Chapter 23
Monitoring jobs and inflation
Why unemployment is a problem
 Lost income and production:
 Loss of a job directly leads to a loss of income and lost production. Lost
production means lower consumption and investment in capitals, which
lowers the living stand in the present and future.
 Lost human capital:
 Prolonged unemployment permanently damages a person’s job prospects by
destroying human capital, as those who lose jobs cannot compete with the
people that replaced them.
The labour force
 The labour force is split into two groups, the working-age population and others who
are either too young or institutionalised and therefore, cannot work.
 The official working age is 15 years old.
 The working-age population is divided into two further groups, those in the labour
force and those not in the labour force.
 The labour force is then divided into two further groups, employed and unemployed.
 A person who is employed either has a full-time job, a part-time job, or is selfemployed.
 A person who qualifies as unemployed according to the QLFS is without work in the
reference week and actively looked for work or tried to start a business in the four
weeks leading to the survey and would have been able to start work or would have
started a business in the reference week, or had not actively looked for a job in the
past four weeks, but had a job or business to start at a definite date in the future.
 Discouraged workers are workers that have not made active efforts to find a job
even though being available and willing to work.
The unemployment rate
 Indicates the extent to which people who want jobs cannot find them
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑒𝑜𝑝𝑙𝑒 𝑢𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑

Unemployment rate =

Unemployment fluctuates just as GDP does and reaches a peak level after a
recession ends.
𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒
× 100
The absorption rate
 The number of people who are of working age and have jobs.
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑒𝑜𝑝𝑙𝑒 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑
× 100
𝑊𝑜𝑟𝑘𝑖𝑛𝑔−𝑎𝑔𝑒
𝑝𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛

Absorption rate =

Falls during a recession and increases during an expansion.
The labour force participation rate
 The willingness for people of the working age to take jobs

𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒
Labour force participation rate = 𝑊𝑜𝑟𝑘𝑖𝑛𝑔−𝑎𝑔𝑒 × 100
𝑝𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛
Marginally attached workers
 A person who currently is neither working nor looking for work but has indicated the
desire for a job and is available for a job.
 Excluded in official unemployment as this person has not made specific efforts in the
past 4 weeks to get a job.
Part-time workers who want full time jobs
 No differentiation between workers who want to work part time and those who
want to work full time, both are regarded as employed.
Most costly unemployment
 Long-term unemployment that results from job loss is the costliest.
 Even though voluntary or short-term job losses bear costs, they do not compare to
people’s jobs that were involuntarily lost and those people must now search for a
new job.
 This is due to the fact that the loss of income and search costs for those seeking
employment are both substantial and harsh on the economy and the person who
has been affected by long-term unemployment.
Unemployment and full employment
 There are four types of unemployment:
 Frictional unemployment:
o Unemployment that arises from the normal labour turnover – from
people entering and exiting the labour force and from the ongoing
creation and destruction of jobs.
o A permanent and healthy phenomenon in a growing economy.
 Structural unemployment:
o Unemployment that arises from the changes in technology or
international competition change the skills needed to perform jobs or
change the location of jobs.
o Usually lasts longer than frictional unemployment as people must
retrain.
 Cyclical unemployment:
o The higher-than-normal unemployment at a business cycle trough
and the lower-than-normal unemployment at a business cycle peak.
 Natural unemployment:
o Unemployment that arises from frictions and structural change when
there is no cyclical unemployment.
o Influence by the age distribution in population, the scale of structural
change (how big is the technological upheaval), the real wage rate,
and unemployment benefits.
o Full employment is when the unemployment rate equals the natural
unemployment rate.
Real GDP and unemployment over the cycle
 The quantity of real GDP at full employment is potential GDP.
 The gap between real and potential GDP is known as the output gap.
 When the unemployment rate is equal to the natural unemployment rate and real
GDP equals potential GDP, the output gap is equal to zero.
 When unemployment rate < natural unemployment rate; real GDP > potential GDP;
output gap is positive.
 When unemployment rate > natural unemployment rate; real GDP < potential GDP;
output gap is negative.
The price level, inflation, and deflation
 Inflation is defined as a persistently rising price level.
 Deflation is defined as a persistently falling price level.
 The annual percentage change of the price level is known as the inflation or
deflation rate.
Why inflation and deflation are problems
 Slow and anticipated inflation or deflation is not a problem, it becomes a problem
when there is a burst of one of above.
 There are 4 affected factors when there is a sudden burst of inflation or deflation
 Redistribution of income:
o Unexpected burst of inflation raises the prices of goods but does not
immediately raise the wages of workers. Workers are worse off as
their income buys less, but employers are better off as their profits
rise.
o Unexpected burst of deflation has an opposite effect. Workers are
better off because their wages can buy more, but employers are
worse off as their profits are less.
 Redistribution of wealth:
o Unexpected burst of inflation leads to the money that the borrower
repays to the lender being able to buy less than the money originally
loaned. The borrower wins and the lender losses.
o Unexpected burst of deflation leads to the money that the borrower
repays to the lender being able to buy more than the money originally
loaned. The borrower losses and the lender wins.


Lowers real GDP and employment:
o Unexpected burst of inflation leads to real GDP rising above potential
GDP and the unemployment rate falls below the natural
unemployment rate, but since this situation is temporary, the
profitable investment dries up, spending falls, real GDP falls below
potential GDP, and the unemployment rate rises.
o Unexpected burst of deflations has even worse effects on real GDP
and jobs, since borrowers are worse off, and spending is cut which
leads to total spending falling and thus a recession and rising
unemployment.
Diverts resources from production:
o Unpredictable bursts of inflation or deflation turn the economy into a
casino and diverts resources from productive activities to forecasting
inflation.
The Consumer Price Index (CPI)
 Measure of the average of the prices paid by urban consumers for a fixed basket of
consumer goods and services.
 The CPI basket contains the goods and services represented in the index, each
weighted by its relative importance.

𝐶𝑜𝑠𝑡 𝑜𝑓 𝐶𝑃𝐼 𝑏𝑎𝑠𝑘𝑒𝑡 𝑎𝑡
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑝𝑟𝑖𝑐𝑒𝑠
CPI = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐶𝑃𝐼 𝑏𝑎𝑠𝑘𝑒𝑡 𝑎𝑡 × 100
𝑏𝑎𝑠𝑒−𝑝𝑒𝑟𝑖𝑜𝑑 𝑝𝑟𝑖𝑐𝑒𝑠
Measuring the inflation rate

Inflation rate =
𝐶𝑃𝐼 𝑡ℎ𝑖𝑠 𝑦𝑒𝑎𝑟−𝐶𝑃𝐼 𝑙𝑎𝑠𝑡 𝑦𝑒𝑎𝑟
𝐶𝑃𝐼 𝑙𝑎𝑠𝑡 𝑦𝑒𝑎𝑟
× 100
Alternative price indexes
 Two alternatives to the CPI
 Personal consumption expenditure deflator (PCE deflator):
o The basket of goods in the PCE deflator is broader than that of the CPI
because it includes all consumption expenditure.
o The difference between CPI and the PCE deflator is minimal.
o PCE deflator = (Nominal C ÷ Real C) × 100
 GDP deflator:
o Similar to PCE deflator but includes all the goods and services
included in the GDP.
o Index in the prices of the items in consumption, investment,
government expenditure and net exports.
o GDP deflator = (Nominal GDP ÷ Real GDP) × 100
Core CPI inflation
 The core CPI inflation rate excludes volatile elements, in attempt to reveal the
underlying inflation trend.
 % change in CPI excluding food and fuel.