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CHAPTER 10 INFLATION AND UNEMPLOYMENT Elby, Carol, Timothy, Suki and Carmen

Chapter 10 Inflation and Unemployment

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Chapter 10 Inflation and Unemployment. Elby , Carol, Timothy, Suki and Carmen. Learning Objectives:. With this chapter, we will learn: about inflation, how it is measured, and its effect on nominal and real incomes - PowerPoint PPT Presentation

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Page 1: Chapter 10 Inflation and Unemployment

CHAPTER 10INFLATION AND UNEMPLOYMENT

Elby, Carol, Timothy, Suki and Carmen

Page 2: Chapter 10 Inflation and Unemployment

Learning Objectives:

With this chapter, we will learn: 1.about inflation, how it is measured,

and its effect on nominal and real incomes

2.the official unemployment rate, the different types of unemployment, and the definition of full employment

Page 3: Chapter 10 Inflation and Unemployment

Consumer Price Index The Consumer Price Index (CPI): Is used to measure inflation and monitor price

changes in a representative “shopping basket” of consumer products

It also compares the prices of the current year with the bas year

Item weights: are fractions that represents the total cost of the

“shopping basket” of consumer goods used to calculate CPI

Base year: is the survey year used as a point of comparison to

subsequent years

Page 4: Chapter 10 Inflation and Unemployment

Simple Consumer Price Index Figure 10.1 on Page 223

PricesQuantity

Consumedper Month

Expenditureper Month

ItemWeights

$20$30$50

$20 ÷ $50 = 0.4$40 ÷ $50 = 0.6

1030

$2.00$1.00

HamburgersMilkshakes

Results of 2003 Survey

Prices 2004 Price 2003 Quantity$2.20 x 10 = $22.00$1.05 x 30 = $31.50

$53.50

$2.20$1.05

Hamburgers

Milkshakes

Prices in 2004

The Prices has

increased

Expenditure per Month

has increased

$3.50That is annual

inflation of 7%

(3.50 ÷ 50) x 100 = 7%

The Consumer Price Index now moves from 100 to 107.

Page 5: Chapter 10 Inflation and Unemployment

Normal Versus Real Income

Consumer Price Index is useful in helping consumers determine the cost of living

(the amount consumers must spend on the range of good and services they buy)

Nominal Income expressed in common dollars

Real Income expressed in base year dollars

Real Income =

Page 6: Chapter 10 Inflation and Unemployment

Normal Versus Real Income Similar Example on Worksheet, Page 2

If Emily’s monthly income increased from $200 to $280, while the CPI rises from 100 to 120.

Will Emily be able to have enough purchasing power to keep up with inflation?

Increase rate of Wei Ling’s Income:(Price Increase)/(Price of Base Year) x 100

($80/ $200) x 100 = 40%

Now compare with the CPI increase (20% inflation rate)

Since Emily’s income by 40%, Emily will have enough purchasing power to keep up with inflation.

Page 7: Chapter 10 Inflation and Unemployment

Limitations of the CPI The consumer price index cannot be used as

effectively due to these cases.

Consumer differences : consumer differences, since it is based on the

consumption patterns of an average household

Changes in spending patterns changes in spending patterns since it uses base-

year quantities

Product quality improvements in product quality

Page 8: Chapter 10 Inflation and Unemployment

The GPD Deflator Indicates the price changes for all goods and

services produced in the economy It weights them in terms of the economy’s

total output Frequent updating increases the accuracy of

the GDP deflator, however the values of GDP are available slower than the CPI

Compares prices in the current year with those in a base year

Page 9: Chapter 10 Inflation and Unemployment

Calculating the GDP DeflatorExample of Worksheet, Page 3

YearOutput of Calculators

Current Price

Output at Current

Price

Output at 2003 Price

GDP Deflator

2003 15,000 $1515,000 x $15 = $225,000

$225,000 100

2004 25,000 $18

2005 30,000 $22

Output x Current Price

Output x Reference Year Price

Annual Output at Current Price Output at Reference YearX 100

Below is an economy that produces only calculators. The reference year is 2003, where the GDP Deflator is 100; calculate the GDP Deflator for each subsequent year.

Therefore, the value of the GDP Deflator increased in proportion with the prices of

the economy’s output

25,000 x $18 = 450,000

 30,000 x $22 = 660,000

 $375,000

 $450,000

120 

146.67

Page 10: Chapter 10 Inflation and Unemployment

Nominal versus Real GDP

Nominal GDP is expressed in current dollars and indicates the purchasing power of an entire economy

Real GDP is expressed in reference year dollars

Real GDP =

Page 11: Chapter 10 Inflation and Unemployment

Finding Real Gross Domestic Product

YearNominal GDP

(current $ billions)

GDP Deflator(1997 = 100)

Real GDP(1997 $ billions)

[(Nominal GDP) ÷ (GDP Deflator)] x 100

1992 $700.50 92.68  

1997 882.7 100.00 [(882.7) ÷ (100)] x 100 = 882.7

2002 1154.9 107.48  

[(700.50) ÷ (92.68)] x 100 = 755.83

[(1154.9) ÷ (107.48)] x 100 = 1074.5

Page 12: Chapter 10 Inflation and Unemployment

Inflation’s EffectInflation redistributes purchasing power among different

groups within the economy:IncomesCost of Living Adjustment: Terms in contracts for income adjustments to accommodate

changes in price levelsFull indexation Nominal income that automatically rises with the inflation ratePartial indexation Nominal income rises at less than the inflation rateFixed incomes Nominal income that stays constant regardless of the rate of

inflation

Page 13: Chapter 10 Inflation and Unemployment

Inflation can also redistribute purchasing power between borrowers and lenders

borrowers win if actual inflation > anticipated inflation

lenders win if actual inflation < anticipated inflation

borrowers and lenders are unaffected if actual inflation = anticipated inflation

Borrowing and Lending

Page 14: Chapter 10 Inflation and Unemployment

Borrowing and LendingInterest rate is established in financial markets Nominal interest rate is the interest rate

expressed in money terms Real interest rate is the nominal interest

rate minus the rate of inflation Real Interest Rate = Nominal Interest Rate – Rate of Inflation A percentage built into a nominal interest

rate to anticipate the rate of inflation for the loan period is known as inflation premium

Page 15: Chapter 10 Inflation and Unemployment

Labour Force SurveyLabour Force Population: All residents of Canada (15 years old and

above), excluding those living in Northwest, Nunavut and Yukon Territories

Labour Force: Is made up of people in the labour force

population that have jobs or are seeking jobsParticipation Rate: Is the percentage of the entire labour force

population that makes up the labour force

Page 16: Chapter 10 Inflation and Unemployment

Official Unemployment RateExample on Worksheet, Page 5

Once the labour force has been determined, its members can be divided into those who are employed and those who are unemployed

Official Unemployment Rate is the percentage of the unemployed people in the entire labour force

Page 17: Chapter 10 Inflation and Unemployment

Example QuestionUsing the following information to determine a) the labour force

b) the labour force populationc) the official unemployment rate.

Unemployed members of the labour force 2.3 millionTotal Population 15 years of age and over 58.9 millionParticipation Rate 64% Workers with full-time jobs 21.4 millionPart-time workers who do not wish to have full time jobs 4.2

millionPart-time workers who wish to have full-time jobs 3.5 millionTotal population less than 15 years of age 14.6 million

Page 18: Chapter 10 Inflation and Unemployment

Finding the labour forceA) The labour force is found by adding the number of

unemployed members of the labour force, workers with full-time jobs, part-time workers who wish to have full-time jobs, and part-time workers who do not wish to have full-time jobs.

(2.3 million + 21.4 million + 3.5 million + 4.2 million) = 31.4 million

Labour Force = 31.4 million

Remember, the labour force is made up of people who have jobs or are seeking jobs.

Page 19: Chapter 10 Inflation and Unemployment

Finding the labour force population

B) The labour force population is found by rearranging the formula used to find the participation rate, by dividing the labour force by the participation rate

Participation Rate = x 100

(31.4 million/64%) = 49.1 million

Labour Force Population = 49.1 million

Page 20: Chapter 10 Inflation and Unemployment

Finding the official unemployment rate

C) The official unemployment rate is found by dividing the total number of unemployed members of the labour force by the labour force, then multiplying by 100

Unemployment Rate = x 100

(2.3 million/31.4 million) x 100 = 7.3%

Unemployment Rate = 7.3%

Page 21: Chapter 10 Inflation and Unemployment

Drawbacks of the Official Unemployment Rate

UNDEREMPLOYMENT is when workers are not fully utilizing their skills and education in their jobs. The rate sometimes understates unemployment by ignoring this factor.

Unemployment statistics do not consider people who give up on looking for jobs after searching for a job without luck. These people are called DISCOURAGED WORKERS and are not considered part of the labor force.

Some people are not honest when responding to Statistics Canada’s labor market survey stating that they are looking for work when they are not. DISHONESTY may overstate employment.

Page 22: Chapter 10 Inflation and Unemployment

Types of Unemployment

FRICTIONAL UNEMPLOYMENT: Workers who are temporarily between jobs or starting to

look for a first jobSTRUCTURAL UNEMPLOYMENT: A mismatch between people and jobs. This type of

unemployment occurs primarily because of gradual changes in the economy.

CYCLICAL UNEMPLOYMENT: Due to fluctuations in output and spending; causes

unemployment to rise and fall.SEASONAL UNEMPLOYMENT: Canadian industries such as agriculture, construction,

and tourism.

Page 23: Chapter 10 Inflation and Unemployment

The Rise in the Natural Unemployment Rate

In recent decades Canada’s estimated natural unemployment rate rose because of several main trends structural change, with shrinking

manufacturing and expanding services past reforms to unemployment insurance

(some of which have been reversed) higher minimum wages in many provinces

Page 24: Chapter 10 Inflation and Unemployment

Full Employment

is the highest expectation of employment for the economy as a whole that also includes natural unemployment

Natural Unemployment Rate, which includes frictional and at least some structural unemployment

Canada is presently associated with an unemployment rate between 6% and 7%

Page 25: Chapter 10 Inflation and Unemployment

Factors affecting Unemployment Trends

In recent decades Canada’s estimated natural unemployment rate rose because of several main trends structural change, with shrinking

manufacturing and expanding services past reforms to unemployment insurance

(some of which have been reversed) Changing participation rates (increasing

young people in labour force) higher minimum wages in many provinces

Page 26: Chapter 10 Inflation and Unemployment

The Costs of Unemployment High unemployment hurts individuals

and the Canadian economy as a whole The cost of unemployment for the entire

economy can be measured by the difference between actual real output and potential output which is the real output associated with full employment

Page 27: Chapter 10 Inflation and Unemployment

Okun’s LawPotential Output: the real output or gross domestic product

associated with full employment.For every percentage point that the unemployment rate exceeds

the natural unemployment rate, the gap between potential output and actual output is 2.5%.

For example: In 2002, the real GDP in 1997 dollars was $1074.5 billion The assumed natural unemployment rate is was 6.5% The unemployment rate was 7.7%(7.7%-6.5%) x (2.5%) $1074.5 x 3%= (1.2 x 2.5) = 32.2 billion= 3%Therefore, in 1997 dollars, the real GDP could have been 32.3

billion higher.

Page 28: Chapter 10 Inflation and Unemployment

END OF CHAPTER 10INFLATION & UNEMPLOYMENT

Elby, Carol, Timothy, Suki and Carmen