global

CHAPTER 4

INFLATION & UNEMPLOYMENT

OBJECTIVE OF LEARNING

1. define inflation 2. identify the different degrees of inflation 3. identify the causes of inflation 4. calculate the inflation rate 5. consider the various costs that inflation

imposes on society 6. identify ways to control inflation

INFLATION

4.1.1. Definition Inflation can be defined as a situation where there is a continuous increase in general price level over time

• generally inflation is a situation where • there is too much money chasing too few goods • cost of living has increased • there is persistent fall in the value in the economy • prices are rising

Degrees of inflation 1. Mild Inflation

• Not serious condition• Normally the general price level would increase up to 5

%. Eg. The CPI is about 1052. Creeping Inflation

• More serious than mild inflation• Occurs when demand is rising but supply is constant,

hence leading to rising prices.• the general price level would normally increase by 10%

and CPI is 110 3. Hyperinlation / galloping inflation / runaway inflation

• Very serious economics condition where the value of money is persistently falling

• Inflation that exceeds 50% per month.

Causes of InflationPrice

Output

AD1

AD2

AS

Q1 Q2

P2

P1

1. Demand Pull Inflation The basic cause of inflation comes

from the demand side, due to factors such as

Increase in money supply (expansionary monetary policy)

Increase in government purchases (expansionary fiscal policy)

Increase in export

p1p2

2. Cost push inflation ( supply push inflation ) the basic cause is the rising costs of

production , such as an increase in wage rates, an increase in the prices of raw materials

when industries are faced with rising production costs , they will push prices up

in terms of AD-AS diagram , this is depicted in Figure 4.2 as an upward shift in

Causes of InflationPrice

Output

AS1

AS2

P2

P1

Q2 Q1

Causes of Inflation

3. Imported Inflation If there is in inflation in the source countries of

imports, imported inflation comes in along with the imported goods and services.

E.g. as inputs or raw materials such as crude oil are purchased at high, inflated prices from the Middle East where the inflation originates, non-oil producers like Singapore import the inflation as well.

Measurement if Inflation

General price level is measured using Price Index1. The GDP Deflator2. The CPI

assuming CPI is used to measure inflation , then the rate of inflation between 2 periods , say period t and period (t-1 ) is given by :

inflation rate = (CPIt – CPIt-1) / CPIt-1 x 100%

e.g. in Dec 1999, CPI was 118.9, and in Dec 1998, it was 115.7, so the inflation rate during 1998 was = 2.77%

it is possible for inflation to be negative, but this rarely happens, this would occur when the general price level falls and it is called deflation

Costs of Inflation

A) Anticipated Inflation (inflation that is expected)

i) Menu costs costs of inflation that arise from actually changing prices

restaurant owners, catalogue producers, and any other business that must post prices will have to incur costs to change their prices because of inflation

ii) Shoe-leather costs costs of inflation that arise from trying to reduce holdings of

cash

B) Unanticipated Inflation (inflation that is not expected) failure to anticipate inflation correctly imposes costs in the labour market and

the capital market In the labour market , unanticipated inflation causes

a) redistribution of income b) departures from full employment

In the capital market , unanticipated inflation causes a) redistribution of income and too much or too little lending and borrowing b) interest rates based on incorrectly anticipated inflation imposes a cost on either the borrower or lender c) inaccurate inflation expectations also create an inappropriate amount of borrowing and lending

Costs of Inflation

Ways to control inflation

3 main ways by which inflation can be controlled i) adopt tight monetary policy undertaken by Central Bank

(Bank Negara) that use some instruments to influence the economy by reducing money supply and higher interest rates.

ii) contractionary fiscal policy that deals with reducing government expenditures and increasing tax

iii) direct control - direct govt intervention in the price

mechanism of the country

direct controla) price pegging

- government fixed the floor and ceiling prices , so that prices will not increase rapidly

- producers will not be able to increase prices according to their own wishes

b) control of trade union - demand for higher wages has caused cost-push inflation

· persuade not to make these demands c) anti-hoarding campaign

- done in M’sia , where reports were made against producers and consumers who store their goods unnecessarily because such

storage could cause artificial shortage and push prices up


direct control d) price tagging

- prices of all goods have to be labelled - prevent producers from over-charging the consumers b) e) rationing - This is done as a last resort whereby consumers are

given coupons to buy goods in certain quantities, - for example, one family is only allowed to buy 10 kilograms of

rice per month. In other words, the demand for the good is predetermined.

To be effective all 3 methods, i.e. monetary policy, fiscal policy and direct control must be implemented simultaneously


UNEMPLOYEMENT

DEFINITION the unemployed are those individuals who do not currently have a job but

who are looking for work individuals who looked for work in the past but are not looking currently

are not counted as unemployed the employed are individuals who currently have jobs

thus, employed + unemployed = labour force people who are not working and are not looking for work are not

considered to be in the labour force such as a full-time student, homemaker, or retiree is not in the labour force

discouraged workers also not included in the official count of the unemployed as they are workers who left the labour force because they could not find jobs

Measurement of Unemployment Unemployment rate the percentage of the labour force that is unemployed it is computed as:

OR

No. of unemployed workers

labour forceX100%

Labour force - no. of employed workers

labour forceX100%

Types of unemployment unemployment can be classified into 3 types:

1. Frictional unemployment unemployment that occurs naturally during the normal workings of an

economy can occur for a variety of reasons such as people change jobs, move across

the country, search for new opportunities or take their time after they enter the labour force to find appropriate job

arises because it takes time for workers to be matched with suitable jobs during this time , workers engaged in a job search will be registered as

unemployed the problem is that information is imperfect employers are not fully informed about what labour is available . workers are not fully informed about what jobs are available . to remedy frictional unemployment - better job information provided by

government job centers , local and national newspaper .


2. Structural unemployment arises from changes in the pattern of demand and supply in the economy pattern of demand - declining demand - change in consumer tastes , goods

out of fashion , competition from other industries , etc. pattern of supply - methods of production - new techniques of production.

Unemployment may result from labour-saving techniques of production or a whole new technology which requires workers with different skills.

people cannot immediately take up jobs in other parts because there is mismatch between workers skill and job requirements due to

not having sufficient education lack of skills and training E.g. when products such as black and white television become obsolete

workers engaged in their production may become unemployed.


3. Cyclical unemployment arises because the economy is in recession and there is deficiency of

demand unemployment increases during recession and decreases during expansion In any economy , actual rate of unemployment = natural rate of unemployment + cyclical

rate of unemployment the natural rate of unemployment is defined as the rate of unemployment

that prevails when output and employment are at the full level of employment level .

even though the economy is operating at the full employment level of employment , there will still be people who are facing frictional and structural unemployment

in other words , natural rate of unemployment = frictional + structural unemployment .

Costs of Unemployment

Costs to the unemployed Even though, people may have more time to pursue leisure activities,

they may be constrained in so doing by a lack of income The unemployed also suffer a loss of status as a certain amount of

social stigma is still attached to being unemployed. More likely to experience divorce, nervous breakdowns, bad health and

are more likely to attempt suicide than the rest of the adult population Long periods of unemployment reduce the value of human capital.

When people are out of work, their skills can become rusty, and they miss out on training in new methods.

Costs to society The main cost to society is the output which is lost people will enjoy fewer goods and services than they could

have consumed with higher employment The country will be producing inside its PPF Whilst government revenue will fall as unemployment rises, it

will have to increase its spending on unemployment related benefits (such as unemployment benefit)

there has been increased evidence of a link between crime and unemployment, particularly in the case of young unemployed men

Costs of Unemployment

Policies to reduce unemployment policies to reduce unemployment depend on the type

of unemployment

1. Frictional unemployment focus primarily on improving the information flows between

employers and job-seekers employment agencies need to be set up to pool and provide

information on the type of job opportunities that are available on the kind of workers who are searching for employment

another much more controversial remedy is for the government to reduce the level of unemployment benefit

structural unemployment encouraging people to look more actively for jobs,

if necessary in other parts of the country encourage people to adopt a more willing attitude

towards retraining, and if necessary to accept some reduction in wages

use wage subsidy programs to encourage employers to hire and train those who otherwise lack the necessary skills to get the jobs

Policies to reduce unemployment

cyclical unemployment adopt expansionary monetary policies by

increasing money supply and reducing interest rates to stimulate aggregate demand or expansionary fiscal policy by increasing government expenditure and reducing tax

Policies to reduce unemployment

Trade-off between Inflation and Unemployment - The Phillips Curve a Phillips curve shows the relationship between the inflation

rate and the unemployment rate there are 2 times frame for PC :

the short-run PC the long-run PC

the short-run PC shows the relationship between inflation and unemployment holding constant the expected inflation rate and natural rate of unemployment . Unemployment

rate (%)

Inflation rate (%)

SRPC

Education

global