The percentage of the working age population in the labor force.

the percentage of the working-age population that is employed

Problems with Measuring the Unemployment Rate

It may understate unemployment:

• Distinguishing between people who are unemployed and not in the labour force
requires judgment (should we exclude “discouraged workers”?)

• It only measures employment, not intensity of employment (full-time vs. part-time;

some people are underemployed)

It may overstate unemployment:

• People might claim falsely to be actively looking for work

• May claim to be unemployed to evade taxes or keep criminal activity unnoticed

The unemployment rate follows the business cycle, rising during recessions and falling
during expansions. Notice, though, that the unemployment rate never falls to zero. To
understand why this is true, we need to discuss the four types of unemployment:
  Frictional unemployment
 Structural unemployment
 Cyclical unemployment
 Seasonal unemployment

Frictional unemployment: Short-term unemployment that arises from the process of matching
workers with jobs.

Would eliminating all frictional unemployment be good for the economy? No, because some
frictional unemployment actually increases economic efficiency. Frictional unemployment
occurs because workers and firms take the time necessary to ensure a good match between
the attributes of workers and the characteristics of jobs. By devoting time to job search,
workers end up with jobs they find more satisfying and in which they can be more productive.
Of course, having more productive and better-satisfied workers is also in the best interest of
firms.

Structural unemployment: Unemployment that arises from a persistent mismatch between

the skills and attributes of workers and the requirements of jobs.

tructural unemployment can last for longer periods because workers need time to learn new
skills.

Structural unemployment can also arise due to a mismatch between the location of workers
and the location of new jobs.

Cyclical unemployment: Unemployment caused by a business cycle recession.

Seasonal Unemployment is due to seasonal factors, like weather or fluctuations of demand

due to the time of the year.

Full Employment

When all unemployment is due to frictional and structural factors, we say that the economy is
at full employment. This means there will always be some unemployment in the economy.

Government Policies and the Unemployment Rate

Governments often attempt to directly influence unemployment.

Example: The Ontario government’s “Second Career” program offers support to retrain laid off
workers. This would reduce structural unemployment.

Other policies try to reduce frictional unemployment, for example by subsidizing new hires.

However, some other government policies probably increase unemployment, like:

• Employment insurance, and

• Minimum wage laws

Employment Insurance (EI)

EI helps unemployed people to spend more time searching for a job that suits their skills which
makes the economy more productive

Minimum Wage Laws

Minimum wage laws are designed to help low-income workers; but raising the wage that firms
have to pay will likely result in them hiring fewer workers.

Labour Unions

Labour unions are organizations of workers that bargain with employers for higher wages and
better working conditions for their members.

Unions are probably not a significant cause of unemployment in Canada.

Efficiency wage: An above-market wage that a firm pays to increase workers’ productivity.

Structural problems
The government can:
 giving people jobs
 unemployment compensation
 relocation of companies and employees
 encourage investments by companies to speed the transitions
 retraining programs

Economists describe cyclical unemployment as the result of businesses not having

enough demand for labor to employ all those who are looking for work at that point
within the business cycle. When demand for a product and service declines, there can be
a corresponding reduction in supply production to compensate. As the supply levels are
reduced, fewer employees are required to meet the lower standard of production
volume. Those workers who are no longer needed will be released by the company,
resulting in their unemployment

Why is the unemployment rate of Canada consistently higher than in US?

but because of a change on the margin betweenparticipation and non-participation

among the non-employed. Relative to Americans, non-employedCanadians became
more likely (or Americans lesslikely) to search for work, and thus to be classifiedas
unemployed
Perhaps the leading explanation relates to differ-ences between the two countries’
unemployment(employment) insurance programs
Because EI/UI programs encourage beneficiaries tosearch for work, this increase in
the “inclusiveness”of Canada’s EI/UI program relative to the US may
have resulted in a greater propensity of non-employed Canadians to search for
work thancomparable Americans.Another explanation points to the rapid growthof
temporary help agency employment in the US.Such intermediaries may reduce the
need for costlyjob-search activities, allowing employees of suchagencies to move
directly from employment to out-of-the-labour-force without an intervening period
ofunemployment.

Price Level and Inflation Rate

Inflation rate refers to the percentage increase in the price level from one year to the next.

In Chapter 4, we used the GDP deflator to measure changes in the price level. It excludes price
of imports and include price of exports.

Two commonly-used measures are:

• The consumer price index (CPI)

• The producer price index (PPI)

The consumer price index or cost-of-living index is a measure of the average change
over time in the prices a typical household pays for the goods and services they purchase.

To calculate the CPI in a given year, we need:

• A basket of goods

• The cost to purchase the basket of goods in a base year

• The prices in the current year

the inflation rate from from one year to the next is the percentage change in the CPI.

The producer price index is an average of the prices received by producers of goods and
services at all stages of the production process.

It is conceptually similar to the CPI, in that it uses a basket of goods, but the goods are those
used by producers.

PPI includes the prices of intermediate goods and raw materials. If prices of these goods rise,
cost of producing final goods and services will rise.

The PPI can give early warning of future movements in consumer prices.

Inflation and Interest Rates

The prime rate is the rate at which the most credit-worthy businesses can borrow.
The conventional mortgage rate is the rate at which the most credit-worthy
individuals can borrow to purchase a house.
The overnight rate is the rate at which banks can borrow from other banks for a period
of 24 hours.
The bank rate is the rate at which the Bank of Canada (our central bank) will lend to
commercial banks. In general, all of the interest rates tend to move up when the bank
rate increases and down when the bank rate falls.

For example, inflation affects the distribution of income and wealth.

• It is unlikely that everyone’s wages would increase at the same rate. Many
people have long-term contracts specifying their wage in nominal terms, for
example.
• Also, nominal assets like cash decrease in value when there is significant
inflation. If you hold much of your wealth in cash, then inflation causes a
significant decrease in real wealth for you.

3.7 Discuss the likely effect of each of the following on the unemployment rate.

1. The length of time workers are eligible to receive Employment Insurance

payments doubles.
2. The minimum wage is abolished.
3. Most Canadian workers join labour unions.
4. More companies make information about job openings easily available on
Internet job sites.

a. and c. are likely to increase the unemployment rate. Lengthening the time
workers are eligible to receive Employment Insurance lowers the opportunity
cost of a job search. An increase in union membership pushes more wages
above market wages, thereby increasing unemployment, at least temporarily
until these workers can find jobs in the non-union sector of the economy.

        b. and d. are likely to reduce the unemployment rate. Abolishing the
minimum wage lowers the wage from above the market wage for some
workers, thereby increasing the number of workers firms will employ. Making
information on job openings more available shortens the search involved in
frictional unemployment.

Unanticipated deflation hurts net debtors. If wages fall along with prices, it

can make it much harder to repay debt since incomes are falling. In addition,
the value of the asset financed may become worth less than the amount of the
loan.
 
Deflation can also create economic problems because it can cause consumers
to postpone purchases as they wait for prices to fall even further. People who
hold cash are the real winners during deflation since the purchasing power of
their cash increases.
The price level measures the average prices of goods and services in the economy.
The inflation rate is equal to the percentage change in the price level from one year to
the next.
Statistics Canada compiles data on three different measures of the price level:
the consumer price index (CPI),
the GDP deflator,
and the producer price index (PPI).
The consumer price index (CPI) is an average of the prices of goods and services
purchased by a typical household.
Changes in the CPI are the best measure of changes in the cost of living as
experienced by the typical household.
Biases in the construction of the CPI cause changes in it to overstate the true inflation
rate from between 0.5 percentage points to 1 percentage point.
The producer price index (PPI) is an average of prices received by producers of goods
and services at all stages of production.

An efficiency wage
increases the unemployment rate since firms pay a higher-than-market wage that increases the
quantity of labour supplied.

A significant reason that the unemployment rate in the United States has been lower than the
unemployment rates in Canada is the more generous unemployment compensation payments
and social insurance programs in Canada and Western Europe, which lower the opportunity
cost of continuing to search for a job.

If Parliament eliminated the unemployment insurance system, the level of real GDP will increase
as frictionally unemployed individuals will take less time to find jobs.

TO calculate REAL GDP we can use

NOMINAL GDP / GDP deflator * 100

If the actual inflation rate is greater than expected: Borrowers win because the real rate at
which they repay the loan is less than expected. Lenders lose because the real rate they
receive as interest on the loan is less than expected.
If the actual inflation rate is less than expected: Borrowers lose because the real rate at
which they repay the loan is greater than expected. Lenders win because the real rate they
receive as interest on the loan is greater than expected.

Real interest rate: Provides a better measure of the true cost of borrowing and the true return
on lending than does the nominal interest rate. If the inflation rate turns out to be higher than
either party expected, borrowers pay and lenders receive a lower interest rate than either of
them expected.