for a job, which means they wouldn’t be included in the unemployment rate and it would decrease

Question 20

What is a jobless recovery or growth recession?

Answer 20

A period in which real GDP growth rate is positive but the unemployment rate is still rising

Question 21

What are job separations?

Answer 21

Terminations of employment that occur because a worker is either fired or voluntarily quits

Question 22

What leads to job separations

Answer 22

1. Structural changes in the economy (job destruction or job creation), 2. Poor management performance, 3. Bad luck at individual companies

Question 23

What is a job search?

Answer 23

The time spent by workers in looking for employment

Question 24

What is frictional unemployment?

Answer 24

Unemployment due to the time workers spend in job search

Question 25

What is the relationship between changes in unemployment rates and frictional employment?

Answer 25

When there is a low unemployment rate, periods of unemployment tend to be quite short, suggesting that much of this unemployment is frictional. When there is a higher unemployment rate, periods of unemployment are longer, suggesting that the amount of frictional unemployment is small relative to the amount of unemployment arising from a downturn in the business cycle

Question 26

How long do you have to be unemployed for to be considered “long-term unemployed” or “structurally unemployed”?

Answer 26

27 weeks

Question 27

What is structural unemployment?

Answer 27

Unemployment that results when there are more people seeking jobs in a particular labour market than there are jobs available at the current wage rate, even when the economy is at the peak of the business cycle

Question 28

What is the wage equilibrium?

Answer 28

The point where labour supply = labour demand

Question 29

Why is the effect of wage floors on a labour market?

Answer 29

The supply and demand model is generally applicable to labour markets.. When the wage rate increases, employers demand less labour, but more workers are willing to supply labour at this rate. The points where labour supply = labour demand is called the wage equilibrium. However, a myriad of factors can contribute to the establishment of wage floors, beneath which no worker’s wage can fall. If the wage floor is above the wage equilibrium, there are more workers willing to supply labour than employers demanding labour, and this can contribute to structural unemployment.

Question 30

When does structural unemployment occur?

Answer 30

When the wage rate (or wage floor) is, for some reason, persistently above the wage equilibrium

Question 31

What are the most important factors that contribute to a wage rate or wage floor being higher than the wage equilibrium?

Answer 31

Minimum wage policies, unions, and efficiency wages, side effects of government policies, and mismatches between skills in demand and skills in supply

Question 32

What is a minimum wage?

Answer 32

A legal or government-mandated floor on the wage rate, which is the market price for labour

Question 33

Why does the minimum wage impact structural unemployment?

Answer 33

For “less-skilled” workers, the minimum wage might be binding, because it raises their wage above the wage equilibrium and leads to structural unemployment. It eliminates the opportunity to work for some workers who would have willingly worked for lower wages

Question 34

Why isn’t the binding effect of minimum wage universal?

Answer 34

The minimum wage in Canada is quite low compared to other nations, and isn’t binding for the vast majority of workers. Research also suggests that minimum wage increases are not associated with employment declines and may actually lead to higher employment when the minimum wage is low compared to average wages

Question 35

What are unions?

Answer 35

An organization of workers that bargains collectively with employers to raise wages and improve working conditions

Question 36

Why do unions impact structural unemployment?

Answer 36

When workers have increased bargaining power, they tend to demand and receive higher wages. The result of these higher wages can push the wage rate above the equilibrium wage. This can be binding and can contribute to structural unemployment

Question 37

What are efficiency wages?

Answer 37

Wages that employers set above the wage equilibrium as an incentive for workers to deliver a better performance

Question 38

Why do efficiency wages impact structural unemployment?

Answer 38

When many firms pay efficiency wages, the result is a pool of workers who want jobs but can’t find them. For example, with Costco paying efficiency wages, a lot of workers are willing to work at Costco but not at Walmart. So, the use of efficiency wages by firms may lead to structural unemployment

Question 39

What is an example of a side effect of government policies that impacts structural unemployment

Answer 39

Generous EI packages - people living on EI may spend more time unemployed because they are not financially pressured into finding employment

Question 40

What is an example of mismatches between an employer and employee that impacts structural unemployment?

Answer 40

A skills mismatch (i.e. more construction workers looking for jobs than there were jobs available in 2009 housing bust), or a geographic mismatch (i.e. Windsor, Ontario having a long-standing surplus of workers after its auto industry declined)

Question 41

What is the natural rate of unemployment?

Answer 41

The normal unemployment rate around which the actual unemployment rate fluctuates; the unemployment rate that arises from the effects of frictional and structural unemployment

Question 42

What is cyclical unemployment?

Answer 42

The difference between the actual rate of unemployment and the natural rate of unemployment due to downturns in the business cycle

Question 43

How do you calculate the natural rate of unemployment?

Answer 43

Natural rate of unemployment = frictional unemployment + structural unemployment

Question 44

How do you calculate the rate of actual unemployment?

Answer 44

Actual rate of unemployment = natural rate of unemployment + cyclical unemployment

Question 45

What are the most important factors that cause the natural rate of unemployment to change?

Answer 45

Changes in labour force characteristics, changes in market institutions, and changes in government policies

Question 46

Give an example of how changes in labour force characteristics can impact changes in the natural rate of unemployment

Answer 46

Unemployment rates tend to be lower for more experienced workers relative to unexperienced workers. Also, because older workers are more likely to be to be family breadwinners, they have a stronger incentive to find and keep jobs. If there are more young people in the labour force, the natural rate of unemployment may rise.

Question 47

Give an example of how changes in market institutions can impact changes in the natural rate of unemployment

Answer 47

Temporary unemployment agencies and gig economies reduce frictional unemployment, reducing the natural rate of unemployment.

Technological changes can increase the demand for “skilled” workers and decrease the demand for “unskilled” workers. If “unskilled” workers are bound by minimum wage, the natural rate of unemployment may increase

Question 48

Give an example of how changes in government policies can impact changes in the natural rate of unemployment

Answer 48

A high minimum wage can increase the natural rate of unemployment. Inversely, job training programs and employment subsidies can decrease the natural rate of unemployment

Question 49

What is a real wage?

Answer 49

A worker’s wage rate divided by the price level

Question 50

What is a real income?

Answer 50

Nominal income divided by the price level

Question 51

How do you calculate the inflation rate?

Answer 51

Inflation rate = ((Price Index Year 2 - Price Index Year 1)/Price Index Year 1) * 100

Question 52

What are the three most important (economic) costs of inflation?

Answer 52

Shoe-leather costs, menu costs, and unit-of-account costs

Question 53

What are shoe-leather costs?

Answer 53

The increased (economic) cost of transactions caused by inflation. They are an allusion to the wear and tear caused by the extra running around that takes place when people are trying to avoid holding onto money (because of inflation)

Question 54

What are menu costs?

Answer 54

The real (economic) cost of changing a listed price. In the face of inflation, firms are forced to change their prices more often than they would if the aggregate price level was stable. This means higher costs for the economy as a whole

Question 55

What are unit-of-account costs?

Answer 55

(Economic) costs arising from the way inflation makes money a less reliable unit of measurement. Unit-of-account costs may be particularly important in the tax system because inflation can distort the measures of income on which taxes are collected (i.e., inflation rate is 10%, business buys asset for $100 and sells for $110, business didn’t make a profit but taxes would have to be paid on phantom gain)

Question 56

What does high inflation cost an economy?

Answer 56

Wasted resources (i.e. production potential)

Question 57

What is an interest rate?

Answer 57

The price charged by a lender to a borrower, calculated as a percentage of the amount borrowed

Question 58

Why does inflation result in “winners” and losers”, economically speaking?

Answer 58

Inflation sometimes helps people while hurting others because economic transactions often involve contracts that extend over a period of time (i.e. loans), and these contracts are normally specified in nominal terms. If inflation is higher than expected, borrowers lose. If inflation is lower than expected, lenders lose

Question 59

What is the nominal interest rate?

Answer 59

The interest rate in dollar terms

Question 60

What is the real interest rate?

Answer 60

The nominal interest rate minus the inflation rate

Question 61

How do you calculate the real interest rate?

Answer 61

Real interest rate = nominal interest rate - inflation rate

Question 62

What is unexpected inflation?

Answer 62

The difference between the actual and expected inflation rates

Question 63

What is disinflation?

Answer 63

The process of bringing down inflation that has become embedded in expectations

Question 64

Explain what a “moral hazard” problem is and how it relates to efficiency wages

Answer 64

Two people come to an agreement, with an understanding that one will behave in a certain way. There is no way for person A to guarantee that person B will behave in the agreed-upon way, without constant monitoring. If there is not a way to perfectly monitor performance, there has to be another way to incentivize person B to perform in the agreed-upon way. Firms offer efficiency wages to incentivize better performance with the hope that higher wage = higher performing

Question 65

What is asymmetric information?

Answer 65

When one party in an economic transaction possesses greater material knowledge than the other party. In certain transactions, sellers can take advantage of buyers because asymmetric information exists whereby the seller has more knowledge of the goods being sold than the buyer. The reverse can also be true

Question 66

What is adverse selection?

Answer 66

In the labour market, you find people with different levels of productivity. How do you know who has different levels of productivity? Firms will offer higher wages to attract more productive workers, since people with more attractive skills will seek out higher wages. More people will be interested to apply for jobs in your firm. Firms often find that offering higher wages than they have to works in their favour

Question 67

How do you calculate how much of a difference in nominal GDP between two years is due to inflation?

Answer 67

1. Find nominal GDP for both years
2. Find real GDP for both years.
3. Find the percentage difference between both nominal GDPs
4. Find the percentage difference between both real GDPs
5. Inflation = Nominal GDP - Real GDP

Question 68

What is the Fisher equation?

Answer 68

It determines the real interest rate:

real interest rate = nominal interest rate - inflation

Question 69

Why might there be a decrease in the unemployment rate during several quarters of a recession?

Answer 69

Discouraged workers leaving the labour force, therefore the unemployment rate goes down

Question 70

Why might there be an increase in the unemployment rate during several quarters of expansion?

Answer 70

Discouraged workers rejoining the labour force and people quitting their jobs to look for new ones, since employment is high

Question 71

What do unemployment rates vary across?

Answer 71

Regions, demographics, ethnicity, and gender

Question 72

Why can the unemployment rate never be zero?

Answer 72

People are always leaving jobs for new ones, and jobs are always being created or destroyed

Question 73

When is employment mainly frictional?

Answer 73

When the unemployment rate is low and the periods spent unemployed are short

Question 74

What is the difference between deflation and disinflation?

Answer 74

Disinflation is a fall in the inflation rate, and deflation is a drop in the overall price level or negative inflation (i.e., -2%)