Measuring Slack and the Cost of Living
The national statistics office reports a working-age population of 20 million. The labour force is 12 million, of whom 10.8 million are employed. Of the employed, 1.4 million work part-time, and 0.5 million of these say they want more hours. A further 0.6 million people are not in the labour force but say they would take a job if one were available. The headline unemployment rate is therefore 10%. The underground economy is estimated at 8% of GDP. The consumer price index gives food a 35% weight, housing 20%, transport 15%, and communications 5%. The statistics office updates weights every ten years and samples prices in urban outlets only. Food and fuel prices have risen sharply, while mobile-phone tariffs have fallen. The government is debating whether to use the headline unemployment rate and CPI to set welfare payments and pensions.
1. Calculate the headline unemployment rate, an adjusted rate including discouraged workers, and an underemployment indicator. Explain the limitations of each measure.
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Headline unemployment = unemployed/labour force = (12 − 10.8)/12 = 1.2/12 = 10%. Including discouraged workers who would take a job: (1.2 + 0.6)/(12 + 0.6) = 1.8/12.6 = 14.3%. The underemployment rate for part-time workers wanting more hours is 0.5/12 = 4.2% of the labour force, or 0.5/10.8 = 4.6% of employment. These adjustments show that the headline understates labour slack. However, adding all discouraged workers may overstate unemployment if some would not accept available jobs or wages. The underground economy (8% of GDP) may also hide employment. For welfare policy, the broader measure is more appropriate, but it is less timely and more subjective.
2. Assess whether the CPI is a suitable index for uprating pensions and welfare payments.
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The CPI may mismeasure the cost of living. Fixed weights for up to ten years overstate the effect of goods whose prices rise, because consumers substitute toward cheaper alternatives. Urban-only outlets miss rural prices, where food and fuel weights may be higher. Quality improvements and new products are poorly captured. Housing is only 20%, which may understate shelter costs for renters. A fall in mobile tariffs with a 5% weight offsets food and fuel, but low-income households spend more on food, so their experienced inflation is higher. For indexation, using headline CPI protects pensions from energy shocks, but it can embed inflation through wage-price spirals. A core index may be better for monetary policy, while a household-specific index may be better for welfare. Judgement: use headline for benefit indexation with a temporary top-up, and core for policy.