Why are economists concerned about
unemployment and inflation?
The costs to the economy are large.
Costs of unemployment
1. Lost production
2. Increased income inequality
Anatomy of Canadian
1. Large variations across ages groups and
2. Large flows in and out of unemployment
3. Unemployment rate is mostly comprised on
those unemployed for a long period of time.
The unemployment pool
The number of unemployed people at any
point in time.
How does unemployment occur?
There are three ways to move out of the
unemployment pool. What are they?
Changes in unemployment usually lag behind
changes in output.
What are some of the variations in
unemployment across groups and provinces?
Unemployment rate, by province
Newfoundland & Labrador 14.9
Nova Scotia 9.8
New Brunswick 9.3
Three types of unemployment
The rate of unemployment associated with the
natural rate of unemployment (u*) at which
cyclical unemployment is zero.
What determines u*?
1. Organization of the labour force
2. Demographics of the labour force
3. Availability of unemployment benefits
What is hysteresis?
The phenomenon that when unemployment is
high, it tends to remain high and fall very
What causes hysteresis?
1. Unemployed become accustomed to not
2. Discouraged workers.
3. Employers hesitate to hire those who have
been unemployed for a lengthy period.
Does EI influence u*?
1. EI benefits allow for a longer job search
2. Reporting effects
3. Employment stability
The costs of unemployment
Loss of output
Okun’s law postulates that a 1% deviation in
u from u* will result in a 2% deviation in Y
Depression, loss of self-esteem
Higher incidence of heart attacks, suicide,
Increased racial tensions
Costs of inflation
Costs of anticipated inflation are small.
Costs of unanticipated inflation are very small
but may affect wealth distribution.
Price level increases at a rate forecasted by all
Price level increases at a pace that has been
incorrectly forecasted by economic agents.
2 minor costs of anticipated
1. Shoe-leather costs
2. Menu costs
Cost of unanticipated inflation
Wealth redistribution from creditors to
Indexation of inflation
Indexation ties the terms of contracts to
2 types of contracts affected by
1. Long-term loan contracts
2. Wage contracts