Chapter 3. Costs of (Not) Working and Living. Unemployment and Inflation

Transcription

1 Chapter 3 Costs of (Not) Working and Living Unemployment and Inflation

2 continued LEARNING OBJECTIVES 3.1 What the unemployment rate measures and misses, and different types of unemployment 3.2 The natural rate of unemployment and its connection to GDP gaps 3.3 Inflation rate and calculating it 3.4 Use of the quantity theory of money to explain inflation rate 3.5 Phillips Curve and its connections to demandpull and cost-push inflations

3 WHO IS UNEMPLOYED? HEALTHY & UNHEALTHY TYPES OF UNEMPLOYMENT Unemployment rate measures percentage of labour force out of work and actively searching for jobs, but misses involuntary part-time and discouraged workers. Four types of unemployment frictional, structural, seasonal, cyclical. Only cyclical is both unhealthy and a problem.

4 Fig. 3.1 Labour Force Categories for Working-Age Population, May 2009 Labour Force (employed + unemployed) Unemployed Not in Labour Force Employed Working-Age Population

5 Fig. 3.2: Unemployment Rates in Canada,

6 Fig. 3.3: Unemployment & Underutilization of Labour, May 2009 Percentage of Labour Force Official unemployment rate 8.7 Involuntary part-time workers 2.6 Discouraged workers 0.2 Total Underutilization Rate 11.5

7 Fig. 3.4 Provincial Unemployment Rates, May 2009 Province Unemployment Rate Newfoundland/Labrador 15.1 Prince Edward Island 13.1 Nova Scotia 8.9 New Brunswick 8.8 Quebec 8.7 Ontario 9.4 Manitoba 4.9 Saskatchewan 4.9 Alberta 6.6 British Columbia 7.6

8 Fig. 3.5 Varieties of Unemployment Type of Healthy/ Problem that Cause Unemployment Unhealthy Needs Addressing? Frictional Healthy No Normal, healthy market adjustments of demand and supply Structural Healthy Yes (worker retraining) Technological change, international competition, resource depletion Seasonal Neutral No Weather and seasons Cyclical Unhealthy Yes (fiscal or monetary policy) Business cycles

9 HOW FULL IS FULL EMPLOYMENT? THE NATURAL RATE OF UNEMPLOYMENT Natural rate of unemployment at full employment, where only healthy frictional, structural, seasonal unemployment. Relative to natural rate, unemployment rate is higher in recessionary gap and lower in inflationary gap.

10 continued UNEMPLOYMENT Statistics Canada sorts working-age population (age 15 and over) into three categories 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 the labour force not employed or unemployed (full-time student, homemaker, retiree)

11 continued Labour force = employed + unemployed Unemployment rate percentage of people in labour force who are unemployed Unemployed Unemployment Rate = 100 Labour Force

12 continued Labour force participation rate percentage of working-age population in labour force (employed or unemployed) Labour Force Participation Rate Labour Force = 100 Working Age Population

13 Unemployment rate misses involuntary part-time workers employed part-time but would rather have full-time job, and 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, discouraged workers

14 Healthy and unhealthy types of unemployment Frictional unemployment due to normal labour turnover and job search; healthy part of changing economy; not a problem Structural unemployment due to technology or international competition making workers obsolete; healthy part of changing economy; problem requiring retraining Seasonal unemployment due to seasonal changes in weather; neither healthy nor unhealthy; not a problem Cyclical unemployment due to fluctuations in economic activity; unhealthy part of changing economy; problem needs addressing

15 NATURAL RATE OF UNEMPLOYMENT Natural rate of unemployment unemployment rate at full employment; includes frictional, structural, seasonal unemployment full employment is not zero percent unemployment but zero percent cyclical unemployment

16 Fig. 3.6 Output Gaps and Unemployment Real GDP and Potential GDP Output Gap Unemployment Rate Real GDP equals potential GDP None Natural rate of unemployment full employment (only frictional, structural, seasonal unemployment) Real GDP below potential GDP Real GDP above potential GDP Recessionary gap Inflationary gap Unemployment rate above natural rate (cyclical unemployment) Unemployment rate below natural rate (less than normal frictional, structural, seasonal employment)

17 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 gap cyclical unemployment when unemployment < natural rate real GDP > potential GDP inflationary gap Economists disagree about the natural rate

18 LIGHTENING UP YOUR WALLET: WHAT IS INFLATION? Inflation hurts those on fixed incomes, creates risk for business investment and can increase in a vicious cycle of expectations. Inflation rate overstates cost of living increases, missing switches to cheaper and improved products/services.

19 INFLATION Inflation is persistent rise in average prices and fall in value of money spend more to get same products/services your money is worth less Consumer Price Index (CPI) measure of average prices of a fixed shopping basket of products and services CPI = 100 for the base year, currently 2002

20 Fig. 3.7 Consumer Price Index Basket Health, personal care 4.7% Recreation, education, reading 12.2% Alcoholic beverages, tobacco products 3.1% Food 17% Transportation 19.9% Shelter 26.6% Clothing, footwear 5.4% Household operations, furnishing and equipment 11.1%

21 Inflation rate annual percentage change in consumer price index Inflation = CPI for current year CPI for previous year CPI for previous year 100 Core inflation rate inflation rate excluding volatile categories

22 Fig. 3.8 Inflation Rates in Canada,

23 Fig. 3.9 Inflation Rates and Core Inflation Rates in Canada,

24 Inflation is a worry because of falling value of money inflation reduces purchasing power of people with fixed (unchanged dollar) income or savings nominal interest rate observed interest rate; dollars per year in interest as percentage of dollars saved realized real interest rate is nominal interest rate adjusted for inflation = nominal interest rate inflation rate

25 Inflation is a worry because unpredictable prices create risk and discourage business investment expectations of inflation can cause inflation Predictable inflation rate between 1 and 3 percent is the Bank of Canada s aim

26 VICIOUS CYCLE

27 Deflation persistent fall in average prices and rise in value of money consumers may postpone purchases, causing contraction and increasing unemployment deflation benefits savers but hurts borrowers deflation is worse than low inflation

28 CPI fixes quantities in shopping basket to isolate only the impact of changing prices on cost of living when prices rise, CPI misses switches to cheaper substitutes and new/improved products inflation rate based on CPI overstates increases in cost of living

29 INFLATION STARTS WITH M THE QUANTITY THEORY OF MONEY Quantity theory of money explains inflation from increases in quantity of money, holding constant velocity of money and quantity of real output.

30 Fig Simple Circular Flow

31 QUANTITY THEORY OF MONEY For any economy with money, M V = P Q M quantity of money V velocity of money number of times a unit of money changes hands P average prices; Consumer Price Index Q aggregate quantity of real output P Q nominal GDP There must be enough money, multiplied by velocity, to allow sales of output produced (nominal GDP) continued

32 Quantity Theory of Money increase in quantity of money causes an equal percentage increase in inflation rate take equation M V = P Q and fix V and fix Q at potential GDP printing money causes inflation Inflation always accompanied by increase in quantity of money

33 WHEN TIM HORTONS PAYS $18 PER HOUR: UNEMPLOYMENT AND INFLATION TRADEOFFS Phillips Curve shows tradeoff between unemployment and inflation consistent with demand-pull inflation. Cost-push inflation, changes in expectations and natural rate of unemployment complicate the original Phillips Curve.

34 UNEMPLOYMENT INFLATION TRADEOFFS Phillips Curve graph showing inverse relation between unemployment and inflation Demand-pull inflation rising average prices caused by increases in demand explain Phillips Curve s tradeoff between unemployment and inflation during expansions, demand is key force causing shortages and pulling up prices for inputs (wages) and outputs

35 Fig Phillips Curve in Canada,

36 Cost-push inflation rising average prices caused by decreases in supply does not fit Phillips Curve caused by supply shocks events directly affecting business s costs, prices, and supply. Decrease in supply key force pushing up output prices, while pushing economy into contraction, increasing unemployment. can cause stagflation simultaneous recession (unemployment) and inflation

37 Fig Phillips Curve in Canada,

38 Both demand-pull and cost-push inflation require accompanying increase in quantity of money Trade-offs between unemployment and inflation of Phillips Curve are complicated due to changes in expectations natural rate of unemployment

39 Fig Types of Inflation Type of Inflation Demand-Pull Cost-Push Phase of business cycle Expansion Contraction Unemployment unemployment unemployment Inflation inflation inflation Relation between Unemployment and Inflation Tradeoff (Phillips Curve) Simultaneous (Stagflation)