Unit-4 With Numericals

Unit-4
Inflation and Unemployment

Inflation
Meaning: Inflation is a significant and sustained increase in the general
price level, which combined by the decrease of the purchasing power.
 Economist concerns with inflation because of two reasons:

• Inflation upsets social relationships and adds uncertainly to economic
decision making.
• Inflation plays a key role in explaining the causes of economic
fluctuations.
Types of inflation:
Demand – pull inflation
Cost – push inflation
Stagflation
Imported inflation
Creeping inflation
1- Demand – pull inflation: Demand pull inflation is inflation which occur
consequence of the rise in aggregate demand (AD).
• There are many factors lead to aggregate demand increase such as rise in
income, rise in wages of labor, decreasing in loan interest rate and so on.
Price (RM)
AD4 AS1
AD3
AD2
AD1
Y1 Y2 Y3
• Increasing in aggregate demand would result in price increase. When prices

increasing continuously until reach full employment level, then demand pull
inflation were occurring.
2- Cost – push inflation: Cost-push inflation is an inflation that occurs due to
high increase in the cost of production, which caused by increase in the cost of
production factors. For example, the price of drink can rise up as a result of
increasing in sugar price.
Price (RM)
AS4
AS3
AS2
AS1
AD1
Y1 Y2 Y3 Y4 Income (Y)
If cost of production will increase and further manufacturer on the other hand
will increase their price. General Price level will increase again. Then, the
inflation occurs.
3-Stagflation: This inflation result from stagnation. This type of inflation appear
in mid 70s (1975) in western countries. This inflation can be defined as increase
in prices accompanied by industrial stagnation and increase level of
unemployment.
4- Imported inflation: This is the inflation which results from the increased
prices of imported raw materials and goods.
5- Creeping inflation: This is the slow increase in the general price level.
Deflation
Deflation is a general decline in prices for goods and services, typically
associated with a contraction in the supply of money and credit in the economy.
During deflation, the purchasing power of currency rises over time.
Economic consequences (effects) of inflation
• A fall in purchasing power of nominal income: The quantity of goods will
decrease according to the increase in prices.
• Income distribution: Inflation causes distribution of income in favor of

borrower and against lenders.
• Decrease of savings: This because the percentage assigned to

consumption will increase saving ration decreases. This will affect
negatively on investment.
• Uncertainty: This leads to economic instability. If there is uncertainty

concerning whether the prices will increase or decrease and to what
extent, then it is very difficult to do any long term contracts.
Remedies/ Ways to control inflation
There are three main ways by which inflation can be controlled:
A- Monetary Policy : (controlled by central bank of the country).
B- Fiscal policy : (controlled by government via instruments taxes and

government expenditure).
C- Direct or physical control

A- Monetary Policy
Central bank can be reduce the inflation through important tools;
(i) Open market operation: The inflation requires the central bank to
reduce the cash. So, the bank will sell equity or bond in the open market
operation.
(ii) Interest rate: In times of inflation the interest rate should be

increased. Increasing in interest rate would discourage the consumption
and investment. So, it will be reducing the aggregate demand, thus
reducing inflation.
B- Fiscal policy: Fiscal policy deals with government expenditure and taxes.
During inflation, government can increase the taxes. So, the value of
consumption will decline and the aggregate demand will fall. So, the inflation
can be reduced.
C- Direct or physical control
Price pegging: The government will fix the floor and ceiling prices so that
prices will not increase rapidly. As a result, the producer will not be able to
increase prices according to their own desires. So, the problems of inflation
will be reduced.
Encourage saving: The government increases the contribution to employees’
provident fund (EPF) or the bankers would be increase the rates or saving.
Price tagging: Every product in the markets need to labeled to prevent
producers over charging to consumers.
To calculate the rate of inflation:
• The Consumer Price Index (CPI)

• Measures the typical consumer’s cost of living CPI is used as the basis of Cost of Living
• How the CPI is Calculated:
1. Fix the “basket.”
The Bureau of Labor Statistics (BLS) surveys consumers to determine what’s in
the typical consumer’s “shopping basket.”
2. Find the prices.
The BLS collects data on the prices of all the goods in the basket.
3. Compute the basket’s cost.
Use the prices to compute the total cost of the basket.
How the CPI Is Calculated (Continued)
4. Choose a base year and compute the index.
The CPI in any year equals:
5. Compute the inflation rate:

The percentage change in the CPI from
the preceding period.
131
EXAMPLE basket: {4 pizzas, 10 lattes} & 2003 is Base year
price of price of
year cost of basket
pizza latte
2003 $10 $2.00 $10 x 4 + $2 x 10 = $60
2004 $11 $2.50 $11 x 4 + $2.5 x 10 = $69
2005 $12 $3.00 $12 x 4 + $3 x 10 = $78
Compute CPI in each year:

Inflation rate:
2003: 100 x ($60/$60) = 100
15% 15% = [(115/100) -1] *
2004: 100 x ($69/$60) = 115 100 and
13% 13% = [(130/115) -1] *
2005: 100 x ($78/$60) = 130 100
133
The basket contains 20 movie tickets and 10 textbooks.
How much did the basket cost in 2004, 2005 and 2006?
Calculate the rate of inflation in 2015.
• Cost of the basket 2004 = ( OMR 10 x 20) + (OMR 50 x 10) = OMR 700
Years Movie tickets Text-books
2004 OMR10 OMR 50
2005 OMR10 OMR 60
2006 OMR12 OMR 60

 Unemployment:
Employment and unemployment are major concerns in macroeconomics.
They are closely related to the standard of living and to the volume of GNP.
Real GNP varies directly with the level of employment and inversely with
the level of unemployment. Therefore understanding changes in employment
and unemployment help economists to understand changes in the level of
real GNP.
Basic concept of employment and unemployment

• In economics employment means “labor engaged in regular work for pay” or
the number of adult workers (aged 18 and over) who have jobs.
• Unemployment is the number of adult workers who are not employed and
are seeking jobs. The unemployed person is the one who must be able and
willing to work and actively seeking work.
Types of unemployment:
(i) Frictional unemployment: Occurs when people are in between jobs,
entering and reentering the labour force. This may even happen in full
employment when people quit their jobs for a better position or higher wages
or when fresh graduates are actively seeking for a job.
(ii) Seasonal unemployment: Arises due to seasonal variation in the activities

of particular industries. This may be caused by climatic changes or changes
in fashion or by the inherent nature of the industries themselves.
(iii) Structural unemployment: Arises due to structural changes in the

economy of a country. A worker loss a job because that job is not longer a part
of the structure of the economy. It has been created through the composition of
the labor force does not respond quickly to meet changing demands,
technological changes or competition from imported goods and so on.
Cont.… types of unemployment
(iv) Technological unemployment: Occurs because of changes in the
techniques of production. Technological changes are taking place constantly
and there is a need for the labour force to keep them updated and be
responsive to these changes.
(v) Cyclical unemployment: Occurs when there is a lack of jobs because of a

downswing in a business cycle or a recession. When the economy falls into a
downswing or recession, the real GDP falls, the demand for goods and
services decreases, companies close down and worker are laid off.
(vi) International unemployment: Those people work in overseas and have

been laid off work.
Reasons of Unemployment
Minimum – wage laws when even the minimum –Wage is high the unemployment will
increase.
Trade unions – increase unemployment
Efficiency wages.
Job search - appropriate jobs.
Socio-economic consequences of unemployment

• For the society unemployment is a loss of production because labor is the
more important factor of production.
• It lowers the standard of living for the whole society.
• Unemployment can damage the social structure of the society and the
political structure.
• Unemployment affects the family and the individual.
Policies to reduce unemployment
(i) Open Market Operation: Open market operation is a policy of buying and selling
government securities by the central bank. During recession, the government will
buy back bond and securities in order to increase aggregate demand. So, total
unemployed can be reduced.
(ii) Interest rate: Interest rate can be used to encourage more investment. To reduce
unemployment, the central bank can reduce the interest rate in order to encourage
the investment and thus create more jobs opportunities.
(iii) Fiscal policy: The governments use the fiscal policy by government expenditure
and taxation. To reduce the unemployment, government will spent more, for
example built more new infrastructure. So, these can create more jobs
opportunities.
(iv). Direct control: To reduce unemployment, government should be build more

retraining facilities. For example- entrepreneur industrial training skills and others.
How is unemployment measured?
• Divides population into three groups:
1- Employed: paid employees, self-employed, and unpaid workers in a family
business.
2- Unemployed: people not working who have looked for work during previous 4
weeks.
3- Not in the labor force: everyone else.
The labor force is the total of workers, including the employed and unemployed.
Labour Force = Employment + Unemployment
For Example
Compute the Labor Force, U-rate, Population, and Labor Force Participation Rate using
this data:
• Labor force = employed+ unemployed Adult population of the U.S.

by group, January 2006
= 143.1 + 7.0
= 150.1 million
• U-rate = (unemployed)/(labor force) x100 No. of employed 143.1 million
= 7.0/150.1x100
= 4.7% No. of unemployed 7.0 million
• Population = labor force + not in labor force

= 150.1 + 77.4 not in labor force 77.4 million
= 227.5
• LFPR= (labor force) / (population) x100
= 150.1/227.5 x100
= 66.0%
References:
Introductory economics (micro and macro) [electronic resource] : A textbook by-

Subhendu Dutta. Dutta, Subhendu. Part B (DU Library)
Multimedia An electronic book accessible through the World Wide Web.
En. Amir B. Jusoh (Lecturer) <[email protected]>

http://amir-economy.blogspot.com/2011/09/basic-macroeconomics-concepts.html
Macroeconomics: Theory and Policy by-D. N. Dwivedi, Tata McGraw-Hill

Education, 2005
https://books.google.co.in/books/about/Macroeconomics.html?id=P1eFyp9Iku8C

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Unit-4

Inflation and Unemployment

 Economist concerns with inflation because of two reasons:

Demand – pull inflation

Cost – push inflation

• Increasing in aggregate demand would result in price increase. When prices

• Income distribution: Inflation causes distribution of income in favor of

• Decrease of savings: This because the percentage assigned to

• Uncertainty: This leads to economic instability. If there is uncertainty

There are three main ways by which inflation can be controlled:

A- Monetary Policy : (controlled by central bank of the country).

B- Fiscal policy : (controlled by government via instruments taxes and

C- Direct or physical control

(ii) Interest rate: In times of inflation the interest rate should be

• The Consumer Price Index (CPI)

5. Compute the inflation rate:

Compute CPI in each year:

Years Movie tickets Text-books

2004 OMR10 OMR 50

2005 OMR10 OMR 60

2006 OMR12 OMR 60

Basic concept of employment and unemployment

(ii) Seasonal unemployment: Arises due to seasonal variation in the activities

(iii) Structural unemployment: Arises due to structural changes in the

(v) Cyclical unemployment: Occurs when there is a lack of jobs because of a

(vi) International unemployment: Those people work in overseas and have

Socio-economic consequences of unemployment

(iv). Direct control: To reduce unemployment, government should be build more

• Labor force = employed+ unemployed Adult population of the U.S.

• Population = labor force + not in labor force

Introductory economics (micro and macro) [electronic resource] : A textbook by-

En. Amir B. Jusoh (Lecturer) <[email protected]>

Macroeconomics: Theory and Policy by-D. N. Dwivedi, Tata McGraw-Hill

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