Unemployment

and
Inflation
Nature of Unemployment
Unemployment

Nature of Unemployment
 NATURE OF UNEMPLOYMENT
• The meaning of ‘unemployment’
• Unemployment: those of working age who are
without work, but who are available for work at
current wage rates.
• It excludes students above 18 years, housewives,
discouraged workers (those who look for jobs and
give up their search in frustration), etc.
 NATURE OF UNEMPLOYMENT
• The meaning of ‘unemployment’
• (ILO/OECD)
• In this measure, the unemployed are defined as
people of working age who are without work,
available to start work within two weeks and
actively seeking employment or waiting to take
up an appointment
NATURE OF UNEMPLOYMENT
 NATURE OF UNEMPLOYMENT

• Underemployment - This constitutes the section of the

labour force seeking for full-time paid employment but
unfortunately, the structure of the employment permit
them to work for only part-time or are employed below
capacity.

• Claimant Unemployment: This is simply a measure of

those in receipt of unemployment related benefits
 NATURE OF UNEMPLOYMENT
• The duration of unemployment
• What determines the average duration of
unemployment? There are three important
factors here.
 NATURE OF UNEMPLOYMENT

• The duration of unemployment

• Determinants of average duration of
unemployment
• The rate of inflow and outflow from the
stock of unemployment
 Flows into and out of unemployment
From jobs From outside the labour force
•People made redundant •School/college leavers
•People sacked •People returning to the
•People temporarily laid off labour force (e.g. after
•People resigning raising children)
INFLOWS
(per period of time)

UNEMPLOYMENT
 Flows into and out of unemployment
From jobs From outside the labour force
•People made redundant •School/college leavers
•People sacked •People returning to the
•People temporarily laid off labour force (e.g. after
•People resigning raising children)
INFLOWS
(per period of time)

UNEMPLOYMENT

To jobs OUTFLOWS To outside the

(per period of time) labour force
•People taking new jobs •People who have become disheartened
•People returning to old and give up looking for a job
jobs who had been •People who have reached retirement age
temporarily laid off •People who temporarily withdraw from
labour force (e.g. to raise a family)
•People who emigrate
•People who die
 NATURE OF UNEMPLOYMENT

• The duration of unemployment

• Determinants of average duration of unemployment
• inflows to and outflows from the stock of
unemployment

Note: the duration of unemployment (DU) will

equal the stock of unemployment (U) as a
proportion of the outflow (F) from
unemployment. DU=U/F

• The number unemployed (the size of the

stock of unemployment).
 NATURE OF UNEMPLOYMENT

• The duration of unemployment

• Determinants of average duration of unemployment
• inflows to and outflows from the stock of unemployment

• The phase of the business cycle

At the onset of a recession, unemployment
will rise, but average length of
unemployment is likely to be short
Lasted recession would mean longer
duration of unemployment
 NATURE OF UNEMPLOYMENT
• The composition of unemployment
• by geographical region, by sex, by age, by
ethnic groups
• The costs/effects of unemployment
• Loss of self – esteem
• Social problems/vices: e.g. prostitution,
armed robbery
• Loss of national output
• Brain drain
• Low standard of living
 NATURE OF UNEMPLOYMENT
• The costs/effects of unemployment
• Parallel markets may develop – people will
be willing to offer themselves for
employment at wage rate lower than the
equilibrium wage rate
• Loss of tax revenues
• Effects on the family (dependents and
divorce)
Unemployment
Causes of Unemployment
 CAUSES OF UNEMPLOYMENT
• Unemployment and the labour market
• Aggregate demand and supply of labour
• Aggregate supply of labour curve shows
the number of workers willing to accept
jobs at each wage rate. The curve is
relatively inelastic (why?)
• Aggregate demand for labour curve shows
the total demand for labour in the economy
at different average real wage rates.
• Real average wage rate is plotted on the
vertical axis.
 Aggregate demand and supply of labour

ASL
Average (real) wage rate

ADL

No. of workers
 CAUSES OF UNEMPLOYMENT

• Unemployment and the labour market

• aggregate demand and supply of labour

• Equilibrium in the model

• AD=AS
 Aggregate demand and supply of labour

ASL
Average (real) wage rate

We

ADL

O
Qe
No. of workers
 CAUSES OF UNEMPLOYMENT
• Unemployment and the labour market

• aggregate demand and supply of labour

• equilibrium in the model

• Disequilibrium unemployment (2 conditions)

• The Aggregate supply of labour much exceed

the aggregate demand

• There must be a “stickiness” in wages. In other

words, the wage rate must not immediately fall
to the equilibrium wage.
 Disequilibrium unemployment

ASL
Average (real) wage rate

Disequilibrium
unemployment

B A
W2

We

ADL

O Q2 Q1
No. of workers
 CAUSES OF UNEMPLOYMENT

• Unemployment and the labour market

• aggregate demand and supply of labour

• equilibrium in the model

• disequilibrium unemployment

• Equilibrium (“natural”) unemployment

It is the difference between those who

would like employment at the current wage
rate and those willing and able to take a job
 Equilibrium unemployment
ASL
Average (real) wage rate

e
We

ADL

O
Qe
No. of workers
 Equilibrium unemployment

ASL N
Average (real) wage rate

e d
We
Equilibrium
unemployment

ADL

O
Qe Q2
No. of workers
 Equilibrium and disequilibrium
unemployment
ASL
Average (real) wage rate

e
We

ADL

O
Qe
No. of workers
 Equilibrium and disequilibrium
unemployment
ASL
Average (real) wage rate

Disequilibrium
unemployment

b a
W2
e
We

ADL

No. of workers
 Equilibrium and disequilibrium
unemployment
ASL
N
Average (real) wage rate

Disequilibrium
unemployment

b a c
W2
e
We Equilibrium
unemployment

ADL

No. of workers
 CAUSES OF UNEMPLOYMENT

• Disequilibrium unemployment

• Causes of disequilibrium unemployment

• Real-wage (classical) unemployment (occurs

when trade unions use their monopoly power
to drive wages above the market clearing
level.

• It could also be caused by the government

setting the national minimum wage too high)
 Real-wage unemployment
ASL
Average (real) wage rate

b b’ a
W1

We

ADL 2
ADL

O Q2 Qe Q1
No. of workers
 CAUSES OF UNEMPLOYMENT

• Disequilibrium unemployment
• real-wage (classical) unemployment

• Demand-deficient (cyclical)
unemployment

• Unemployment caused by a fall in

aggregate demand with no corresponding
fall in the real wage rate.
 Demand-deficient unemployment
ASL
Average (real) wage rate

Sticky wages

Demand-deficient
unemployment

W1 Reduction in
aggregate demand
W2

ADL 1
ADL 2
O Q2 Q1
No. of workers
 CAUSES OF UNEMPLOYMENT

• Disequilibrium unemployment
• real-wage (classical) unemployment

• demand-deficient (cyclical) unemployment

• Unemployment arising from a growth in

the labour supply
 CAUSES OF UNEMPLOYMENT

• Equilibrium unemployment
• Frictional (search) unemployment

Unemployment that occurs as a result

of imperfect information in the labour
market.
It often takes time for workers to find
jobs (even though there are vacancies)
and in the meantime they are
unemployed
 Average duration of unemployment
Wage rate offered (Wo)
Wage rate

Equilibrium Wage rate acceptable

duration to a worker (Wa)

O Te
Length of time of unemployment
 CAUSES OF UNEMPLOYMENT

• Equilibrium unemployment
• frictional (search) unemployment

• Structural unemployment
• Unemployment that arises from changes in the
pattern of demand or supply in the economy.
• People made redundant in one part of the
economy cannot immediately take up jobs in
other parts (even though there are vacancies).
• Occupational and geographical immobility of
labour
 CAUSES OF UNEMPLOYMENT

• Equilibrium unemployment
• frictional (search) unemployment

• Structural unemployment
• changing pattern of demand
 CAUSES OF UNEMPLOYMENT

• Equilibrium unemployment
• frictional (search) unemployment

• Structural unemployment
• changing pattern of demand
• regional unemployment
 CAUSES OF UNEMPLOYMENT

• Equilibrium unemployment
• frictional (search) unemployment

• Structural unemployment
• changing pattern of demand
• regional unemployment
• technological unemployment
 CAUSES OF UNEMPLOYMENT

• Equilibrium unemployment
• frictional (search) unemployment

• Structural unemployment
• changing pattern of demand
• regional unemployment
• technological unemployment
 CAUSES OF UNEMPLOYMENT

• Equilibrium unemployment
• frictional (search) unemployment

• Seasonal unemployment
• It occurs when the demand for certain types
of labour fluctuates with the seasons of the
year
• Example: Agriculture
• Residual Unemployment
• Physical and/mental disabilities
 CURES FOR UNEMPLOYMENT

• Demand Management/Demand Side

Policies: Fiscal and monetary policies are
intended to increase aggregate demand and,
therefore the equilibrium level of national
income.
• Supply – Side Policies: Policies are intended
to increase the economy’s potential rate of
output by increasing the supply of factor inputs,
such as labour inputs and capital inputs, and by
increasing productivity
 Question

• Using the concepts of equilibrium and

disequilibrium unemployment explain why
the labour market does not clear.
 Unemployment and
Inflation
Aggregate Demand, Aggregate Supply and the
Price Level
 AD, AS and the PRICE LEVEL

• The aggregate demand curve: It is the

total level of spending in the economy

• It consists of four elements: consumer

spending (C), private investment (I),
government expenditure on goods and
services (G) and expenditure on exports
(X) less expenditure on imports (M).
Price level Aggregate demand Curve

AD

National output
 AD, AS and the PRICE LEVEL
• Why the AD curve slopes downwards?
• Income effect
• Substitution effect
• foreign trade effect
• real balance effect
• interest rate effect
• AD can shift to the right (increase in AD) or
shift to the left (decrease in AD) due to:
• Changes in consumption, investment,
government expenditure or exports minus
imports
 AD, AS and the PRICE LEVEL

• The aggregate demand curve

• The aggregate supply curve: The aggregate
supply (AS) curve shows the amount of
goods and services that firms are willing to
supply at each level of prices.
 Aggregate Supply Curve
AS
Price level

•• short-run
short-run AS
AS curve
curve

National output
 AD, AS and the PRICE LEVEL
• The aggregate demand curve

• The aggregate supply curve

• Shifts in the aggregate supply curve could be

caused by:
• technology

• the labour force

• the stock of capital

• wage rates and other input prices

 AD, AS and the PRICE LEVEL

• The aggregate demand curve

• The aggregate supply curve

• Equilibrium
 Aggregate demand and aggregate supply

AS
Price level

If the price level is initially P2,

the excess demand will
cause price level to rise to Pe
Pe
b a
P2

AD

National output
 AD, AS and the PRICE LEVEL

• The aggregate demand curve

• The aggregate supply curve

• Equilibrium

• Shifts in the AD curve

 AD, AS and the PRICE LEVEL

• The aggregate demand curve

• The aggregate supply curve

• Equilibrium

• shifts in the AD curve

• shifts in the AS curve

Inflation
 INFLATION
• Inflation is defined as a persistent and appreciable
increase in the general price level of goods and services
and factors of production. In other words, it is a
continuing or persistent tendency for the level of price to
rise.

• Deflation is the opposite, a persistent tendency for

the general price level to fall

• The rate of inflation measures the annual percentage

increase in prices (CPI)

• The most usual measure is that of consumer

prices: i.e. retail prices
 INFLATION
• The costs of inflation

• “Shoe Leather cost” and “Menu cost”

• Redistribution effects

• Uncertainty and lack of investment

• Balance of payments worsening

• Resources used to cope with inflation

 Consumer price Index (CPI)
• The consumer price index (CPI) is the
price of basket of goods and services
relative to the price of the same basket in
some base year.

• It measures, overtime, the cost of buying

the same quantity of goods and services

• The CPI for any given period is

calculated as the current cost of the
basket of consumer items divided by the
cost of the same basket in the base year
 Consumer price Index (CPI)
• A measure of the overall level of prices
redistribution

• Published by Ghana Statistical Service (GSS)

• Used to:

• Track changes is the typical household’s

cost of living

• Adjust contract for inflation

• Allow comparison of dollar figures from
different years
How the GSS constructs the CPI
 Calculation of the CPI: Example

Cost of basket of the current year (2000)

Good Quantity Current Cost in

(Basket) per unit current
price year
Shirt 10 5,000 50,000
Cement 4bags 12,000 48,000
Maize 3bags 7,000 21,000
Rice 4bags 9,000 36,000
Total 155,000
 Calculation of the CPI: Example
Cost of basket in the base year (1990)
Good Quantity Price of Cost in
(Basket) base year base year
Shirt 10bags 3,500 35,000
Cement 4bags 9,200 36,800
Maize 3bags 6,000 18,000
Rice 4bags 7,800 31,200
Total 121,000
Calculation Inflation
 Type of Inflation
1. Suppressed Inflation
•This type of inflation occurs when tough price and wage
controls are introduced to prevent or restrain the price level
from rising.
•This does not eliminate the underlying inflationary
pressures

2. Creeping Inflation
•This type of inflation is experienced when the
inflationary rate is fairly stable from year to year,
averaging less than 5% with the price level
gradually creeping upwards.
 Type of Inflation
3. Strato – Inflation
•In a strato-inflation, the inflation rate ranges from
about 10% to several hundred percent without ever
completely spiraling into a hyper – inflation.

4. Hyper – Inflation or Galloping Inflation

•When the inflation rate accelerates to several
hundred to many thousands percent per day, then
we have hyper – inflation. Example Zimbabwe
 Type of Inflation
5. Bottleneck Inflation
•Bottleneck Inflation takes place when aggregate
supply falls drastically and aggregate demand
remains at same level.

•Thus, rises in prices must be ascribed to supply

bottlenecks (the increasing immobility of resources
or mismanagement of resources) rather than to
increase in aggregate demand.
 Real GDP controls for Inflation
•Changes in nominal GDP can be due to:
• changes in prices
• changes in quantities of output produced

•Changes in real GDP can only be due to changes

in quantities, because real GDP is constructed using
constant base-year prices.
 Practice Question

•Compute Nominal GDP in 2002

•Compute Real GDP in each years using 2002 as
the base year
 Answers to practice problem
•Nominal GDP: multiply Ps & Qs from same
year
2002: $1 x 10 + $10 x 3 = $40
2003: $2 x 15 + $15 x 4 = $90

•Real GDP: multiply each year’s Qs by 2002 Ps

2002: $1 x 10 + $10 x 3 = $40
2003: $1 x 15 + $10 x 4 = $55

•So in real terms, GDP did not rise as much as it

would seem from nominal terms.
Exercise: Compute the CPI and inflation
• The basket contains 20 bags of
Cocoa and 10 bags of Rice
For each year,
Prices: 1. compute
Cocoa Rice the cost of the
2009 Gh¢10 Gh¢15 basket
2010 Gh¢11 Gh¢15 2. compute the CPI
(use 2009 as the
2011 Gh¢12 Gh¢16
base year)
2012 Gh¢13 Gh¢15 3. compute the
inflation rate from
GDP Deflator
 GDP deflator
Example: Computation of GDP deflator : Base year 1990
Type of Price per Base year Nominal Real
good Output Unit (¢) price (¢) GDP GDP
(2000) (2000) (1990)

Computers 20 1,500 1,200 30,000 24,000

Shirts 200 500 300 10,000 60,000

Cement 50bags 800 550 40,000 27,500
Calculators 40 700 630 28,000 25,200

198,000 136,700
 GDP deflator
Example: Computation of GDP deflator
 INFLATION
• Causes of inflation
• Demand-pull Inflation: Demand-pull inflation is
caused by continuing rises in aggregate demand.
• Causes of demand-pull inflation
• War
• Increase in exports and restrictions on Imports
• Rapid industrialization and economic Growth
• Increase in wages and salaries without a
corresponding increase in output and rising
population
 Demand-pull inflation

AS
Price level

P1

AD1

O Q1
National output
 Demand-pull inflation

AS
Price level

P1
AD2

AD1

O Q1
National output
 Demand-pull inflation

AS
Price level

P2

P1
AD2

AD1

O Q1 Q2
National output
 INFLATION
• Causes of inflation
• Cost-Push inflation: is associated with
continuing rises in costs and hence continuing
leftward (upward) shifts in the AS curve. Such
shifts occur when costs of production rise
independently of aggregate demand.
• Causes of cost-push inflation:
 Wage-push inflation
 Profit-push inflation
 Import-price-push inflation
 Tax-push inflation
 The exhaustion of natural resources
 Cost-push inflation

AS1
Price level

P1

AD

O Q1
National output
 Cost-push inflation
AS2
AS1
Price level

P1

AD

O Q1
National output
 Cost-push inflation
AS2
AS1
Price level

P2
P1

AD

O Q2 Q1
National output
 INFLATION
• Interaction of demand-pull and cost-push
inflation
• Assume that powerful groups are constantly
pushing up the costs of production.
• At the same time, assume that the
government, in order to prevent a rise in
unemployment, is constantly boosting the
level of aggregate demand (say, by cutting
taxes)
• The net effect on output and employment
may be very small, but prices may rise
substantially
The interaction of demand-pull and cost-push inflation

AS1
Price level

P1

AD1

National output
The interaction of demand-pull and cost-push inflation

AS2
AS1
Price level

P2

P1

AD2

AD1

National output
The interaction of demand-pull and cost-push inflation
AS3 AS
2
AS1

P3
Price level

P2

P1 AD3

AD2

AD1

National output
 INFLATION
• Policies to tackle inflation
• Demand-side policies
• fiscal and monetary policies

• Supply-side policies
• Restrictions on Factor Price Increases
(e.g., Wage Freeze )
• Introduction of Efficient Production
Methods
Thank You