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MCD 2090 Macroeconomics (Week 5)

Tutorial 5: Unemployment and Inflation (Chapter 7 and 8)

Period 1

Section A – Homework
1. How is the unemployment rate calculated? What are the three conditions some-
one needs to meet to be counted as unemployed?

Unemployment occurs when a person who is actively searching for

employment is unable to find work. Unemployment is often used as a measure
of the health of the economy. The unemployent rate is the percentage of people
that are within the labour force without a job but is registered as available to
work. Unemployment rate can be calculated by dividing number of unemployed
people over total labour force. People who are not in the labour force are kids
and elderlies. A low unemployment rate means that the economy is more likely
to be producing near its full capacity, maximising output, and driving wage
growth and raising living standards over time. However, extremely low unem-
ployment can also be a cautionary sign of an overheating economy, inflationary
pressures, and tight conditions for businesses in need of additional workers. The
most frequent measure of unemployment is the unemployment rate, which is
the number of unemployed people divided by the number of people in the labor
force. The unemployment rate is calculated by taking the number of people in
the labor force, that is, the number employed and the number unemployed, di-
vided by the total adult population and multiplying by 100 to get the percentage.
To be counted as unemployed, one must not be working, one must be ready to
work (working age), and one must be actively looking for work but has not
found any in the previous 4 weeks.
2. What are the problems in measuring the unemployment rate? In what ways does
the official ABS measure of the unemployment rate understate the true degree of
unemployment? In what ways might the official ABS measure overstate the true
degree of unemployment?
The Australian Bureau of Statistics (ABS) defines a person who is unemployed as
one who, during a specified reference period, is not employed for one hour or
more, is actively seeking work, and is currently available for work. ABS surveys
the Australian population every month and publishes a bulletin of statistics, in-
cluding statistics on unemployment. However, since it only calculates people who
work for one hour or more, it understates part-timers who are working for less
hours but is actively searching for more work. It also understates discouraged
workers who have given up looking for a job or does not need a job. This is es-
pecially heightened during times of recession. There are also people who claims
to be unemployed but in reality, are not. They do this just to get the unemploy-
ment benefits.

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3. Calculate the missing values in the table of data collected in the labour force sur-
vey.

working age population

employment 11 million
unemployment (LF-Employed) 640212
unemployment rate 5,5%
labour force 11640212
(employed+unemployed)
11mill*100/(100-5.5)
labour force participation rate 62%

4. What is the natural rate of unemployment? What is the relationship between the
natural rate of unemployment and full employment?
Full employment does not mean 0 unemployment. It means the economy has
reached the natural rate of employment (5%). The natural rate of unemploy-
ment represents the lowest unemployment rate where inflation is stable or the
unemployment rate that exists with non-accelerating inflation. The government
must maintain 5% natural unemployment, so the employment reaches 95% for
maximum efficacy. Full employment refers to the situation in which people who
are willing to work at existing wages are able to get jobs readily and are able to
move from one job to another. The economy is considered to reach full employ-
ment when it has reached the natural rate of unemployment. When the economy
is at full employment, real GDP is equal to potential real GDP. However, when the
economy is below full employment, the unemployment rate is greater than the
natural unemployment rate and real GDP is less than potential. Finally, when the
economy is above full employment, then the unemployment rate is less than the

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natural unemployment rate and real GDP is greater than potential. Operating
above potential is only possible for a short while, since it depends on workers
working overtime.

Section B
5. Outline the three main types of unemployment.
Cyclical unemployment is unemployment caused by business cycle contraction or
recession.
Frictional unemployment is a short term unemployment due to job-search and
the normal turnover in the labour market.
Structural unemployment is caused by mismatch between skills of a worker and
requirements for jobs. This is because of an absence in demand for certain skill
sets usually due to technological progression. To solve this, workers should en-
dure training and acquire new skillsets to match the demand.
Cyclical and structural unemployment result in longer periods of unemployment
compared to frictional unemployment.

6. Discuss the effect on the unemployment rate of the following:

a. The minimum wage decreases unemployment. This fixed cost incentivises
working age citizens to search for jobs. However, firms may prefer to hire dai-
ly workers (freelancers) as opposed to permanent workers in order to avoid
paying the minimum wage.
b. Trade unions increases the rate of unemployment because trade unions de-
mand higher wages by doing strikes. This discourages companies to hire more
new workers as the cost for wages increase above equilibrium level.
c. Efficiency wages (relate with piece rate system) in theory is when there is no
excess labour and no excess demand for labour, also known as equilibrium.
However, efficiency wages may increases structural unemployment. In effi-
ciency wages, firms often utilise the piece rate system to pay workers accord-
ing to their output. Firms may increase wages in order to incentivise workers
to work more and produce higher levels of output. This could lead to disequi-
librium in which the wage is higher than the equilibrium point. The supply of
labour will exceed the demand and thus, unemployment increases.

7. Discuss the likely impact of each of the following on the unemployment rate:
a. The length of time workers are eligible to receive unemployment benefit pay-
ments doubles.
The basic period for unemployment benefit is 3-6 months, 4 weeks after being
unemployed. Increasing this amount would increase unemployment as workers’
opportunity cost, which is the salary received if they work, is compensated by
the government. Since they have a longer period of compensation (2x6 months),
they might just hold on to the unemployment benefit for longer in order to find a
good job. Government could give vocational training during this period so even if

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they cannot find jobs after 6-12 months, they can start their own business or
provide freelance services using the unemployment benefit as starting capital.
b. The minimum wage is abolished.
Higher minimum wage leads to lower unemployment as workers are more incen-
tivised to find jobs. As many people become employed, receiving a higher mini-
mum wage would also mean higher disposable income and higher consumer
spending. This would in turn create more jobs and decrease unemployment fur-
ther. However, firms may not want to hire as many workers as they used to as
the minimum wage increased. If the minimum wage is abolished, market forces
will determine the price of labour. This would decrease the unemployment rate
as firms can pay lower wages and hire more workers, adjusting to their needs. If
piece rate system (efficiency wages) is used, workers are also more motivated to
work as they have the chance to get higher wages.
c. Most workers join trade unions.
This would increase unemployment rate as trade unions would often demand for
higher wages. When the wages exceed equilibrium level, there will be a deficit in
demand for labour and surplus of supply, leading to unemployment.
d. More companies make information on job openings easily available on Internet
job sites.
This would decrease unemployment as it would be much easier to find jobs on-
line based on a particular worker’s qualifications. It would help solve the problem
for structural unemployment where skills do not match with the job, reduce time
for frictional unemployment as well.

8.Read
When answering questions based on articles, please note the following the arti-
steps; cle and
answer
Step 1: Read all the questions from the article.
the fol-
Step 2: Number all the paragraphs in the article lowing
ques-
Step 3: Browse through the article and match the questions and the tions
paragraphs
i.Accord-
Step 4: Write the answers to the questions ing to
the arti-
cle, what is the NSW state’s unemployment rate for 15 to 24 year olds and
overall unemployment rate?
The state’s overall 12.2 per cent unemployment rate for 15 to 24 year olds.
ii. What are the reasons for 15 to 24 year olds to experience high unemployment
rate?
Most young people age 15 to 24 are not working as 60% of them attend univer-
sity. There is not much low-skilled entry level jobs available as the economy is

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switching to a knowledge and service-based economy, where skills and educa-
tion is the minimum requirement.
iii. Explain how educational reform could contribute to reducing rates of unemploy-
ment?
Increasing minimum age for working population would reduce rate of unem-
ployment as people have to finish high school first before entering the labour
market. This would mean they are more qualified and skilled.
Reforming education system to increase vocational training could lower the un-
employment rate as students would graduate as qualified workers without hav-
ing to go to university if they are unable to do so.
THE SYDNEY MORNING HERALD 16 MARCH 2016
Youth unemployment: the Sydney hotspots
by Anna Patty
The latest national snapshot from the anti-poverty organisation the Brotherhood of St
Laurence shows the unemployment rate for people aged 15 to 24 in Sydney’s East-
ern Suburbs is 12.5 per cent, behind Blacktown with a rate of 14.2 per cent. In
Ryde, the rate is 11.4 per cent in the 12 months to January this year. In NSW, youth
unemployment rates are still as high as 16.5 per cent on the central coast and 15.6
per cent in Sydney’s inner south-west, according to the latest Australian Bureau of
Statistics figures collated by the Brotherhood of St Laurence.
The new data which maps jobless rates around the country shows that some re-
gional areas are close to or above 20 per cent. The Hunter Valley region, excluding
Newcastle, has a rate of 21.8 per cent. On the Mid North Coast of NSW it is 19.5 per
cent. The state’s overall 12.2 per cent unemployment rate for 15 to 24 year olds is
more than twice the overall unemployment rate of 5.2 per cent. This is an improve-
ment from a high of almost 14 per cent in December 2014.
Brotherhood executive director Tony Nicholson said the recent improvement
masked ‘stubborn’ pockets of youth unemployment and rates that remain much
higher than they were before the Global Financial Crisis.
‘It’s deeply concerning that some 258 000 young people in the labour market across
the nation are unable to find work. In “hot spots” the job search is much harder for
them,’ he said.
‘Digging into the data, we find some regions bearing a much heavier burden than
others. Our globalised economy makes it hard for young people to find entry-level
jobs, and this puts them at risk of being locked out of stable employment long term.
‘This generational issue needs sustained attention on all fronts: schools, vocational
training and universities as well as welfare assistance and employment programs.’
Mr Nicholson said there was a lower proportion of lower-skilled entry-level jobs.
About 60 per cent of young people in NSW went on to university.
‘The broad issue is the economy in transition to a knowledge and service-based
economy where employers place a premium on education, skills and qualifications,’
he said.

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Source:  Anna Patty (2016), ‘Youth unemployment: The Sydney hotspots’,  The Syd-
ney Morning Herald, Fairfax Media, 16 March, at <www.smh.com.au.> viewed 25
September 2016.

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Period 2

Section A – Homework
1. Briefly describe the major measures of the price level.
Gross domestic product (GDP) represents the total output of goods and services.
However, as GDP rises and falls, the metric doesn't factor the impact of inflation
or rising prices into its results.
CPI measures the prices of goods and services purchased by consumers over a
period of time to show how price level has changed.
GDP Deflator shows how much a change in gdp is affected by change in price
level. It compares current year’s price levels with a base year. GDP Deflator is
the broadest measure and shows the real GDP.
Producer Price Index (PPI) measures the prices of goods and services at all
stages of production process.
2. What potential biases exist in calculating the consumer price index? What steps
has the Australian Bureau of Statistics taken to reduce the size of the biases?

Biases include substitution bias where a certain good or service may be sub-
stitued by another product due to reasons of price, quality, and needs, the in-
crease in quality bias where as time continues product prices may increase due
to higher quality of materials, new product bias where a new product may re-
place the old one, and outlet bias where different vendors may sell the product
at different prices.. The Australian Bureau of Statistics updates the market bas-
ket every 5 years or as fast as 3 months as season changes to reduce substitu-
tion bias and new product bias. They also use statistical methods to reduce the
quality bias and conduct point-of-purchase surveys to track where consumers
actually make their purchases to reduce outlet bias. Some areas can also experi-
ence higher inflation compared to other areas depending on the purchasing
power of that particular area.

3. Consider a simple economy that produces only three products. Use the informa-
tion in the following table to calculate the inflation rate for 2015 as measured by
the consumer price index.

CPI= (cost of market basket at current year)/(cost of market basket at base

year)*100%

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2012 expenditure= 2*$20 + 10*$4+6*$15 =170
2014 expenditure= 2*22+10*4.2+6*15= 176
2015 expenditure= 2*25+10*4.5+6*14= 179
CPI 2012 = 170/170 *100%= 100%
CPI 2015 = 179/170 *100%= 105.3%
Inflation 2015 = (105.3%-100%)=5.3%

4. If inflation is expected to increase, what is likely to happen to the nominal interest

rate?
If expected inflation increases, the nominal interest rate will increase and the
demand for real balances will fall. As nominal interest rates rise, consumers will
tend to save their disposable income and decrease spending. This fall in spend-
ing would cause slow-down in the economy and decrease inflation.

Section B
5. In each of the following explain whether you think the CPI would overestimate, underes-
timate or accurately estimate the general price level, assuming all else remains constant.
a. A severe drought reduces the production of tropical fruit, causing the price of
tropical fruit to rise significantly.
Overestimated as tropical fruit is only one part of the basket of goods and ser-
vices, these goods are normal goods that can be substituted. Inputting these
prices in the CPI causes substitution bias.

b. Consumers switch to buying front-loading clothes washing machines instead of

the less water-efficient top-loading washing machines, even though front-loading
washing machines are more expensive.
Overestimate, this is new product bias as the old product is obsolete and no
longer used.
c. New technology significantly decreases the price of 3D televisions.
Accurate as this reflects a fall in price for consumer goods.

6. What are the costs of inflation?

The ultimate cost of inflation is the decrease in quality of life due to higher price
levels. Inflation may cause uncertainty and decrease in investments. Inflation in
domestic production may decrease its international competitiveness, as exports
become more expensive, other countries may produce the same good at a lower
price. This worsens current account deficit. Menu costs, which is the cost of
changing price signs also increase. High inflation can also mean deep recession,
this is part of the boom and bust cycle. This cycle shows that low inflation is the
best way to maintain growth.
7. Distinguish between demand-pull inflation and cost-push inflation, and give an
example of a factor that might cause each to occur.

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Demand pull inflation is when inflation is caused by a rise in aggregate demand.
This can be controlled using monetary and fiscal policies.
Cost push inflation is when an increase in the price inputs causes a decrease in
aggregate supply. It can be controlled using government fiscal policies such as
price ceiling and price floor as well as income tax.

8.Read
When answering questions based on articles, please note the following the arti-
steps; cle and
answer
Step 1: Read all the questions from the article. the fol-
Step 2: Number all the paragraphs in the article lowing
ques-
Step 3: Browse through the article and match the questions and the tions
paragraphs i.Accord-
ing to the
Step 4: Write the answers to the questions
article,
what is
the inflation rate, annual wage growth rate, economic growth rate and unemploy-
ment rate?
ii.According to Blyth, what is the good deflation?
iii.According to the article, what has caused the deflation?

THE SYDNEY MORNING HERALD 13 JULY 2016

All eyes on inflation next week, but not everything is as it seems…

by Jessica Irvine
Something quite odd is happening in the economy. Economic growth is quite robust
and the jobless rate is falling. But price pressures are abating. How can that be?
Usually, when economies heat up, you expect to see price pressures building. More
economic activity drives higher employment, higher wages and higher prices at the
store. But inflation figures for the March quarter revealed the shock finding that
prices actually fell 0.2 per cent, although prices still rose over the year by 1.3 per
cent. This is consistent with other evidence we have seen of easing wages pres-
sure. Annual wages growth has slowed from 4 to 2 per cent a year. But the econo-
my grew 3.1 per cent over the year ended March and the jobless rate has fallen be-
low 6 per cent. So, why aren’t prices rising? There are several possible explana-
tions.
The pessimistic point of view is that the economy is actually much softer than sug-
gested by the jobs and growth figures. Low price rises mean the economy is some-
how much weaker than we realised. Indeed, the most pessimistic argument is that a
period of sustained price falls may just be around the corner. This ‘deflation shock’

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makes for great headlines, but the reality is more benign. Most economists are ex-
pecting to see prices rising again; that is, we have not entered a period of falling
prices. Price pressures will, however, likely be shown to remain low. But there are
other possible explanations for this other than that the economy is heading off a
cliff.
In a note to clients after the last inflation report, Commonwealth Bank chief econ-
omist Michael Blythe went through the components of the consumer price index one
by one to assess whether weak price pressure could really be attributed to weak
demand.
At the top of the list, food prices fell 0.2 per cent in the quarter. It’s unlikely that
people suddenly stopped wanting as much food. More likely, price falls were driven
by increased price competition by existing supermarkets and the entry of new play-
ers like Aldi and Costco. This, as Blythe points out, is an example of ‘good’ defla-
tion. The price of clothing also fell, thanks to heavy post-Christmas discounting,
which is usually reversed later in the year. If falling prices are due to better deals for
consumers, not weak consumer demand, they are of less concern.
Housing price pressures were also weak. This includes rents, the price of new hous-
ing and some utility charges. Rental price growth is low as increased supply of new
investment properties comes onto the market. Communication prices fell, again
thanks to increasing competition among telecommunications players. There were
also smaller than usual rises in health and education. ‘None of this is to say that in-
flation is anything but low,’ Mr Blythe wrote. But it does say that price weakness is
not necessarily indicative of weaker demand, but other factors.
Lower prices are a global phenomenon in the wake of the GFC. These have been
extraordinary times in the global economy. As long as growth remains robust and
the jobs market solid, we can expect to see price pressures return. It may take a
while, however, as the economy continues its slow rebalancing away from mining
and towards housing and services.
Source: Jessica Irvine (2016), ‘All eyes on inflation next week, but not everything is as it
seems…’, The Sydney Morning Herald, Fairfax Media, 16 July, at  , viewed 10 October
2016.

9. Complete Post-class homework after watching the video.

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