Question

Answer 3 of the following 5 questions based upon media quotations. Each question will be graded out of 5. Your grade will be based upon your explanation in support of your answer.

1. “But economists believe that one of the most important sources of bias in the Consumer Price Index as a measure of the cost of living occurs when consumers shift their buying patterns in response to a change in relative prices…”

What is the nature of the bias noted in this statement?

2. “She believes that the number of jobs created (employment rate), rather than the unemployment rate, gives a more timely indication of the state of the economy.”

Explain what thinking must lie behind this claim.

3. “Rising Canadian dollar forces Canadian companies to focus on the domestic market.”

Explain how the rising Canadian dollar can have this effect.

4. “Business productivity in the last quarter grew at its fastest pace in six years, offering another explanation for how the strong U.S. economy has kept inflation under control.”

Explain how higher productivity would keep inflation under control.

5. “We consider it entirely possible that an encouraged worker effect will set in when employment picks up, which could lead to a paradoxical rise in the unemployment rate.”

Explain how this could occur.

Answer 1

Views are personal

1. “But economists believe that one of the most important sources of bias in the Consumer Price Index as a measure of the cost of living occurs when consumers shift their buying patterns in response to a change in relative prices…”
   1. The most commonly cited measure of inflation in the United States is the Consumer Price Index, or CPI. The CPI is calculated by government statisticians at the US Bureau of Labor Statistics based on the prices in a fixed basket of goods and services that represents the purchases of the average family of four.
   2. When the price of a good rises, consumers tend to purchase less of it and to seek out substitutes instead. Conversely, as the price of a good falls, people will tend to purchase more of it. This pattern implies that goods with generally rising prices should tend over time to become less important in the overall basket of goods used to calculate inflation, while goods with falling prices should tend to become more important.
2. “She believes that the number of jobs created (employment rate), rather than the unemployment rate, gives a more timely indication of the state of the economy.”
   1. The unemployment rate is the proportion of unemployed persons in the labor force.
   2. Unemployment adversely affects the disposable income of families, erodes purchasing power, diminishes employee morale, and reduces an economy's output.
   3. According to the U.S. Bureau of Labor Statistics (BLS), when workers are unemployed, their families lose wages, and the nation as a whole loses their contribution to the economy in terms of the goods or services that could have been produced. Unemployed workers also lose their purchasing power, which can lead to unemployment for other workers, creating a cascading effect that ripples through the economy. In this way, unemployment even impacts those who are still employed.
3. “Rising Canadian dollar forces Canadian companies to focus on the domestic market.”. The main factors known to influence the value of the Canadian dollar are:
   1. Interest rates: Relatively higher interest rates in Canada increase foreign investors’ demand for Canadian dollar-denominated securities.
   2. Commodity prices: The value of the Canadian dollar is correlated to the strength of world commodity prices. When commodity prices rise, Canada’s terms of trade improve because its goods have become relatively more valuable.
   3. Inflation rates: Inflation is the rate at which general price levels rise over time. If inflation in Canada were to exceed foreign inflation rates, this would reduce the purchasing power of the Canadian dollar relative to foreign currencies. That reduction would be reflected in a relative decline in the value of the Canadian dollar. The opposite is also true. Sustained, relatively low inflation in Canada has a positive influence on the exchange rate.
   4. International trade of goods and services: When a country has a trade surplus, exports exceed imports, putting upward pressure on the exchange rate (the demand for the currency exceeds the supply). When a country has a trade deficit, imports exceed exports, putting downward pressure on the exchange rate (the supply for the currency exceeds the demand).
   5. Foreign investment and debt payments: Inflows of foreign investment in Canada increase the foreign demand for Canadian dollars, pushing the exchange rate up. Direct investment made by Canadians abroad has the opposite effect. Debt payments made to foreigners push the exchange rate down.
   6. Productivity: A country’s productivity the amount of output that can be produced with a given level of inputs can be a factor in the determination of the exchange rate through its effect on relative prices and international competitiveness. For example, if productivity in Canada were to grow faster than in the United States, the prices of Canadian goods would become more competitive and, over time, Canadian output and exports would increase, leading to greater demand for Canadian dollars.
4. “Business productivity in the last quarter grew at its fastest pace in six years, offering another explanation for how the strong U.S. economy has kept inflation under control.”
   1. In fact, productivity growth does not affect the inflation rate, although the reverse can be true.
   2. Productivity growth is a real phenomenon. But as economist Milton Friedman, the Nobel laureate, has observed, inflation is always and everywhere a monetary phenomenon. Productivity growth is a real phenomenon because it occurs when the real output of goods and services rises relative to the real quantity of labor and capital inputs into the production process.
   3. Productivity is increased through better utilization of real economic resources: labor and capital. That improved utilization is not a monetary phenomenon.
   4. Inflation is a monetary phenomenon because it represents a rise in the stated price of goods and services above and beyond any increase in productivity. More precisely, U.S. inflation in recent decades has been a monetary price phenomenon.
   5. Inflation has erupted when interest rates have been too low, usually because the financial markets foolishly followed erroneous signals from the Federal Reserve on interest rates. This has led to inflationary credit growth.
5. “We consider it entirely possible that an encouraged worker effect will set in when employment picks up, which could lead to a paradoxical rise in the unemployment rate.”

   1. While the unemployment figure is rising, the number of people entering the workforce is declining. This is also reflected in the labour force participation rate, which includes people who are either currently employed or looking for employment. This figure is also declining, more so for the urban youth.

   2. That’s an interesting paradox. With more unemployment, the number of job seekers should also swell. But that is not the case.

Thank you:)