Lecture notes Prepared by Anton Ljutic

© 2004 McGraw–Hill Ryerson Limited Growth, Unemployment and Inflation CHAPTER FOUR

© 2004 McGraw–Hill Ryerson Limited Understand the meaning and benefits of economic growth Explain what is meant by unemployment and employment Understand what inflation is and why it is costly to the economy This Chapter Will Enable You to:

© 2004 McGraw–Hill Ryerson Limited Economic Growth (I) An increase in an economy’s real GDP per capita or an increase in the economy’s capacity to produce –Nominal GDP The value of GDP in terms of prices prevailing at the time of measurement It is equal to real GDP multiplied by the price level –Real GDP The value of GDP measured in terms of prices prevailing in a given base year –GDP Deflator A measure of the price level of goods included in the GDP.

© 2004 McGraw–Hill Ryerson Limited Economic Growth (II) Measuring growth GDP deflator: Real GDP = (Nominal GDP/real GDP) x 100 = (Nominal GDP/GDP deflator) x 100

© 2004 McGraw–Hill Ryerson Limited Economic Growth (III) Additional measures Real GDP per capita (per person) Economic growth rate = Real GDP/population = (Increase in real GDP/capita) / (previous year real GDP/capita) x 100

© 2004 McGraw–Hill Ryerson Limited Growth and Economic Welfare More doesn’t always mean better because: –Higher GDP may be the result of including the value of some services that were previously excluded –The quality or desirability of the goods produced is ignored –Per capita GDP will fall if population growth exceeds the growth of GDP –The social and environmental costs of higher GDP are ignored

© 2004 McGraw–Hill Ryerson Limited Unemployment …is the situation in which persons 15 years old and over are actively seeking work but do not have employment –Frictional unemployment The part of total unemployment caused by the fact that it takes time for people to find their first job or to move between jobs –Structural unemployment The part of total unemployment that results from structural changes in an economy’s industries –Cyclical unemployment The unemployment that occurs as a result of the recessionary phase of the business cycle

© 2004 McGraw–Hill Ryerson Limited Natural Rate of Unemployment …is the unemployment rate at full employment (when there is only frictional and structural unemployment and cyclical unemployment is zero) It could change if: –Employment insurance benefits change –The average job search time changes –Labour-force participation rates change

© 2004 McGraw–Hill Ryerson Limited Measuring Unemployment (I) Unemployment rate –The percentage of people in the labour force who do not hold paid employment Working age population –The country’s total population excluding: Those under 15 years of age Those living in the three territories or on Aboriginal reserves Full-time members of institutions, including those in the armed forces = (No. of unemployed/labour force) / x 100

© 2004 McGraw–Hill Ryerson Limited Measuring Unemployment (II) Labour Force –Members of the working age population, either employed or unemployed Participation rate –The percentage of those in the working age population who are actually in the labour force Employed –Those people who are in the labour force and hold paid employment

© 2004 McGraw–Hill Ryerson Limited Measuring Unemployment (III) Population Working age population Labour force Employed Unemployed

© 2004 McGraw–Hill Ryerson Limited Criticism of the Official Rate (I) Understated because all part-timers are included as full-timers Understated because it excludes discouraged workers –Discouraged worker An individual who wants work but is no longer actively seeking it because of the conviction that no opportunities exist

© 2004 McGraw–Hill Ryerson Limited Criticism of the Official Rate (II) Overstated because of false information from some EI recipients Overstated because of false information from those working in the underground economy

© 2004 McGraw–Hill Ryerson Limited Costs Of Unemployment (I) GDP gap –The amount of lost goods and services that did not get produced because the economy was operating at less than full employment (i.e., had cyclical unemployment) Okun’s Law –“For every 1 percent of cyclical unemployment, an economy’s GDP would be 2.5 percent below its potential” = potential GDP – actual GDP

© 2004 McGraw–Hill Ryerson Limited Costs of Unemployment (II) Social costs –Unemployment causes a lot of bitterness, disappointment, anger, loss of self-esteem, and a sense of failure –Alcoholism, accidents, claims on the health- care system, violence, and crime will all rise as a result –They do not fall evenly across society

© 2004 McGraw–Hill Ryerson Limited Inflation (I) …is a persistent rise in the general level of prices Consumer price index (CPI) –A measurement of the average level of prices of the goods and services that a typical Canadian family consumes –Statistics Canada derives this index, by first defining a representative basket of goods and services, and then collecting prices, monthly, on each item. The basket reflects the spending habits of a household of four, and the prices are weighted to reflect a typical consumption pattern –It is used to measure the inflation rate

© 2004 McGraw–Hill Ryerson Limited Inflation (II) Inflation rate The Rule of 70 –Estimates the time it will take for a figure to double in value given a certain percentage growth rate. The formula is: = (change in price index/previous year’s index) x 100 Number of years to double = 70 / growth rate

© 2004 McGraw–Hill Ryerson Limited Costs of Inflation (I) Redistributive effects –Those whose nominal income increases less than the rate of inflation will suffer because their real income decreases Nominal income –The present dollar-value of a person’s income Real income –The purchasing power of income. Nominal income divided by the price level –Employees who have weak bargaining power in the market place are affected more –Bracket creep The more you earn, the more you are taxed

© 2004 McGraw–Hill Ryerson Limited Costs of Inflation (II) If inflation is unexpected, it hurts the lender and benefits the borrower –Real interest rate The rate of interest measured in constant dollars –Nominal interest rate The interest rate that you are quoted = nominal interest rate – inflation rate

© 2004 McGraw–Hill Ryerson Limited Costs of Inflation (III) Output costs –Unknown inflation could reduce the amount of investment in the economy, then the rate of economic growth slows down and total output will be lower than it would have been –Menu costs of inflation Business costs that are involved in changing prices –Inflation has a negative effect on exports –Inflation will cause consumers to begin to substitute imports for the higher-priced Canadian products

© 2004 McGraw–Hill Ryerson Limited Causes of Inflation Demand-pull –Inflation that occurs when total demand for goods and services exceeds the economy’s capacity to produce those goods Cost-push –Inflation caused by an increase in the costs of production or in profit levels, with the effect being on the supply side

© 2004 McGraw–Hill Ryerson Limited Cost-Push Inflations Wage push –Increased wages push up costs, which push up prices Profit-push –If firms have enough market power they might enhance profits by increasing prices Import-push –The increase in the cost of imports triggers price increases in industries that are dependent on those imports

© 2004 McGraw–Hill Ryerson Limited The meaning, measurement and benefits of economic growth The concepts, types and measurement of unemployment and employment The concepts, types and measurement of inflation and its costs to the economy Chapter Summary: What to Study and Remember