1. Chapter 10 Inflation and Unemployment
Elby, Carol, Timothy, Suki and Carmen

2. Learning Objectives: With this chapter, we will learn:
about inflation, how it is measured, and its effect on nominal and real incomes
the official unemployment rate, the different types of unemployment, and the definition of full employment

3. 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

4. Simple Consumer Price Index
Figure 10.1 on Page 223
Results of 2003 Survey
Quantity
Consumed
per Month
Expenditure
per Month
Item
Weights
Prices
Hamburgers
Milkshakes
$2.00
$1.00 10 30
$20
$30
$50
$20 ÷ $50 = 0.4
$40 ÷ $50 = 0.6
Expenditure per Month has increased $3.50
Prices in 2004
Prices
2004 Price 2003 Quantity
Hamburgers
Milkshakes
$2.20
$1.05
$2.20 x 10 = $22.00
$1.05 x 30 = $31.50
$53.50
That is annual inflation of 7%
(3.50 ÷ 50) x 100 = 7%
The Consumer Price Index now moves from 100 to 107.
The Prices has increased

5. 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 =

6. 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.

7. Limitations of the CPI Consumer differences :
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

8. 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

9. Calculating the GDP Deflator Example of Worksheet, Page 3
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.
Year
Output of Calculators
Current Price
Output at Current Price
Output at 2003 Price
GDP Deflator
2003
15,000
$15
15,000 x $15 = $225,000
$225,000
100
2004
25,000
$18
2005
30,000
$22
Output x Reference Year Price
Output x Current Price
Carmen can you make it appear one by one for the answer!? The answer one are in red fyi!
25,000 x $18
= 450,000
 $375,000
120 
 30,000 x $22
= 660,000
 $450,000
146.67
Annual Output at Current Price
Output at Reference Year
Therefore, the value of the GDP Deflator increased in proportion with the prices of the economy’s output
X 100

10. 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 =

11. Finding Real Gross Domestic Product
Year
Nominal 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 =
[(1154.9) ÷ (107.48)] x 100 =

12. Inflation’s Effect Incomes
Inflation redistributes purchasing power among different groups within the economy:
Incomes
Cost of Living Adjustment:
Terms in contracts for income adjustments to accommodate changes in price levels
Full indexation
Nominal income that automatically rises with the inflation rate
Partial indexation
Nominal income rises at less than the inflation rate
Fixed incomes
Nominal income that stays constant regardless of the rate of inflation

13. Borrowing and Lending
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

14. Borrowing and Lending
Interest 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

15. Labour Force Survey Labour Force Population: Labour Force:
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 jobs
Participation Rate:
Is the percentage of the entire labour force population that makes up the labour force

16. Official Unemployment Rate Example 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

17. Example Question Using the following information to determine
a) the labour force
b) the labour force population
c) the official unemployment rate.
Unemployed members of the labour force million
Total Population 15 years of age and over million
Participation Rate %
Workers with full-time jobs million
Part-time workers who do not wish to have full time jobs million
Part-time workers who wish to have full-time jobs million
Total population less than 15 years of age million

18. Finding the labour force
A) 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 million million 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.

19. 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

20. 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%

21. 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.

22. Types of Unemployment FRICTIONAL UNEMPLOYMENT:
Workers who are temporarily between jobs or starting to look for a first job
STRUCTURAL 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.

23. 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

24. 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%

25. 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

26. 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

27. Okun’s Law
Potential 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 $ billion
The assumed natural unemployment rate is was 6.5%
The unemployment rate was 7.7%
(7.7%-6.5%) x (2.5%) $ 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.

28. End of Chapter 10 Inflation & Unemployment
Elby, Carol, Timothy, Suki and Carmen