Macroeconomics Canadian 1st Edition Hubbard Solutions Manual 1

Solution Manual for Macroeconomics Canadian 1st
Edition Hubbard OBrien Serletis Childs 0137022107

9780137022106
Download full solution manual at:
https://testbankpack.com/p/solution-manual-for-macroeconomics-canadian-1st-
edition-hubbard-0137022107-9780137022106/
Download full test bank at:

https://testbankpack.com/p/test-bank-for-macroeconomics-canadian-1st-edition-
hubbard-0137022107-9780137022106/
Unemployment and Inflation
Brief Chapter Summary and Learning Objectives

5.1 Measuring the Unemployment Rate and the Labour Force Participation
Rate (pages 122–126)
Define the unemployment rate and the labour force participation rate, and understand
how they are computed.
▪ Statistics Canada uses the results of a monthly household survey to calculate the
unemployment rate, the labour force participation rate, and the employment-population
ratio. An establishment survey, or payroll survey, is used to measure total employment in
the economy.
5.2 Types of Unemployment (pages 126–129)

Identify the four types of unemployment.
▪ There are four types of unemployment: frictional, structural, cyclical, and seasonal.
5.3 Explaining Unemployment (pages 129–131)

Explain what factors determine the unemployment rate.
▪ Government policies can reduce the level of frictional and structural unemployment by
aiding job search and worker retraining.
▪ Some government policies can add to the level of frictional and structural unemployment
by increasing the time workers devote to searching for jobs, by providing disincentives for
firms to hire workers, or by keeping wages above their market level.
Copyright © 2015 Pearson Canada Inc.

CHAPTER 5 | Unemployment and Inflation 65
5.4 Measuring Inflation (pages 131–134)

Define price level and inflation rate, and understand how they are computed.
▪ The price level measures the average prices of goods and services in the economy. The
inflation rate is equal to the percentage increase in the price level from one year to the next.
5.5 Using Price Indexes to Adjust for the Effects of Inflation (pages 135–136)
Use price indexes to adjust for the effects of inflation.
▪ To correct for the effects of inflation, we can divide a nominal variable by a price index
and multiply by 100 to obtain a real variable.
5.6 Real versus Nominal Interest Rates (pages 136–137)

Distinguish between the nominal interest rate and the real interest rate.
▪ The real interest rate is the nominal interest rate minus the inflation rate.
5.7 Does Inflation Impose Costs on the Economy? (pages 137-139)

Discuss the problems inflation can cause.
▪ When the inflation rate is different from the expected inflation rate some people gain and
some people lose.
Key Terms
Consumer price index (CPI), p. 132. An Inflation, p. 131. A general increase in the
average of the prices of the goods and services prices of goods and services over time.
purchased a typical household.
Inflation rate, p. 132. The percentage increase
Cyclical unemployment, p. 127. in the price level from one year to the next.
Unemployment caused by a business cycle
recession. Labour force, p. 123. The sum of employed and
unemployed workers in the economy.
Discouraged workers, p. 124. People who are
available for work but have not looked for a job Labour force participation rate, p. 123. The
during the previous four weeks because they percentage of the working-age population in the
believe no jobs are available for them. labour force.
Efficiency wage, p. 130. A higher-than-market Menu costs, p. 138. The costs to firms of
wage that a firm pays to increase worker changing prices.
productivity.
Natural rate of unemployment, p. 128. The
Employment-population ratio, p. 123. A normal rate of unemployment, consisting of
measure of the portion of the population frictional unemployment plus structural
engaged in paid work. unemployment.
Frictional unemployment, p. 126. Short-term Nominal interest rate, p. 136. The stated
unemployment that arises from the process of interest rate on a loan.
matching workers with jobs.

66 CHAPTER 5 | Unemployment and Inflation
Price level, p. 132. A measure of the average Structural unemployment, p. 127.

prices of goods and services in the economy. Unemployment that arises from a persistent
mismatch between the skills and attributes of
Producer price index (PPI), p. 134. An average workers and the requirements of jobs.
of the prices received by producers of goods and
services at all stages of the production process. Unemployment rate, p. 122. The percentage of
the labour force that is unemployed.
Real interest rate, p. 136. The nominal interest
rate minus the inflation rate. Working age population, p. 122. People 15
years of age and older who are legally entitled to
Seasonal unemployment, p. 127. work in Canada.
Unemployment that is due to seasonal factors,
such as weather or the fluctuation in demand for
some products during different times of the year.
Chapter Outline
BlackBerry reducing its global workforce by 40 percent.
In September 2013, BlackBerry, formerly one of Canada’s largest tech companies, announced it would be
laying off 40 percent of its worldwide employees – estimated at 4,500 workers. The layoffs were due to the
problems the company had experienced with falling demand for its smartphone during the 2007–2009
recession and from competition from world leaders, Apple and Samsung. The layoffs also indicated how
slowly the worldwide economy was recovering from the recession of 2007–2009. Economists at Statistics
Canada and the Bank of Canada were forecasting that unemployment would not return to normal levels for
at least another two years. Some economists had even begun speaking of the “new normal,” in which
unemployment might be stuck at high levels for many years.
5.1 Measuring the Unemployment Rate and the Labour Force Participation
Rate (pages 122-126)
Learning Objective: Define the unemployment rate and the labour force participation
rate, understand how they are computed.
A. The Household Survey

Each month Statistics Canada conducts the Labour Force Survey to collect data needed to compute the
monthly unemployment rate. They then use this data to calculate the unemployment rate. People are
considered employed if they worked during the week before the survey or if they were temporarily away
from their jobs. People are considered unemployed if they did not work in the previous week but were
available for work and had actively looked for work during the previous four weeks.
The labour force is the sum of employed and unemployed workers in the economy. The unemployment
rate is the percentage of the labour force that is unemployed. Discouraged workers are people who are
available for work but have not looked for a job during the previous four weeks because they believe no
jobs are available for them. The labour force participation rate is the percentage of the working-age

population in the labour force. The employment-population ratio measures the percentage of the working
age population that is employed.
B. Problems with Measuring the Unemployment Rate

The unemployment rate is not a perfect measure of the current state of joblessness. During a recession, an
increase in the number of discouraged workers occurs, but these workers are not counted as unemployed.
The Labour Force Survey (LFS) also counts people as being employed if they hold part-time jobs even
though they would prefer to hold full-time jobs. There are other problems, which cause the measured
unemployment rate to overstate the extent of joblessness. The survey that is used to measure the
unemployment rate does not verify the responses of people included in the survey. A person might claim
to be actively looking for a job to remain eligible for government programs for the unemployed. Other
people might be employed but engaged in illegal activity or might want to conceal a legitimate job to avoid
paying taxes.
C. Trends in Labour Force Participation

The labour force participation rate determines the amount of labour that will be available to the economy
from a given population. The higher the labour force participation rate, the more labour will be available
and the higher a country’s level of GDP. The labour force participation rate of adult men has declined
gradually since 1975, but the labour force participation rate of adult women has increased sharply. The
overall labour force participation rate rose from 61.5 percent in 1976 to a high of 62.7 percent in 2008.
D. How Long Are People Typically Unemployed?

In the modern Canadian economy, the typical unemployed person stays unemployed for a relatively brief
period of time, although that time lengthens significantly during a recession.
E. Job Creation and Job Destruction over Time

The Canadian economy creates and destroys thousands of jobs every year. The creation and destruction of
jobs results from changes in consumer tastes, technological progress, and the successes and failures of
entrepreneurs in responding to the opportunities and challenges of shifting consumer tastes and
technological change. When the LFS announces the increases or decreases in the number of people
employed and unemployed each month, these are net figures.
5.2 Types of Unemployment (pages 126-129)

Learning Objective: Identify the four types of unemployment.
A. Frictional Unemployment and Job Search

Most workers spend some time engaging in a job search, and most firms spend time searching for someone
to fill a job opening. Frictional unemployment is short-term unemployment that arises from the process
of matching workers with jobs. There will always be some workers who are frictionally unemployed
because they are between jobs and in the process of searching for new ones.
Some unemployment is due to seasonal factors, such as weather or fluctuations in demand during different
times of the year. Seasonal unemployment refers to unemployment due to factors such as weather, variations
in tourism, and other calendar-related events.
B. Structural Unemployment
Structural unemployment is unemployment that arises from a persistent mismatch between the skills and
attributes of workers and the requirements of jobs. This type of unemployment can last for longer periods
than frictional unemployment because workers need time to learn new skills.

C. Cyclical Unemployment
When the economy moves into recession, many firms find their sales falling and cut back on production.
As production falls, firms lay off workers. Cyclical unemployment is unemployment caused by a business
cycle recession.
D. Seasonal Unemployment
Seasonal unemployment is unemployment that is due to seasonal factors, such as weather or
the fluctuation in demand for some products during different times of the year. Examples include
department stores hiring in November and December followed by layoffs in January, ski resorts
closing down at the end of the ski season, and construction projects laying off in parts of Canada
with harsh winter weather. Statistics Canada publishes two sets of unemployment figures each
month: one that is seasonally adjusted and another that is not seasonally adjusted. The seasonally
adjusted data eliminate the effects of seasonal unemployment.
E. Full Employment
The natural rate of unemployment is the normal rate of unemployment, consisting of frictional
unemployment plus structural unemployment. The natural rate of unemployment is also called the full-
employment rate of unemployment.
Teaching Tips
Though categorizing unemployment as frictional, structural, or cyclical is useful in understanding the
sources of unemployment, Statistics Canada provides estimates of total unemployment. It does not classify
unemployment as frictional, structural, or cyclical.
Extra Solved Problem 5.2

The Reasons for Unemployment
Some of the data Statistics Canada collects regarding the reasons people are unemployed appear in the
following table (numbers are in thousands, not seasonally adjusted).
Unemployment Reason for unemployment

Job losers New and
Temporary Job re-
Year Rate Number Total layoff Other leavers entrants
2004 7.2 1,234.4 1,182.0 82.0 1,100.0 134.4 500
2005 6.8 1,177.8 1,137.1 79.3 1,057.8 120.0 493.8
2006 6.3 1,109.3 1,074.6 82.5 992.1 117.2 469.1
2007 6.0 1,079.6 1,042.7 78.2 964.5 115.1 458.7
2008 6.1 1,105.4 1,066.3 77.3 989.0 116.4 476.6
2009 8.1 1,490.7 1,491.3 117.0 1,374.3 116.4 604.8
2010 8.1 1,495.4 1,462.9 81.6 1,381.3 114.1 628.5
2011 7.5 1,394.6 1,348.5 71.9 1,276.6 118.0 602.6
2012 7.3 1,372.0 1,323.7 71.3 1,252.4 119.6 611.3
Source: Statistics Canada. Labour force survey estimates Table 282-0054, Table 282-0215.

a. Calculate the percentage of the unemployed who lost their jobs and the percentage that left their
jobs from 2004 to 2012.
b. Explain why the results in part a may sum to a value greater than 1.
Solving the Problem

Step 1: Review the chapter material.
This problem is about the sources of unemployment, so you may want to review the section
“Types of Unemployment,” which begins on page 126 in the textbook.
Step 2: Answer part (a) by calculating the percentage of the unemployed who lost their jobs
and the percentage that left their jobs from 2004 to 2012.
For example, the percentage of job losers in 2004 can be calculated as (1,182.0/1,234.4)  100
= 95.8%. The percentage of re-entrants and new entrants in 2004 is (500)/1234.4  100 =
40.5%. The percentages for the three categories in each year are
Percentages of those unemployed

Year Job Losers Job Leavers
2004 95.8% 10.9%
2005 96.5% 10.2%
2006 96.9% 10.6%
2007 96.6% 10.7%
2008 96.5% 10.5%
2009 100.0% 7.8%
2010 97.8% 7.6%
2011 96.7% 8.5%
2012 96.5% 8.7%
Step 3: Answer part (b) by calculating the total percentage of the unemployed who were
either lost their jobs or left their jobs.
These percentages can add up to more than 100 percent of the unemployed if for some reason
a person was unemployed in the previous period and is no longer in the labour force. Two
reasons for this are the aging of the baby boomers and discouraged workers.
Explaining Unemployment (pages 129-131)

5.3 Learning Objective: Explain what factors determine the unemployment rate.
A. Government Policies and the Unemployment Rate

Governments can help reduce the level of frictional unemployment by pursuing policies that help speed up
the process of matching unemployed workers with unfilled jobs. Governments can help reduce structural
unemployment by implementing policies that aid worker retraining. Some government policies, however,
can add to the level of frictional and structural unemployment. In the Canada and most industrial countries,
the unemployed are eligible for employment insurance payments. The unemployed spend more time
searching for jobs because they receive these payments. Employment insurance helps the unemployed
maintain their income and spending, which lessens the personal hardship of being unemployed and reduces
the severity of recessions. In Canada, unemployed workers are typically eligible to receive unemployment
insurance payments equal to about 55 percent their previous wage (maximum $501/week: 2013) for up to
45 weeks. In many other countries workers are eligible to receive unemployment payments for a year or
more, and payments may equal 80 percent of their previous wage.

Each province and territory in Canada sets the lowest legal wage that firms can pay workers. If the
minimum wage is set above the market wage determined by the demand and supply of labour, the
quantity supplied of labour will be greater than the quantity of labour demanded. As a result, the
unemployment rate will be higher than it would be without the minimum wage. Studies estimate that a 10
percent increase in the minimum wage reduces teenage unemployment by about 2 percent.
B. Labour Unions
Labour unions are organizations of workers that bargain with employers for higher wages and better
working conditions for their members. In unionized industries, the wage is usually above what otherwise
would be the market wage, but most economists believe that this does not result in an increase in the overall
unemployment rate because only about 17.5 percent of workers outside the government sector are
unionized.
C. Efficiency Wages
Many studies have shown that workers are motivated to work harder by higher wages. An efficiency wage
is a higher-than-market wage that a firm pays to increase worker productivity. Efficiency wages are another
reason economies experience some unemployment even when cyclical unemployment is zero.

The Greying of the Unemployment Rate
The unemployment rate changes not only as the number of unemployed workers changes (the numerator of
the unemployment rate formula) but also as the size of the labour force changes (the denominator of the
unemployment rate formula). As the textbook notes, there has been a dramatic increase in the number of
women in the labour force since the mid 1970s. The participation rate among adult women increased from
45.7 percent in 1976 to 62.4 percent in 2010. In the early part of the twenty-first century, the labour force
will be affected by the aging of the “baby boomers”—Canadians born between 1946 and 1964. According
to the 2012 estimates, the median age of Canadians was 40.0 years, an increase of 6.4 years since 1992.
Despite improvements in health care and the increased life expectancy of Canadians, many older workers
are leaving the labour force. In 1976, 15.4 percent of men 65 years and older were in the labour force. In
2012 this figure is about 17.1 percent. For women the numbers are 4.2 percent and 8.8 percent respectively.
The average age of retirement in 2011 for men was 63.2, compared to an average age of 61.3 in 1997.
There are several reasons why many workers today retire earlier than in years past. First, many boomers
have greater disposable incomes than people in other age groups and choose to use this income to consume
more leisure. Second, career advancement becomes more difficult after age 40. Third, a large number of
Canadian companies offer older workers early retirement plans, while few offer incentives to delay
retirement. If these trends continue, the disappearance of baby boomers from the labour force will have a
significant impact on the size of the labour force.
a. What effect will the retirement of the baby boomers have on the unemployment rate?
b. Can the size of the labour force increase despite of the retirement of older workers?
Solving the Problem

This problem is about factors that determine the unemployment rate, so you may want to review
the section “Explaining Unemployment,” which begins on page 129 in the textbook.

Step 2: Answer part (a) by explaining what effect the retirement of baby boomers will have
on the unemployment rate.
Holding other factors that affect the labour force constant, as baby boomers retire, the
unemployment rate will rise because the numerator of the unemployment rate formula would
not change much (relatively few baby boomers are unemployed), while the denominator
becomes smaller as the labour force declines.
Step 3: Answer part (b) by explaining whether the size of the labour force can increase
despite the retirement of older workers.
It is possible, but unlikely, that labour force will increase, because the birth rate among women
in the 1980s and 1990s was less than in the 1950s and 1960s. To offset the decline in the labour
force due to the retirement of the baby boomers, there would have to be new job seekers—
either immigrants or current Canadian residents who had not been in the labour force.
Measuring Inflation (pages 131-134)

5.4 Learning Objective: Define price level and inflation rate, and understand how they are
computed.
The price level is a measure of the average prices of goods and services in the economy. The inflation rate
is the percentage increase in the price level from one year to the next. The GDP deflator is the broadest
measure of the price level, but if we want to know the impact of inflation on the typical household, the
deflator may be misleading because it includes prices of products that are not purchased by the typical
household. Changes in the consumer price index come closest to measuring changes in the cost of living as
experienced by the typical household.
A. The Consumer Price Index

To obtain prices of a representative group of goods and services, the BLS surveys 30,000 households on their
spending habits. The survey is used to construct a market basket of 211 types of goods and services used by
the typical urban family of four. The consumer price index (CPI) is an average of the prices of the goods
and services purchased by the typical urban family of four. One year is chosen as the base year, and the value
of the CPI is set equal to 100 for that year. In any other year the CPI equals the ratio of the dollar amount
necessary to buy the market basket in that year divided by the dollar amount necessary to buy the market
basket in the base year, multiplied by 100. The CPI is sometimes called the cost-of-living index.
B. Is the CPI Accurate?

The CPI is the most widely used measure of inflation. It is important that the CPI be as accurate as possible,
but there are four biases that cause the CPI to overstate the true inflation rate: substitution bias, increase in
quality bias, new product bias, and outlet bias. The BLS continues to take steps to reduce the size of the
bias.
C. The Producer Price Index

In addition to the GDP deflator and the CPI, the government also computes the producer price index
(PPI), which is an average of the prices received by producers of goods and services at all stages of the
production process. Changes in the PPI can give an early warning of future movements in the CPI.


Calculating the CPI
The consumer price index (CPI) compares the cost of a market basket of goods in a given year with the cost
of the same market basket in the base year. Suppose that a market basket includes (1) admission for two to
a local theatre for a weekend movie, (2) a large box of popcorn at the theatre, (3) a large pepperoni pizza
(carry-out from a local pizzeria), and (4) a two-litre bottle of diet Coke.
Theatre
admission for Diet
Year one person Popcorn Pizza Coke
1 $5.00 $2.00 $12.00 $1.25
2 6.00 2.50 12.50 1.40
3 6.50 3.00 13.00 1.50
Assume that Year 1 is the base year. Calculate the value of the CPI for each year and the rate of inflation
for Years 2 and 3.
Solving the Problem

This problem is about using the CPI to calculate the inflation rate, so you may want to review
the section “Measuring Inflation,” which begins on page 131 in the textbook.
Step 2: Determine the value of the market basket.
The value of the market basket is the sum of the quantity of each good included in the basket
multiplied by its price. The market basket in this example has a quantity of two for theatre
admissions, and a quantity of one for each of the other goods. The value of the market basket
in Year 1, the base year, is (2  $5.00) + $2.00 + $12.00 + $1.25 = $25.25. The table in Step
3 gives the value of the market basket for all three years.
Step 3: Calculate the value of the CPI and the inflation rates for Years 2 and 3.
The CPI is the ratio of the value of the market basket in a given year to the value of the market
basket in the base year, multiplied by 100. We can use the CPI to calculate the inflation rate,
which is the percentage change in the CPI from Year 1 to Year 2 and from Year 2 to Year 3.
These values are in the following table:
Value of the Rate of

Year Market Basket CPI Inflation
1 $25.25 100.0 —
2 28.40 112.5 12.5%
3 30.50 120.8 7.4%
Extra Making
Explaining How the CPI Measures
the
the Price Level and Rate of Inflation
Connection
There are many misconceptions about how the consumer price index (CPI) is constructed and exactly what
it measures. Economists John Greenlees and Robert McCelland addressed these misconceptions in an
article published in the Monthly Labor Review. They explain that “. . . when prices change, the goal of the
CPI is to measure the percentage by which consumers would have to increase their spending to be as well

off with the new prices as they were with the old prices . . . .” The following information regarding the CPI
and its construction are taken from the Greenlees and McCelland article.
Using Price Indexes to Adjust for the Effects of Inflation (pages 135-136)
5.5 Learning Objective: Use price indexes to adjust for the effects of inflation.
Price indexes give us a way of adjusting for the effects of inflation so that we can compare dollar values
from different years. To correct for the effects of inflation, we can divide a nominal variable by a price
index and multiply by 100 to obtain a real variable. Economic variables that are calculated in current-year
prices are referred to as nominal variables.
Extra Making
Even Workers With College Diplomas Suffer Real
the
Earnings Loss from 2000 to 2010
Connection
A slow-growing economy in 2011 left millions of Americans nervous about the future. But many were also
nervous about a decline in their real earnings in the recent past. Data from the U.S. Census Bureau shows
that real wages, which are nominal wages adjusted for inflation, declined from 2000 to 2010 for most groups
classified by education level. Workers who had less than a high school education (12.4 percent of all
workers) suffered a 10.9 percent decline over the decade. Although high school graduates (30.7 percent of
all workers) had a real earnings decline of just over 5 percent, this decline was less than those who had
some college (26.4 percent of workers) and college graduates (19.5 percent of workers). Even those who
earned master’s degrees (8.0 percent of workers) earned less in 2010 than in 2000. Only those who earned
advanced degrees—MD, JD, MBA, and Ph.D.—experienced an increase in their real earnings.
Values of the Consumer Price Index (CPI) are used to convert nominal earnings to real earnings. (See
Solved Problem 5.1 in the textbook.) To compute the real earnings figures, a special version of the CPI was
used: the Consumer Price Index Research Series Using Current Methods (CPI-U-RS). This index is used
to estimate what the rate of inflation for all urban consumers would be using methods of estimation currently
used for all years since 1978. For the period between December 1977 and December 1998, the annual
increase in the CPI-U-RS is 4.28, compared to an annual increase in the CPI-U of 4.73 over the same period.
Sources: David Wessel, “Only Advanced-Degree Holders See Wage Gains,” Wall Street Journal, September 19, 2011; Bureau of
Labor Statistics http://bls.gov.
Real versus Nominal Interest Rates (pages 136-137)

5.6 Learning Objective: Distinguish between the nominal interest rate and the real interest
rate.
The difference between nominal and real values is important when money is being borrowed and lent.
Because it is corrected for the effects of inflation, the real interest rate provides a better measure of the true
cost of borrowing and the true return to lending than does the nominal interest rate. The nominal interest
rate is the stated interest rate on a loan. The real interest rate is the nominal interest rate minus the inflation
rate. For the economy as a whole, we can measure the nominal interest rate as the interest rate on overnight
loans between commercial banks.
The nominal interest rate will be less than the real interest rate when the inflation rate is negative. Deflation
is a decline in the price level.


Computing the Real Rate of Interest
The real interest rate is defined as the nominal interest rate minus the inflation rate. The textbook uses the
bank rate (overnight loans between commercial banks) as a measure of the nominal interest rate. The real rate
of interest can be estimated for 2004 through 2010 by using the average bank rate and the rate of inflation as
measured by the December to December percentage change in the consumer price index.
2006 2007 2008 2009 2010 2011 2012

Bank rate 4.3 4.6 3.2 0.6 0.85 1.25 1.25
Percentage change in the CPI 1.7 2.4 1.2 1.3 2.4 2.3 0.8
Source: Cansim Series V122530, V41693242.

a. What was the real interest rate in the years 2006 through 2012?
b. Based on real interest rates from 2009 to 2011, why was it likely that the real rate will be higher
in later years?
Solving the Problem

This problem refers to real and nominal interest rates, so you may want to review the section
“Real versus Nominal Interest Rates,” which begins on page 136 of the textbook.
Step 2: Answer part (a) by calculating the real interest rate in the years 2006 through 2012.
The real interest rate equals the nominal rate of interest minus the rate of inflation.
2006 2007 2008 2009 2010 2011 2012

Real interest rate 2.6 2.2 2 -0.7 -1.55 -1.05 0.45
Step 3: Answer part (b) by explaining why it is likely that the real rate will be higher in
years after 2011.
It is unlikely that the real interest rate would continue to be negative indefinitely. A negative
real interest rate means that lenders are receiving a negative real return on funds they have lent.
Eventually, nominal interest rates will have to rise in order to make the real interest rate
positive.
Extra Making
Low Real Interest Rates on Treasury Debt Force
the
Investors to Consider Alternatives
Connection
A slow-growing economy and increased federal spending forced the U.S. Treasury Department to borrow
1.8 trillion between January 2010 and January 2011, or about $5 billion per day. Holding demand for
Treasury securities constant, an increase in supply of these securities will lead to lower prices and higher
interest rates. But because the demand for Treasury securities also increased, interest rates remained low
throughout 2011. The real interest rate on ten-year Treasury securities was around 2 percent, a level close
to the lowest ever reached in the United States. Low real interest rates encourage firms and consumers to
borrow to fund construction of new buildings, equipment and purchases of automobiles and other durable
goods. But in 2011 many firms were holding large amounts of cash, and consumers who feared losing their
jobs, were unemployed, or had difficulty paying their mortgages were reluctant to take on new debt.
Bondholders and other savers, especially retirees who seek steady income, view low real interest rates on
Treasury securities differently from borrowers. Bill Gross, head of PIMCO, the world’s largest bond fund
advised bondholders to “. . . find something else that’s attractive.” While Princeton economist Burton
Malkiel agreed that U.S. Treasury securities are currently poor choices for investors, he endorsed two other
types of bonds: (1) Tax-exempt municipal bonds, issued by state and local governments, that offer yields
higher than those on Treasury debt, some of which are tied to reliable sources of revenue (for example,
bridge and tunnel fees) and are free of state and local taxes; (2) bonds issued by foreign countries that are
in better fiscal condition than the United States. Canada and Australia, for example, currently have low
debt-to-GDP ratios and abundant natural resources that can be used to fuel economic growth. Malkiel
suggests that another strategy for savers: buy a portfolio of blue-chip common stocks that offer dividends.
Canada expects to have a budget surplus by 2015 at which time the supply of Canadian government bonds
will decline. Upward pressure on bond prices will likely be sufficient to keep interest rates on Canadian

bonds relatively low for the foreseeable future. On October 23, 2013, Stephen Poloz, governor of the Bank
of Canada, indicated that the Bank will likely keep their key rate steady until at least mid-or late 2015.
Sources: Matt Phillips, “Real Interest Rates: 1919–The Present,” Wall Street Journal, October 13, 2011; Burton G. Malkiel, “The
Bond Buyer’s Dilemma,” Wall Street Journal, December 7, 2011; and Matt Cover, “At Current Rate of Federal Borrowing,
Government on Track to Hit Legal Limit on National Debt on March 14,” cnsnews.com, February 24, 2011. Gordon Isfeld,
“Bank of Canada drops rate guidance, lowers growth forecast” Financial Post October 23, 2013.
Does Inflation Impose Costs on the Economy? (pages 137-139)

5.7 Learning Objective: Discuss the problems that inflation causes.
A. Inflation Affects the Distribution of Income

Inflation does not reduce the affordability of goods and services to the average consumer, but it still imposes
costs on the economy. Inflation affects the distribution of income. Some people will find their incomes
rising faster than the rate of inflation, and so their purchasing power will rise. Other people will find their
incomes rising slower than the rate of inflation, and so their purchasing power will fall. The extent to which
inflation redistributes income depends, in part, on whether the inflation is anticipated.
B. The Problem with Anticipated Inflation

When inflation is anticipated, its main costs are that paper money loses some of its value. Anyone holding
paper money will find its purchasing power decreasing each year by the rate of inflation. To avoid this cost,
workers and firms will try to hold as little money as possible but will have to hold some. Firms that print
catalogues listing prices of products will have to reprint them more frequently. Stores will devote more time
and labour to changing prices. Menu costs are the costs to firms of changing prices. Anticipated inflation
raises taxes paid by investors because they are taxed on the nominal payments they receive rather than on
the real payments.
C. The Problem with Unanticipated Inflation

When people borrow money or banks lend money, they must forecast the rate of inflation, so they can
calculate the real rate of interest on a loan. When the actual inflation rate turns out to be different from the
expected rate, some people gain, and other people lose. This apparently unfair redistribution is a key reason
why people dislike unanticipated inflation.
Extra Economics in Your Life:

How will the real interest rate affect the cost of your car loan?
Let’s assume that the old clunker you have been driving needs $500 in repairs in order to pass an annual
car inspection. You are considering buying a new car, and you contact car dealers and banks to determine
the best deal you can get on a car loan. Assume two different scenarios: (a) The lowest interest rate you
find on a five-year car loan is 10 percent, and the annual rate of inflation for the next five years is 9 percent.
(b) The lowest interest rate you can find on a five-year car loan is 6 percent, and the annual rate of inflation
for the next five years is 1 percent.
Question: Under which scenario—(a) or (b)—will you pay less, in real income, for your car loan?
Answer: Although the nominal interest rate is much lower under scenario (a), you should base your
decision on the real interest rate. Of course, you will not know what the actual rate of inflation will be in
the future, but if the rate of inflation is 9 percent annually, the real rate of interest on your car loan will be

only 1 percent. Under scenario (b), if the annual rate of inflation is 1 percent over the duration of your loan
the real rate of interest will be 5 percent. You will pay less in real income under scenario (a) even though
the nominal interest rate is much higher than it is under scenario (b).
Extra AN INSIDE LOOK News Article to Use in Class

Visit www.myeconlab.com for current An Inside Look news articles.
SOLUTIONS TO END-OF-CHAPTER EXERCISES

SOLUTIONS TO QUESTIONS AND PROBLEMS FOR CHAPTER 5
Answers to the Thinking Critically About Policy Questions
1. You should expect the unemployment rate to increase as a PMI below 50 indicates a
slowdown in economic activity, which would cause cyclical unemployment to rise.
2. The PMI for the manufacturing sector is about only the manufacturing sector, which
accounts for only 12.5 percent of GDP. Activity in other sectors like natural resources or services
is much more important to the overall economy than activity in manufacturing. It is possible that
increases in activity in those sectors can overwhelm drop offs in manufacturing. Further, the PMI
is based on expectations and expectations can change very quickly. Just because you expect to be
hiring in the next three months doesn’t mean you will be. Firms might not win contracts, or
contracts that a firm didn’t expect to get can work out.
Review Questions
Measuring the Unemployment Rate and the Labour Force Participation

5.1
rate, and understand how they are computed.
1.1 The unemployment rate is calculated monthly from data gathered by Statistics Canada in its Labour
Force Survey. The unemployment rate equals the percentage of the labour force that is unemployed:
(Unemployed/Labour Force)  100. The three conditions to be counted as unemployed are the person (1)
did not work in the previous week, (2) was available for work, and (3) actively looked for work at some
time during the previous four weeks.
1.2 The official Statistics Canada (StatsCan) measure of the unemployment rate understates the true
degree of unemployment to the extent that it does not count discouraged workers as unemployed because
they have stopped looking for a job, and it counts involuntary part-time workers as employed even though
these workers would prefer to work more hours. The official StatsCan measure overstates the true degree
of unemployment because (1) some people claim are not actively looking for work but they claim to be so
they can remain eligible for government payments to the unemployed and (2) some people have jobs in the
underground economy that they do not claim.

Types of Unemployment (pages 126-129)

5.2 Learning Objective: Identify the four types of unemployment.
2.1 The four types of unemployment are frictional unemployment, structural unemployment, cyclical
unemployment, and seasonal unemployment. Frictional unemployment is short-term unemployment that
arises from the process of matching workers with jobs. Structural unemployment is unemployment that
arises from a persistent mismatch between the skills and attributes of workers and the requirements of jobs.
Cyclical unemployment is unemployment caused by a business cycle recession. Seasonal unemployment is
unemployment caused by changes in economic activity due to changes in the seasons.
2.2 The natural rate of unemployment is the normal rate of unemployment, consisting of frictional
unemployment plus structural unemployment. The natural rate of unemployment is also called the full-
employment rate of unemployment. Economists do not define full employment as being an unemployment
rate equal to zero because the creating and destroying of jobs that leads to frictional unemployment and the
structural changes in the economy from factors such as innovation that lead to structural unemployment are
ongoing features of a growing, dynamic economy. No economy attains an unemployment rate of zero, even
during wartime.

3.1 The payment of government employment insurance likely raises the unemployment rate. The
employment insurance payments lower the opportunity cost (the income lost by not working) of continuing
to search for a job, which leads the unemployed to spend more time searching for a job. The payment of
government employment insurance lessens the severity of recessions by helping the unemployed maintain
their income and spending.
3.2 a. Minimum wage laws likely increase the rate of unemployment if they are set above the market
clearing wage rate. (Author’s note: this is still subject to some debate.)
b. Labour unions, by negotiating higher wages for their members, tend to increase the
unemployment rate.
c. Efficiency wages, like labour unions, tend to increase the unemployment rate.

5.4 Learning Objective: Define price level and inflation rate, and understand how they are
computed.
4.1 The GDP deflator is the broadest measure of the price level because it includes the prices of all
final goods and services included in GDP. The Consumer Price Index measures the prices of goods and
services purchased by consumers. The Producer Price Index measures the prices of goods and services at
all stages of the production process.
4.2 The potential biases include the substitution bias, the increase in quality bias, the new
product bias, and the outlet bias.

5.1 A nominal variable is a variable measured in current dollars, which means that it is measured using
the actual prices from that year. A real variable is a variable measured in constant dollars, which means that
it is measured using prices from the base year. That is, a real variable is adjusted for the effects of inflation.
5.2 The real wage for a given year between 2004 and 2011 can be calculated by using this formula:
Real wage = (Nominal Wage/CPI)  100. For example, the real wage for 2005 would be calculated as Real
wage2005 = (Nominal Wage2005 / CPI2005)  100.

5.6 Learning Objective: Distinguish between the nominal interest rate and the real interest rate.
6.1 The nominal interest rate is the stated interest rate on a loan, while the real interest rate is the
nominal interest rate minus the inflation rate.
6.2 It is impossible to know whether a particular nominal interest rate is “high” or “low” without
knowing the inflation rate. It is the real interest rate that matters to borrowers and lenders, not the nominal
interest rate. A nominal interest rate of 5 percent with an inflation rate of zero has a higher real interest rate
than a nominal interest rate of 20 percent with an inflation rate of 19 percent.

7.1 We know from the circular flow of expenditures and income that when inflation increases the
nominal value of expenditures it must also increase nominal incomes. Consequently, inflation does not
reduce the purchasing power of the average consumer.
7.2 Inflation affects the purchasing power of money. People with incomes rising faster than the rate of
inflation enjoy an increasing purchasing power, while people with incomes rising more slowly than the rate
of inflation are hurt by a decreasing purchasing power. In general, inflation particularly hurts people on
fixed incomes, such as retired persons who may be receiving a pension of a fixed number of dollars each
year. (As we noted, though, the Social Security payments received by retired workers are increased every
year by an amount equal to the change in the CPI..)
Problems and Applications

Measuring the Unemployment Rate and the Labour Force Participation
5.1
rate, and understand how they are computed.

1.1
Working-Age Population 28,180,900
Employment 16,877,000
Unemployment 1,423,600
Unemployment rate 7.7%
Labour Force 18,487,700
Labour Force Participation Rate 65.6%
Employment-Population Ratio 60.6%
Source: Cansim Table 282-0001 Series v2091030, v2091051, v2091072, v2091135, v2091177,
v2091198, v2091219.
The number of people unemployed is computed using the definition that the unemployment rate equals the
number of unemployed divided by the sum of the number of unemployed and the number of employed. The
labour force equals the employed plus the unemployed. The working-age population is computed using the
definition that the labour force participation rate equals the labour force divided by the working-age
population. The employment-population ratio equals the number of employed divided by the working-age
population.
1.2 The key is to realize that the labour force is not a fixed number of people. If enough people enter
the labour force, with most becoming employed and only some becoming unemployed, then the
unemployment rate could decrease while the number of unemployed increases.
1.3 The unemployment rate fell because people stopped looking for work and became discouraged
workers. The “headline” number of jobs lost, 2,800, actually refers to the net number of jobs created. Net
jobs created is the number of new jobs created minus the number of jobs lost. In this case, 2,800 more jobs
were lost than created.
Types of Unemployment (pages 126-129)

5.2 Learning Objective: Identify the four types of unemployment.
2.1 Decisions are made by comparing the marginal cost and benefit associated with the activities. The
decision of applying for graduate school depends on the opportunity cost of attending versus the payoff
received from a graduate degree. During a recession, jobs are less plentiful and the chances of getting a
high-wage job offer are lower. This means that the opportunity cost of attending graduate school is lower,
so new university and college graduates are more likely to attend graduate school instead. Conversely,
demand in the job market is higher during an expansion, so the opportunity cost of attending graduate
school is also higher.
2.2 Disagree. The economy would operate less efficiently if frictional unemployment were eliminated.
By devoting the time to job search, workers end up with jobs they find satisfying and in which they can be
more productive. Government policy to enhance the job search process of matching workers with jobs could
make the economy operate more efficiently, but entirely eliminating frictional unemployment would not be
efficient.

2.3 For someone frictionally unemployed, the advice would be to keep searching. The person has the
required skills, but matching worker skills to job openings takes time. For someone structurally
unemployed, the advice would center on the need to retrain or to find another occupation. For someone
cyclically unemployed, the advice would be to realize that the search will take longer because of the
recession, and to consider temporarily taking a lower-paying job or going back to school until the economy
picks up.
2.4 Efficiency wages can increase the productivity of workers as well as workers incomes. They can
also increase the profitability of firms. The main disadvantage of efficiency wages is they tend to increase
unemployment.

3.1 If Parliament eliminated the Employment Insurance system, the opportunity cost of job search
would increase, decreasing the level of frictional unemployment. There would be conflicting effects on the
level of real GDP. Lower frictional unemployment would increase real GDP, but the possibility of less
effective matching of worker skills to jobs due to less job search would decrease real GDP. Well-being
would probably decrease if the unemployment insurance system were eliminated because unemployed
workers would suffer large drops in income.
3.2 Prices were much lower in 1965 than they are today. It is difficult to state whether $0.50 was below
the equilibrium wage in 1965 without information about the level of wages in 1965.
3.3 If this analyst is correct, we cannot conclude that Costco is paying efficiency wages and Walmart
is not. The higher Costco wages would be due to the higher-skilled workers required to sell the Costco’s
higher-cost products.

5.4 Learning Objective: Define price level and inflation rate and understand how they are
computed.
4.1 The statement misinterprets the CPI. The inflation rate in 2010 is the percentage change in the CPI
since 2009, not since the base year.
4.2 The CPI, at any point in time, uses a fixed market basket, comparing the cost of buying the fixed
market basket in the current period to the cost of buying the fixed market basket in the base period. As a
fixed market basket, Statistics Canada uses the quantities in the market basket, not the quantities actually
purchased in the current period.
4.3 a)
City January 2011 January 2012 Percentage Change
Halifax 111.6 112.6 0.9%
Montreal 112.8 115.0 1.95%
Toronto 107.8 114.2 5.94%
Regina 142.1 149.7 5.35%
Calgary 95.9 95.8 -0.1%
Vancouver 98.4 98.4 0.0%

Toronto had the highest house price increase from January 2011 to January 2012. Calgary
had the lowest, with house prices decreasing 0.1%.
b) Because we’re dealing with index numbers we can only tell how much house prices have
changed from one year to another. We’d need actual house prices to tell which city had the most
expensive homes. If all the cities had the same house prices in the base year, we could use an
index to compare house prices, but that definitely wasn’t the case in January 2011. Price indexes
like this are really only useful for comparing prices over time, not between cities.
5.1 In the United States, the real minimum wage in 1957 was $3.70 [($1.00/27)  100], and in 2010 it
was $3.37 [($7.25/215)  100]. In France, the real minimum wage in 1957 was €1.9 [(€0.19/10)  100],
and in 2010 it was €6.92 [(8.86/128)  100].
Therefore, between 1957 and 2010, there was an 8.92 percent decrease in the real minimum wage in the
United States: [($3.37 – $3.70) / $3.70]  100. And there was a 264.21 percent increase in the real minimum
wage in France: [(€6.92 – €1.9) / €1.9]  100.
It does not matter whether we have information about the base year as long as we have the CPI data.
Whatever the base year is, we would get the same percentage increase in prices. The percentage increase in
the price level was less in the United States {[(215 – 27)/27 × 100] = 696%} than in France {[(128 – 10)/10
× 100] = 1,180% }.
5.2 Real GDP in 2007 = (Nominal GDP in 2007 /CPI in 2007)×100 = (1,529,6/111.45)×100
= $1,372.45 billion. Real GDP in 2009 = (Nominal GDP in 2009/CPI in 2009) =
(1529.0/114.45)×100 = $1,336.00 billion, making the percentage drop in real GDP = {(1,372.45-
1336)/1,336}×100% = 2.7%.

5.6 Learning Objective: Distinguish between the nominal interest rate and the real interest rate.
6.1 The real interest rate on a loan with a nominal interest rate of 20 percent and 19 percent inflation is
1 percent. The real interest rate on a loan with a nominal interest rate of 5 percent and 2 percent inflation is
3 percent. Therefore, you should prefer the loan with the 20 percent nominal rate.
6.2 Real interest rate = Nominal interest rate – Inflation rate. With $1,000 you can purchase 500
hamburgers at the beginning of the year. If you lend $1,000 for one year at an interest rate of 5 percent, you
will receive $1,050 at the end of the year. With the higher price of hamburgers, at the end of the year you
can buy $1,050/$2.08 = 504.8 hamburgers. So, you can purchase [(504.8 − 500)/500]  100 = 0.96% more
hamburgers. Therefore, the real interest rate you receive on the loan is 0.96 percent. Notice that this is very
close to the real interest rate on the loan, calculated by subtracting the 4 percent inflation in hamburger
prices from the 5 percent nominal interest rate on the loan.

6.3 Lenders would agree to a nominal interest rate of almost zero percent, because with
deflation, the real interest rate would be higher than the nominal interest rate by the rate of
deflation.

7.1 Menu costs are the costs to firms of changing prices. The Internet allows firms to change prices at
little cost so that it has reduced the size of menu costs.
7.2 When the inflation rate turns out to be much higher than most people expected, then the real interest
rate is lower than it was expected to be when loans were made. This means that you would rather be a
borrower.

Macroeconomics Canadian 1st Edition Hubbard Solutions Manual 1

Uploaded by

Copyright:

Available Formats

You might also like

Macroeconomics Canadian 1st Edition Hubbard Solutions Manual 1

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Macroeconomics Canadian 1st Edition Hubbard Solutions Manual 1

Uploaded by

Copyright:

Available Formats

Solution Manual for Macroeconomics Canadian 1st

Edition Hubbard OBrien Serletis Childs 0137022107

Download full test bank at:

Unemployment and Inflation

Brief Chapter Summary and Learning Objectives

5.2 Types of Unemployment (pages 126–129)

5.3 Explaining Unemployment (pages 129–131)

Copyright © 2015 Pearson Canada Inc.

5.4 Measuring Inflation (pages 131–134)

5.6 Real versus Nominal Interest Rates (pages 136–137)

5.7 Does Inflation Impose Costs on the Economy? (pages 137-139)

Copyright © 2015 Pearson Canada Inc.

Price level, p. 132. A measure of the average Structural unemployment, p. 127.

A. The Household Survey

Copyright © 2015 Pearson Canada Inc.

B. Problems with Measuring the Unemployment Rate

C. Trends in Labour Force Participation

D. How Long Are People Typically Unemployed?

E. Job Creation and Job Destruction over Time

5.2 Types of Unemployment (pages 126-129)

A. Frictional Unemployment and Job Search

Copyright © 2015 Pearson Canada Inc.

Extra Solved Problem 5.2

Unemployment Reason for unemployment

Copyright © 2015 Pearson Canada Inc.

Solving the Problem

Percentages of those unemployed

Explaining Unemployment (pages 129-131)

A. Government Policies and the Unemployment Rate

Copyright © 2015 Pearson Canada Inc.

Extra Solved Problem 5.3

Solving the Problem

Copyright © 2015 Pearson Canada Inc.

Measuring Inflation (pages 131-134)

A. The Consumer Price Index

B. Is the CPI Accurate?

C. The Producer Price Index

Copyright © 2015 Pearson Canada Inc.

Extra Solved Problem 5.4

Solving the Problem

Value of the Rate of

Copyright © 2015 Pearson Canada Inc.

Real versus Nominal Interest Rates (pages 136-137)

Copyright © 2015 Pearson Canada Inc.

Extra Solved Problem 5.6

2006 2007 2008 2009 2010 2011 2012

Copyright © 2015 Pearson Canada Inc.

Solving the Problem

2006 2007 2008 2009 2010 2011 2012

Copyright © 2015 Pearson Canada Inc.

Does Inflation Impose Costs on the Economy? (pages 137-139)

A. Inflation Affects the Distribution of Income

B. The Problem with Anticipated Inflation

C. The Problem with Unanticipated Inflation

Extra Economics in Your Life:

Copyright © 2015 Pearson Canada Inc.

Extra AN INSIDE LOOK News Article to Use in Class

SOLUTIONS TO END-OF-CHAPTER EXERCISES

Answers to the Thinking Critically About Policy Questions