BEO6600 · Business Economics
Inflation and Unemployment
Session 8 links saving and investment through the financial system, then turns to unemployment. The financial system channels funds from savers to borrowers through markets (bonds = debt, shares = equity, the ASX) and intermediaries (banks). For a closed economy the identity is national saving S = Y − C − G = I, split into private saving (Y − T − C) and public saving (T − G; a budget deficit when G > T). The loanable-funds market sets the real interest rate where saving (supply) meets investment (demand); its headline result is crowding-out — a budget deficit shifts saving left, raising the rate and displacing private investment. On the labour side, the ABS Labour Force Survey gives the unemployment rate (unemployed ÷ labour force) and participation rate (labour force ÷ adult population); the natural rate comes from frictional, structural and classical unemployment, and a binding minimum wage is a labour-market price floor.
What this chapter covers
- 018.1 Financial markets (bonds, shares, the ASX) vs intermediaries (banks)
- 028.2 The saving = investment identity; private and public saving
- 03Budget surplus vs deficit and government debt
- 048.3 The loanable-funds market and the real interest rate
- 058.4 Three policy shifts; crowding-out as the headline result
- 068.5 Measuring unemployment (labour force, U-rate, participation rate)
- 078.6 The natural rate; frictional, structural and classical unemployment
- 088.7 A binding minimum wage as classical unemployment
Worked example: labour-force rates and a loanable-funds shift
- +1(a) Labour force = employed + unemployed = 9.4 + 0.6 = 10.0m.
- +1Unemployment rate = unemployed ÷ labour force × 100 = 0.6 ÷ 10.0 × 100 = 6.0% — divide by the labour force, not the adult population.
- +1Participation rate = labour force ÷ adult population × 100 = 10.0 ÷ 12.5 × 100 = 80%.
- +1(b) A budget deficit is public dissaving, so it reduces national saving — the supply of loanable funds shifts left.
- +1Result: the real interest rate rises, and higher rates discourage private investment — that displacement is crowding-out, the single most-tested takeaway from this diagram. A budget surplus does the reverse.
Key terms
- Saving = investment identity
- For a closed economy, Y = C + I + G implies national saving S = Y − C − G = I. National saving splits into private saving (Y − T − C) and public saving (T − G): a budget surplus when T > G, a deficit when G > T, with accumulated deficits forming government debt.
- Loanable-funds market
- Supply and demand applied to saving and borrowing, with the real interest rate as the price. Supply is national saving (slopes up), demand is investment (slopes down), and the rate adjusts to the crossing where the funds savers supply equal those borrowers demand.
- Crowding-out
- The headline result of the loanable-funds diagram: a budget deficit reduces national saving, shifting the supply of funds left, which raises the real interest rate and reduces private investment. The government's borrowing displaces private borrowers; a budget surplus does the reverse.
- Unemployment rate
- The percentage of the labour force that is unemployed: (unemployed ÷ labour force) × 100, where the labour force = employed + unemployed. The participation rate, by contrast, divides the labour force by the adult population — mixing the two denominators is the most common slip.
- Natural rate of unemployment
- The normal level of unemployment that persists even in the long run, made up of frictional (time to match workers to jobs), structural (skills mismatch) and classical unemployment (a real wage stuck above the market-clearing level, as with a binding minimum wage, unions or efficiency wages). Cyclical unemployment is the swing around it over the business cycle.
Inflation and Unemployment FAQ
What is the difference between the unemployment rate and the participation rate?
The unemployment rate divides the unemployed by the labour force (employed + unemployed) and multiplies by 100. The participation rate divides the labour force by the whole adult population. The most common exam slip is using the adult population as the denominator for the unemployment rate — only the participation rate uses it. So in an economy with 0.6m unemployed, 10.0m in the labour force and 12.5m adults, the unemployment rate is 6.0% (0.6/10.0) and participation is 80% (10.0/12.5).
What is crowding-out and why does a budget deficit cause it?
A budget deficit means the government borrows, which is public dissaving and reduces national saving. In the loanable-funds market that shifts the supply of funds left, pushing the real interest rate up. Higher rates make borrowing costlier, so private firms and households invest less — the government's borrowing has displaced private investment. That displacement is crowding-out, the most-tested result of the diagram; a budget surplus reverses it (supply right, rate down, investment up).
Does BEO6600 ask me to price bonds?
No. The financial-system content describes a bond by its term, credit (default) risk and tax treatment, and distinguishes a bond (debt — you lend, earn interest, get repaid) from a share (equity — you own a slice and share the risk and reward, traded on the ASX). But present-value and bond-pricing formulas are explicitly out of scope; the drillable skills are loanable-funds shifts and the labour-force arithmetic.
Why is the natural rate of unemployment above zero?
Because of three structural sources. Frictional unemployment is the time it takes to match workers to jobs — inevitable as sectors shift. Structural unemployment comes from a skills mismatch, addressed by retraining. Classical unemployment arises when the real wage is stuck above the market-clearing level — a binding minimum wage, union bargaining or efficiency wages — creating a surplus of labour. Note that discouraged workers, who want work but have stopped searching, are counted as not in the labour force, so the official rate can understate joblessness.
Exam move
Two skills are drillable here, so practise both. For the loanable-funds market, treat each policy like a micro supply-and-demand shift: decide which curve (saving = supply, investment = demand), which direction, then read the new real rate and quantity. Memorise the three cases — saving incentive (supply right, rate down), investment incentive (demand right, rate up), budget deficit (supply left, rate up, crowding-out). Crowding-out is the single most-tested result. For unemployment, lock in the formulas and especially the denominators: the unemployment rate divides by the labour force, the participation rate by the adult population. Recognise the three types of unemployment behind the natural rate, and see a binding minimum wage as the Session-3 price floor applied to labour, creating a labour surplus. No present-value or bond-pricing maths is examined.
