LEARNING OUTCOMES 6 & 7
INFLATION &
EMPLOYMENT
INFLATION
This is an important performance indicator.
It measures the rate of change in the general level of prices.
It indicates changes in the purchasing power of the pound.
It is calculated using the Consumer Prices Index.
This index features the most common items purchased by
average families (basket of goods) and monitors each month,
changes in their prices.
It is calculated as follows:
CPI
cost of basket of goods this month
_____________________________
X 100
=
cost of basket of goods in the base year
CALCULATION OF THE INFLATION RATE
The annual inflation rate is:
this year’s CPI – last year’s CPI
_________________________
last year’s CPI
X
100
Between any 2 years, one of which is the base year, the
rate of inflation is the difference in the 2 index numbers.
Between any 2 years, neither of which is the base year,
the rate of inflation is the difference in the 2 index
numbers divided by the earlier index number X 100.
The base year is given the index 100 and is used as a
reference point for comparison.
The Consumer Prices Index (CPI) is prepared monthly by the
Department of Employment.
WHY IS INFLATION BAD?
It reduces the power of your money to make purchases.
It causes people on fixed incomes to experience a fall in their
real incomes.
It causes money tied up in savings to lose real value if the
rate of interest earned is not at least equal to the rate of
inflation.
It makes our exports less competitive and may cause people
to buy the comparatively cheaper imports rather than pay
rising prices.
WHAT CAN CAUSE INFLATION?
When the demand for goods and services outstrips the
economy’s capacity to produce them (ie excess demand over
supply) then demand will pull up prices.
Excess demand over supply can arise at times of rising
general income levels.
Increases in the cost of factor inputs eg raw materials, wages
etc, when passed on to the consumer will push up prices.
A growth in the money supply eg through excessive lending
by the financial sector will reduce the value of the currency
circulating round the economy.
STRATEGIES FOR TACKLING INFLATION
Dampen down the level of demand by making borrowing
and credit more expensive.
Encourage increased capacity by encouraging business to
expand and new business to set up eg Enterprise Allowances,
Grants etc.
Ensure wage rises are accompanied by productivity
agreements.
Keep tight control of the money supply through reduced
lending, increasing reserve asset ratio and higher interest
rates.
UNEMPLOYMENT
represents wasted human resources
The rate of unemployment is another important economic
indicator.
It measures the number of people claiming unemployment
benefit as a percentage of the workforce.
It is calculated as follows:
Unemployment
Rate
=
Number of claimants
__________________
Workforce
X
100
It will not necessarily give a true picture of unemployment
since not all unemployed claim benefit and the definition
of the workforce changes from time to time.
CAUSES OF UNEMPLOYMENT
These fall into 2 categories:
Demand factors
and
(relate to the employer)
Demand for labour is
derived from demand for
products and services they
produce – could therefore
be an elastic demand
The Business Cycle
Supply factors
(relate to the employee)
Level of skills possessed
Financial incentive to work
Level of wages commanded
Structural changes
Substitutability
Power of the Trades Union
TYPES OF UNEMPLOYMENT
Seasonal
work which fluctuates with the time of year
eg unemployment during the winter months in
the tourist industry
Frictional
caused by delays in moving from job to job
Structural
caused by changes in the different sectors of
the economy eg shrinking manufacturing sector
Real Wage
some employers may not be prepared to afford
as many non-skilled workers who now must be
paid at least the legal minimum wage
Technological
jobs unfilled because demand for new skills is
not being matched by up-to-date training
schemes leading to a skills shortage
PROBLEMS CAUSED BY UNEMPLOYMENT
Individuals lose income, motivation, skills and confidence
Firms lose output and therefore profit
Communities suffer decline and increasing crime
Governments lose tax revenues while having to finance
increased spending on benefits, training schemes,
community improvement schemes and policing.
The Economy will contract ie falling National Income, and
cheaper imports may be sucked in
STRATEGIES FOR TACKLING UNEMPLOYMENT
Introduce more flexible work patterns ie job sharing, part-time
Increase incentive to work ie bigger financial gap between
being on benefits and the minimum wage
Increase the availability of training schemes
Encourage growth in the economy eg aid to small businesses
Regional Policy benefits to attract work to hard hit areas of
the country
Import controls to protect UK firms
Reduce employer’s marginal cost of employing workers
UNEMPLOYMENT AND INFLATION
THE LINKS
It was generally thought that there was an inverse relationship
between inflation and unemployment.
ie when unemployment was high, inflation was low
and when unemployment was low inflation was high
This stems from a study done by Phillips and illustrated by his
Phillips Curve.
There have however been periods of time during which
this is not the case eg mid 70s with high inflation and
unemployment and the lat 90s with low inflation and
low unemployment so Phillips’ theory has broken down.