Chapter 5: Monitoring Jobs and Inflation 

18 January 2019 
ECON 2200 Lecture - Week 3 
 
 
Employment and Unemployment 
● Why unemployment is a problem: 
○ Lost incomes and production 
○ Lost human capital 
● Labour Force Survey​ → sum of employed and unemployed workers 
○ Every month, Stats Canada conducts a survey in which it asks 54,000 
households. Population is divided into two groups: 
■ Working-age population → total number of people aged 15 
years and over; divided into 2 groups 
1. People in the labour force 
2. People not in the labour force 
○ On temporary layoff with an expectation of recall 
○ Without work but has made specific efforts to find 
a job within the previous 4 weeks 
○ Has a new job to start within 4 weeks 
■ People too young to work (under 15 years of age) 
 
Four Labour Market Indicators 
● Unemployment rate​ → percentage of labour force that is unemployed 
○ (# of people unemployed / labour force) x 100 
○ Increases in recession and reaches its peak after recession ends 
● Involuntary part-time rate​ → percentage of labour force who work part 
time but want full-time jobs 
○ (# of involuntary part-time workers / labour force) x 100 
● Labour force participation rate​ → percentage of working-age population 
who are members of the labour force 
○ (Labour force / working-age population) x 100 
● Employment rate ​→ percentage of working-age population who have jobs 
○ (Employment / working-age population) x 100 
 
Other Definitions of Unemployment 
● Purpose is to measure the underutilization of labour resources 
● Official measure (Stats Canada) is an imperfect measure because: 
○ Discouraged searchers​ → person who currently is neither working 
nor looking for work but has indicated that he/she wants and is 
available for a job (repeated failures) 

 
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○ Long-term future starts​ → person with a job to start in more than 

four weeks is ​not counted as unemployed 
○ Involuntary part-timers​ → part-time workers who want full-time jobs 
and can’t find them are ​not counted as unemployed 
● The most costly unemployment → unemployment that results from job loss 
 
Unemployment and Full Employment 
● Frictional unemployment​ → unemployment that arises from normal labour 
market turnover 
○ Permanent and healthy phenomenon of a growing economy 
○ Increases in the # of people entering and reentering the labour force 
○ Increases in unemployment benefits raise frictional unemployment 
● Structural unemployment​ → unemployment created by changes in 
technology and foreign competition that change skills needed to perform 
○ Lasts longer than frictional unemployment 
● Cyclical unemployment​ → higher than normal unemployment at a business 
cycle trough and lower than normal unemployment at a business cycle peak 
○ i.e. Worker laid off at beginning of recession and rehired when 
expansion begins 
● Natural unemployment​ → unemployment that arises from frictions and 
structural change when there is no cyclical unemployment 
○ Natural unemployment rate​ → natural unemployment as a 
percentage of labour force 
○ Changes over time and is influenced by: 
■ Age distribution of population 
■ Scale of structural change 
■ Real wage rate → e ​ mployment is higher 
■ Unemployment benefits 
● Full employment​ → situation in which the unemployment rate equals the 
natural unemployment rate 
○ No cyclical, frictional and structural unemployment 
 

 
 
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Real GDP and Unemployment over the Cycle 

● Potential GDP →​ quantity of real GDP produced at full employment 
○ Capacity of economy to produce output on a sustained basis 
● Output Gap​ → Real GDP - Potential GDP = Output Gap 
○ Fluctuates around the natural unemployment rate 

 
 
Price Level, Inflation and Deflation 
● Price level ​→ average level of prices and the value of money 
○ Inflation​ → persistently rising price level 
○ Deflation → ​ persistently falling price level 
● Measure inflation rate/deflation rate 
● Distinguish between money values and real values of economic variables 
 
The Real Variable in Macroeconomics 
● Use the GDP deflator to deflate to deflate nominal variables to find their 
values. 
○ Real wage rate = (Nominal wage rate / GDP deflator) x 100 
○ Not real interest rate! 

 
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Why Inflation and Deflation are Problems 
● Low, steady and anticipated i​ nflation or deflation is not a problem 
● Unpredictable i​ nflation or deflation is a problem because: 
○ Redistributes income and wealth 
○ Lowers real GDP and employment 
○ Diverts resources from production 
● Hyperinflation​ → inflation rate that is so rapid that workers are paid twice a 
day because money loses its value so quickly 
 
Consumer Price Index (CPI) → measures the average of prices paid by urban 
consumers for a ‘fixed’ basket of consumer goods and services 
● Reference base period → CPI defined to equal 100 
○ i.e. Average CPI of 12 months of 2002 equals 100 
 
Constructing the CPI involves 3 stages: 
● CPI basket​ → based on consumer expenditure survey conducted by Stats 
Canada; undertaken infrequently 
● Monthly price survey​ → check prices of goods and services in the CPI 
basket in the major cities 
● Calculating the CPI 
1. Find the cost of the CPI basket at base-period prices 
2. Find the cost of the CPI basket at current-period prices 
3. Calculate the CPI for the current period 
 

 
 
(Cost of basket at current-period prices / cost of basket at base-period prices) x 100 
● CPI = ($70 / $50) x 100 = 140 
● CPI is 40% higher in the current period than it was in the base period 
 
 
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Measuring the inflation rate 
● Inflation Rate​ → percentage change in the price level from one year to the 
next (2 years); inflation rate equals: 
○ [(CPI this year - CPI last year) / CPI last year] x 100 
● Low when the price level is rising slowly 
● Negative when the price level is falling 
 
Biased CPI​ → might overstate the true inflation for four reasons: 
● New goods bias​ → new goods not available the base year 
○ If they are more expensive than goods they replace, they put an 
upward bias on CPI 
● Quality change bias​ → rise in price is payment for improved quality 
○ Not inflation, but still counts as inflation 
● Commodity substitution bias​ → fixed CPI and doesn’t take into account 
consumers’ substitutions from goods whose relative prices increase 
● Outlet substitution bias​ → people switch to buying from cheaper sources, 
but CPI doesn’t take into account the outlet substitution 
 
Consequences of the Bias 
● Distorts private contracts 
● Increases government outlays (close to ⅓ of federal outlays are linked to CPI) 
● Bias of 0.6% 
 
GDP Deflator  
● (Nominal GDP / Real GDP) x 100 
● Broader measure of price level than CPI because it includes ​all final 
expenditure​ on Canadian produced goods and services 
 
Core Inflation Rate → excludes volatile prices of CPI basket in an attempt to reveal 
the inflation trend 
● CPI-Trim → excludes top and bottom 20% most extreme price changes 
● CPI-Median → measures inflation as percentage change in middle items 
● CPI-Common → statistical method to reveal most common price changes 

 
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