Principles of Macroeconomics

SAYRE // MORRIS
Tenth Edition

CHAPTER 4

Measuring the
Economy 2:
Unemployment and
Inflation

Prepared by Hanika Bhojwani-Chen, Centennial College

© 2021 McGraw Hill
 CHAPTER 4

Measuring the
Economy 2:
Unemployment and
Inflation
Learning Objectives:
1. Describe what unemployment is and how it is
measured
2. Explain the different types of unemployment and
the costs of unemployment
3. Explain what inflation is and how it is measured
4. Explain the two types of inflation and describe
© 2021 4-
the costs of inflation

© 2021 4-
LO1: Unemployment

© 2021 4-
 Measuring
– The working-age population is the country’s
total
population excluding:
• those under 15 years of age
• those in the 3 territories or on aboriginal
reserves
• full-time residents of mental or penal
institutions, hospitals, or the armed
forces

© 2021 4-
 Measuring
• Labour force

– Members of the working-age population, who

are either employed or unemployed

• Employed

– Those who are in the labour force and in

hold paid employment

• Unemployed

– Those who are in the labour force and

actively seeking employment, but do not
© 2021 4-
 Measuring
hold paid employment

© 2021 4-
Population and Unemployment, Can

Total population 37.06 m

Working-age population 30.29 m
Labour force 19.81 m
Employed 18.66 m
Unemployed 1.16 m
Source: Adapted from Statistics Canada, Tables 17-10-0005-01 and 14-10-0018-01, January 20, 2020.

© 2021 4-
 Visual representation

Source: Adapted from Statistics Canada, Tables 17-10-0005-01 and 14-10-0018-01, January 20, 2020.

© 2021 4-
 Measuring
• Participation rate
– The percentage of the working-age population,
who are
in the labour force (either employed or
unemployed)

Participation rate
labour
= force x 100
working-age population

• Canada’s participation rate for 2018:

19.81 x 100 = 65.40%
30.29
© 2021 4-
 Measuring
• Unemployment rate
The percentage of those in the labour force, who do
not hold
paid employment

Unemployment rate = number unemployed x 10

labour force

• Canada’s unemployment rate for 2018:

1.16 x 100 = 5.9%
19.81

© 2021 4-
 Test Your
• If the population of Etrusca is 20 million,
the working age population is 15 million,
the number of employed is 9 million and
the number unemployed is 1 million:
a) What is the size of the labour force?
b) What is the participation rate?
c) What is the unemployment rate?

© 2021 4-
 Test Your
• If the population of Etrusca is 20 million,
the working age population is 15 million,
the number of employed is 9 million and
the number unemployed is 1 million:
a) What is the size of the labour force?
b) What is the participation rate?
c) What is the unemployment rate?
a. Labour force = employed + unemployed = 9 + 1 = 10 million
b. Participation rate = labour force/working age population
= (10/15) x 100 = 66.7%
c. Unemployment rate = unemployed /labour force
© 2021 4-
Test Your
= (1/10) x 100 = 10%

© 2021 4-
LO2: The Different
Types
of Unemployment

© 2021 4-
 Types of
Frictional Unemployment

– Unemployment related to the time it takes

for people to find their first job or to move
between jobs

Structural Unemployment

– Unemployment that results from a mismatch

in the skills or location between jobs available
and the people looking for work
© 2021 4-
 Types of
• Cyclical Unemployment

– Occurs as a result of the recessionary

phase of the business cycle

– At the peak of the business cycle, there is full

employment

© 2021 4-
 Types of
• Natural Rate of Unemployment
– When there is no cyclical unemployment
– Occurs when there is full employment
– Can change as a result of:
• Employment insurance benefit changes
• Average job search time changes
• Labour-force participation rate changes

© 2021 4-
 Test Your
• Categorize each of the following sets of
circumstances as
frictional, structural, or cyclical unemployment.

a. Sanjit, a pulp-mill worker, is laid off because the

mill’s
inventories are at an all-time high.
b. Five weeks ago, Alison left a job she did not
like and is still looking for another job.
c. Ian was a fisher on the East Coast but sold
his boat after years of hard work with little
return. He has not been employed now for
© 2021 4-
 Test Your
almost a year.

© 2021 4-
 Test Your
• Categorize each of the following sets of
circumstances as
frictional, structural, or cyclical unemployment.

a. Sanjit, a pulp-mill worker, is laid off because the

mill’s
inventories are at an all-time high. Cyclical
b. Five weeks ago, Alison left a job she did not
like and is still looking for another job.
Frictional
c. Ian was a fisher on the East Coast but sold his
boat after years of hard work with little return.
© 2021 4-
 Test Your
He has not been employed now for almost a
year.
Structural

© 2021 4-
Criticisms of the Official Rate

• The reported unemployment rate may be:

– Understated because part-timers are included as
full-
timers
– Understated because it excludes discouraged
workers (those who want work but are not
seeking it, believing that no opportunities exist)
– Overstated because of false information
from some EI recipients
– Overstated because of false information from
those
© 2021 4-
working in the underground economy

© 2021 4-
 Costs of
• GDP Gap

– The difference between potential GDP and

actual GDP (real or nominal)

GDP Gap = Potential GDP – Actual GDP

© 2021 4-
 Costs of
• Okun’s Law

– For every 1 percent of cyclical unemployment,

an
economy’s GDP is 2.5 percent below its
potential

GDP gap = 2.5  cyclical unemployment %  GD

© 2021 4-
 Test Your
• Given a natural rate of unemployment of
8 percent, an actual rate of 10 percent,
and real GDP of $800 billion, calculate
potential GDP.

© 2021 4-
 Test Your
• Given a natural rate of unemployment of
8 percent, an actual rate of 10 percent,
and real GDP of $800 billion, calculate
potential GDP.

GDP gap = 2.5  cyclical unemployment % 

GDP
= 2.5 x 2% x 800 billion
= $40 billion

Potential GDP = Actual GDP + GDP gap

= 800 + 40 billion
© 2021 4-
Test Your
= $840 billion

© 2021 4-
LO3: Inflation

© 2021 4-
 Inflation

• Increase in the general level of prices

sustained over a period in an economy.

– Measured using a price index. Most widely used:

1. Consumer Price Index (CPI)

2. GDP Deflator

© 2021 4-
 Measuring Inflation-CPI

• Consumer Price Index (CPI)

– A measurement of the average level of prices of the

goods
and services that a typical Canadian family
consumes

CPI = cost of basket in a given year x 100

inflation rate = index year 2 – index year 1 x 1

index year 1
© 2021 4-
Measuring Inflation – core CPI

• Core CPI
– Excludes items with highly volatile prices:
• Fruits and vegetables
• Gas
• Fuel oil
• Mortgage interest
• Tobacco
– Gives a better indication of underlying long-term
inflation
rate
© 2021 4-
Measuring Inflation – GDP Deflato

• GDP Deflator

– A measure of the price level of goods

and services included in the GDP

GDP Deflator = nominal GDP x 100

real GDP

© 2021 4-
 Measuring Inflation

CPI GDP Deflator

Explicit index using Implicit index measuring
a constructed bundle the ratio of nominal to real
of goods GDP
Bundle of goods remains Bundle of goods changes
constant each year
Does not include capital or Includes capital and
government goods and government goods and
services services
Includes imported goods Excludes imported goods

© 2021 4-
 Test Your
• Fill in the blanks to one decimal place:

2018 2019 2020

Nominal GDP ($billion) 443.0 474.0 507.0
Real GDP ($billion) 374.0 389.0
GDP deflator (2010 = 100) 121.9 126.1
Population (millions) 26.1 26.4 27.0
Real GDP per capita

© 2021 4-
 Test Your
• Fill in the blanks to one decimal place:

2018 2019 2020

Nominal GDP ($billion) 443.0 474.0 507.0
Real GDP ($billion) 374.0 389.0
GDP deflator (2010 = 100) 118.4 121.9 126.1
Population (millions) 26.1 26.4 27.0
Real GDP per capita

© 2021 4-
 Test Your
• Fill in the blanks to one decimal place:

2018 2019 2020

Nominal GDP ($billion) 443.0 474.0 507.0
Real GDP ($billion) 374.0 389.0 402.0
GDP deflator (2010 = 100) 118.4 121.9 126.1
Population (millions) 26.1 26.4 27.0
Real GDP per capita 14,329.5 14,734.8 14,888.9

© 2021 4-
 Nominal vs. Real Income

• Nominal Income

– The present dollar-value of a person’s income

• Real Income

– The purchasing power of income; that is,

nominal income divided by the price level

© 2021 4-
 Test Your
• Etruria’s nominal GDP rose from $42 billion
in 2019 to $45 billion in 2020. During the
same period, its inflation rate was 5%.
a) By what percentage did nominal GDP increase?
b) By what percentage did real GDP increase?

© 2021 4-
 Test Your
• Etruria’s nominal GDP rose from $42 billion
in 2019 to $45 billion in 2020. During the
same period, its inflation rate was 5%.
a) By what percentage did nominal GDP increase?
b) By what percentage did real GDP increase?
a) 45 – 42 x 100 = 7.14%
42
b) % change in real GDP = % change in nominal income –
inflation rate: 7.2% - 5% = 2.2%

© 2021 4-
 Rule of 70

• Estimates the time it will take for a figure to

double in value given a certain percentage
growth rate

years to double = 70 / % growth rate

Example:

– $1000 invested at 10% will double in:

– 70 / 10 = 7 years
© 2021 4-
 Test Your
• If the inflation rate is 7 percent, how long will
it take for
prices to double?

© 2021 4-
 Test Your
• If the inflation rate is 7 percent, how long will
it take for
prices to double?
# of years to double = 70 / % growth rate
= 70 / 7
= 10 years

© 2021 4-
LO4: The Costs of
Inflation

© 2021 4-
 Costs of Inflation

• Redistributive Costs
– shifts income from the economically weak to the
economically strong
– shifts income from lenders to borrowers
• Output Costs
– reduces the level of investment and economic
growth
– increases menu costs (such as the cost
of revising catalogues, websites, and so
forth)

© 2021 4-
– reduces exports and increases imports

© 2021 4-
 Galloping Inflation

• Also called hyperinflation

– Extremely high rates of inflation
• Example – Germany after WWI
– Prices rose by 5470 percent in 1922 and 1 300 000
000 000
times in 1923
– The economy collapsed, unemployment
and violence increased
• Example - Zimbabwe in 2008
– prices were doubling every 25 hours
© 2021 4-
 Costs of Inflation

• Real Interest Rate

– The rate of interest measured in constant dollars

Real interest rate = nominal rate  the inflation

© 2021 4-
 Test Your
• If you borrowed a sum of money for one
year at a nominal rate of interest of 11
percent and during that same year the
inflation rate was 4 percent, what real rate
of interest did you pay?

© 2021 4-
 Test Your
• If you borrowed a sum of money for one
year at a nominal rate of interest of 11
percent and during that same year the
inflation rate was 4 percent, what real rate
of interest did you pay?

Real rate of interest = nominal rate – inflation rate

= 11 – 4
= 7%

© 2021 4-
 Types of Inflation

• Demand Pull Inflation

– When total demand for goods and services
exceeds the
economy’s capacity to produce
• Cost Push Inflation
– Caused by an increase in the costs of production
or in
profit levels, with the effect being on the supply
side
– Includes wage-push, profit-push, and
© 2021 4-
import-push inflation

© 2021 4-
 CHAPTER 4 SUMMARY

Key Concepts to
Remember
1. What is unemployment and how is it measured?
2. Different types of unemployment
3. Costs of unemployment
4. What is inflation and how is it measured?
5. Costs of inflation
6. Two types of inflation

© 2021 4-