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Chapter 5 (Lecture Notes and Textbook Notes)

Tuesday, February 7, 2023
Birdget O’Shaughnessy
ECON 1BB3 C02

Lecture Notes (Tuesday, February 7, 2023)

 Saving by households = "private saving" → Sp=Y +TR−T −C
 Saving by govt = "public saving" → Sg=T −TR−G
→ Surplus if T > G+TR
→ Deficit if G+TR>T
 *In closed economy, national saving (S) = investment (I)
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Textbook Notes (pg 119 – 148)

Introduction
 For many describe state of economy using: unemployment rate and inflation rate
 Misery index (inflation and unemployment rates added to estimate state of economy)
 Most discussed in media and during political campaigns

5.1 Measuring the Unemployment Rate and the Labour Force

Participation Rate
 Unemployment rate = % of labour force unemployed
 Change views on health of economy and dictate politics

Labour force survey (LFS)

 Focus only on working age population = people 15+ legally entailed to work in Canada
 Participants put into categories
1. Employed = anyone w job
 Ex - Paid work, unpaid work for family business, or worked for themselves
 Anyone who normally would have worked
2. Unemployed = don't have job but willing/able to work and looked for work in last 4
weeks
 Ex - Temporarily laid off
3. Not in labour force = people unable/unwilling to do paid work
 Would like to have job, but given up looking
 Labour force = sum of employed and unemployed workers in economy
 Unemployment rate = % of labour force unemployed

 Labour force participation rate = % of working age population in labour force

 Employment-participation ratio = portion of population engaged in paid work

 Determines amount of labour available to economy from given population

 ↑ labour force participation = ↑ GDP

Problems with measuring the unemployment rate

 Distinguishing b/t people not in labour force
 Discouraged workers = available for work but not looking for job during previous 4
weeks b/c believe no jobs available for them
 Everyone considered "employed" despite working few hours/week
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 Understates problems in labour market

 LFS doesn't verify responses
 Overstate extent of joblessness

5.2 Types of Unemployment

1. Frictional unemployment and job search
 Frictional unemployment = short-term unemployment that arises from process of
matching workers w jobs
 Always occur b/c people b/t jobs
 ↑ economic efficiency
 Devoted time to job search = better employees satisfied w job
2. Structural unemployment
 Arises from persistent mismatch b/t skills and attributes of workers and requirements of
job
 Also arise due to mismatch b/t location of workers and new job
 Workers need to learn new skills to find job
3. Cyclical unemployment
 Caused by business cycle rescission
 Workers laid off during recission b/c falling sales and cut backs
4. Seasonal unemployment
 Due to seasonal factors (weather or fluctuation of demand for products)
 Cause unemployment rates to be over or understated
 Publish 2 sets of unemployment figures each month

Full employment
 When only remaining unemployment is structural and frictional
 Natural rate of unemployment = normal rate of unemployment, consisting of frictional
unemployment + structural unemployment, or unemployment rate that exists when economy at
potential GDP

5.3 Explaining Unemployment

Government policies and unemployment rate
 Reduce implementing policies that aid worker retraining
 Increase by ↑ time workers devote to searching for jobs, providing disincentives for firms, or
wages above equilibrium

Employment insurance
 Canadian program for supporting unemployed workers
 Replace 55% of earnings up to $562/week
 Spend more time searching for jobs b/c opportunity cost of job search lower
 Greater match b/t employe and work
 If no EI, suffer large declines in income = reduced spending = recession worse

Minimum wage laws

 Each province sets lowest legal wage
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 If set above market-clearing wage, quantity of labour supplied > quantity of labour demanded

Labour unions
 Orgs of workers that bargain w employers for higher wages and better working conditions
 In unionized industries, wage > market-clearing wage

Efficiency wages
 Higher-than-market wage that firm pays to increase worker productivity
 ↑ worker motivation = ↑ production
 Firm raises cost to workers of losing job b/c many other available jobs pay less
 Quantity of labour supplied exceed quantity of labour demanded

5.4 Measuring Inflation

 Inflation = general increase in price of goods/services over time
 Price level = measure of average prices of goods/services in economy
 Inflation rate = % increase in price level from year to year

The consumer price index

 Measure changes in prices faced by average household
 Statistics Canada conducts Survey of Household Spending yearly
 Create basket of what households purchase
 Weight of goods based off survey
 Consumer price index (CPI) = average of prices of goods/services purchased by typical household
 Faily good indicator of cost of living

Is CPI accurate?
 Most widely reported measure of inflation
 Used to track state of economy and set prices and change wages
 Biases that cause changes in CPI to overstate true rate of inflation
1. Substitution bias
 Doesn't account for buying more/less of good/service
2. Increase in quantity bias
3. New product bias
 Not updated every time new product comes out
4. Outlet bias
 Not updated to reflect changes in where people buy things

Producer price index (PPI)

 Average prices received by producers of goods/services at all stages of production
 Includes prices of intermediate good sand raw materials
 Changes in PPI give early warning of movements in CPI
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5.5 Using Price Index to Adjust for the Effects of Inflation

 Able to compare dollar values from different years

 Nominal variables = economic variables calculated in current year prices

 If tracking changes in economic variable divide nominal variable by price index and x100 to get
real variable

5.6 Real versus Nominal Interest Rates

 Nominal interest rates = stated interest rate on loan
 Real interest rate = nominal interest rate minus inflation rate
 Amount of extra buying power you pay back when loan repaid

 All interest rates tend to move up when bank rate increases and down when bank rate falls

5.7 Does Inflation Impose Costs on the Economy

 Nominal income generally increases w inflation

Inflation affects the distribution of income

 Depends on whether inflation anticipated or unanticipated

Problem with anticipated inflation

 Menu costs = costs to firms of changing prices
 Raise cost of capital for business investment

Problem with unanticipated inflation

 Unable to predict future costs when borrowing/lending money