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
 Measuring
CHAPTER 4
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 the
costs of inflation

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 LO1: Unemployment

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Measuring Unemployment
– 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

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Measuring Unemployment

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Population and Unemployment,
Canada 2018

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.

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 Visual representation

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

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 Measuring Unemployment
• Participation rate
– The percentage of the working-age population,
who are in the labour force (either employed
orParticipation
unemployed) rate = labour
force x 100
working-age population

• Canada’s participation rate for 2018:

19.81 x 100 = 65.40%
30.29
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 Measuring Unemployment
• Unemployment rate
The percentage of those in the labour force, who
do not hold paid employment
Unemployment rate = number
unemployed x 100
labour force
• Canada’s unemployment rate for 2018:
1.16 x 100 = 5.9%
19.81

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 Test Your Understanding
• 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?

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 Test Your Understanding
• 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
= (1/10) x 100 = 10%
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 LO2: The Different Types
of Unemployment

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 Types of Unemployment
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
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 Types of Unemployment
• 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

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 Types of Unemployment
• 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

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 Test Your Understanding
• 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 almost a year.
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 Test Your Understanding
• 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. He has not been
employed now for almost a year. Structural

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 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 working in the underground economy

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 Costs of Unemployment
• GDP Gap

– The difference between potential GDP and

actual GDP (real or nominal)

GDP Gap = Potential GDP –

Actual GDP

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 Costs of Unemployment
• 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 %  GDP

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

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 Test Your Understanding
• 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
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= $840 billion 4- 22
 LO3: Inflation

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 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

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 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
cost of basket in a base year

inflation rate = index year 2 – index

year 1 x 100
index year 1

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 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
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 Measuring Inflation – GDP
Deflator
• GDP Deflator

– A measure of the price level of goods and

services included in the GDP

GDP Deflator = nominal

GDP x 100
real GDP

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

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 Test Your Understanding
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

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 Test Your Understanding
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

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 Test Your Understanding
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

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 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

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 Test Your Understanding
• 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?

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 Test Your Understanding
• 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%
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 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

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 Test Your Understanding

• If the inflation rate is 7 percent, how long

will it take for prices to double?

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 Test Your Understanding

• 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

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 LO4: The Costs of
Inflation

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 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)
– reduces exports and increases imports
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 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

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 Costs of Inflation

• Real Interest Rate

– The rate of interest measured in constant

Real interest rate = nominal rate  the

dollars
inflation rate

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 Test Your Understanding
• 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?

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 Test Your Understanding
• 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%

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 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 import-
push inflation
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 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

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