CHAPTER 29 Unemployment and Inflation Because learning changes everything.® ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. INFLATION Inflation is defined as a persistent increase in the general price level of goods and services. Inflation cause an increase in the cost of living and decrease the purchasing power and value of money. Inflation is measured by using the Consumer Price Index (CPI). a weighted CPI measures changes in the average prices of a ‘market basket’ of goods and services purchased by a typical urban household such as foods, shelter, clothing, medical, furniture etc. an increase in the CPI reflects inflation in the economy. 29-2 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. INFLATION Measuring Inflation Rate In Malaysia the CPI is based on the prices of more than 400 items which are grouped into categories such as food, beverages, clothing and footwear, transport and communication, fuel and power, medical and health expenses etc. Rate of inflation can be measured as a % change in CPI from one year to another. Inflation rate this year = CPI this year - CPI previous year x 100 CPI previous year 29-3 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. INFLATION (cont.) Types of Inflation There are 2 types of inflation – demand-pull and cost-push inflation. (A) Demand-pull inflation This type of inflation is caused by excess aggregate demand in at full employment level of output. Demand-pull inflation occurs when aggregate demand (AD) exceeds the aggregate supply (AS). because AD = C + I + G + (X - M), any increase of these components will cause aggregate demand to rise. 29-4 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. Demand-pull inflation (cont.) - when the economy is at full employment level, an increase in agg. dd will cause an increase in general price level. - this can be shown by a rise in agg.dd from AD5 to AD6 which cause no change in output (at Yf) but price increase sharply from P3 to P4. 29-5 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. INFLATION (cont.) Causes of demand-pull inflation a) Increase in the expenditure components of agg. dd -an increase in the level of consumption, investment, government spending and net exports can lead to dd-pull inflation. b) Expansionary monetary policy - An increase in money supply will cause the agg.dd to increase. - Eg. A lower interest rate will encourage borrowing and spending by the consumers and investment to rise. This can cause dd-pull inflation. 29-6 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. INFLATION (cont.) (B) Cost-Push Inflation -This type of inflation is caused by a decrease in aggregate supply due to an increase in cost of production. Causes of cost-push inflation a) Increase in production cost. Eg – increase in wages of labors (called wage-push inflation) increase in prices of imported raw materials or final goods (called import inflation), increase in tax (called tax-push inflation), increase in interest rates, rental, sales tax, petrol, water, electricity tariffs etc. 29-7 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. INFLATION (cont.) b) Greed for profit. - Happens when firms gain more power and able to increase price to make more profits. - Can also happens when firms stock up on goods and create artificial shortage to increase price to earn more profits. -Eg OPEC increase oil prices from USD65 in 2006 to over USD100per barrel in 2008. c) Decrease in natural resources or natural disaster - Eg. Overfishing has caused the prices of many types of fish and fish-based products to rise each year. - As land become scarce, price of agricultural products have also increased over the years. ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. 29-8 Cost-Push Inflation (cont.) AS General Price Level P2 AS2 A P1 AD AS1 Y2 Y1 National output Initially the equilibrium is at pt. A. Price is at P1 and output at Y1. When the aggregate supply curve shift leftward from AS1 to AS2 price increase from P1 to P2 and output falls from Y1 to Y2. The increase in the general price level is called cost-push inflation. 29-9 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. INFLATION (cont.) Effects of Inflation (i) Unequal income distribution and wealth - some people will gain and some will lose -Debtors, businessmen, real property owners and non-fixed income earners will gain. -fixed-income earners like pensioners, govt servants and creditors will lose. (ii)Fall in savings and increase in investment -Inflation increase profits of firms and so investment may increase since the return is more attractive. -Savings of households will fall as cost of living rise. 29-10 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. INFLATION (cont.) (iii) Deficit in the balance of payments -As price of goods increase during inflation exports may fall when foreign demand for the country’s products fall. -Inflation will also make price of imported goods cheaper. -Fall in exports and rise in imports will lead to balance of payments deficit. (iv)Fall in production -Inflation can cause trade union to demand for higher wages. -If their demand is not met, they may go on strikes, pickets etc and these may cause productivity to fall. ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. 29-11 INFLATION (cont.) Measures/Methods to Control Inflation (A) Contractionary Fiscal Policy (Budget Surplus: T > G) (i)Increase in taxes (↑T ) An increase in tax will reduce the disposable income of individuals income and their consumption on goods and services. This is turn will lead to a fall in prices. (ii)Decrease in govt expenditure (↓G) A reduction in government spending will directly affect aggregate demand. The government will cut the salary of its civil servant and postpone development projects to reduce the purchasing power of the public. ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. 29-12 INFLATION (cont.) (B) Contractionary Monetary Policy (i) Open Market Operations The central bank may sell government securities, short-term bonds or treasury bills in the open market to the public to reduce bank deposits and credit creation of commercial banks. Money supply will reduce, hence reducing aggregate demand and price level. (ii) Raising Reserve Requirement In the event of inflation, the central bank will increase the required reserve ratio of all commercial banks. 29-13 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. INFLATION (cont.) (iii) Raising the discount rate/bank rate (Interest on loan) A rise in the bank rate will cause an increase in the cost of borrowing. Loans become costly to borrow and firms will reduce borrowing and spending. Aggregate demand will reduce and inflation rate will drop. The high interest rates will also encourage the public to increase saving and this will decrease the aggregate demand and price level. (iv) Credit control Ref to Chap – Public Policies (Slide p. ) 29-14 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. INFLATION (cont.) (C) Direct Measures Controlling prices of selected items. Eg ceiling price. Controlling wages - implementing laws to prohibit strikes, pickets etc., or limit the amt of increase in wages that trade union can bargain. Increase agg supply by increasing productivity of workers, giving subsidies to producers (called supply-side economics) Launch anti-hoarding campaign to prevent artificial shortage. 29-15 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. UNEMPLOYMENT Unemployment occurs when people who are in the working age group, able and willing to work, but not able to find a suitable job. Involved those who are people between the age 16 and 65 who are not working, but are actively seeking jobs in the economy. 29-16 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. UNEMPLOYMENT (cont.) Population Labour force Employed 66 years and above 16–65 years Below 16 years Outside labour force Unemployed 29-17 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. UNEMPLOYMENT (cont.) Labour Force All persons above the age of 16 and older who are employed or are actively seeking employment. The labour force consists of employed and unemployed persons. Is everyone above 16 years of age included in the labour force? -No, because students, housewives, pensioners are considered as outside of labour force. 29-18 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. UNEMPLOYMENT (cont.) Types of Unemployment (1)Frictional Unemployment This is a short-term or temporary unemployment. Occurs when people enter the labour market to look for jobs or people leave their jobs, either voluntarily or from being sacked, and are unemployed for a period of time while they are looking for a new job. Includes new entrants such as school-leavers, fresh graduates and reentrants, such as people who quit their jobs for a better position or higher wages, or former homemakers. 29-19 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. UNEMPLOYMENT (cont.) (2) Seasonal Unemployment Seasonal unemployment occurs when certain products cannot be produced during a certain season. Hence, many workers are temporarily laid off on a short-term basis during certain times of the year. Example: construction workers who will be unemployed during rainy season, a fisherman who is unable to fish during the monsoon season or in winter, and workers in holiday resorts who are unemployed during off-peak periods. 29-20 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. UNEMPLOYMENT (cont.) (3) Structural Unemployment This unemployment results from structural decline of industries, unable to compete or adapt to changing demand and new products, or changing method of production. introduction of new products or technology made the existing product obsolete, hence the skills of workers are no longer suitable with the jobs available. Eg. telegraph operators that lose their jobs due to the use of telephones and internet. 29-21 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. UNEMPLOYMENT (cont.) (4) Cyclical Unemployment This unemployment is caused by a decrease in agg. demand, due to a downswing of the business cycle (recession). When an economy is under recession, agg. demand falls and national income falls further. Hence, consumption falls, production reduces, companies may close down and workers are laid off, resulting in cyclical unemployment. Cyclical unemployment is a serious form of unemployment. (5) Hidden unemployment Refers to individuals who are actually employed but not productive. Common in traditional agriculture where several family members work on small piece of land. ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. 29-22 UNEMPLOYMENT (cont.) Effects of Unemployment (i) Loss of job skills If unemployment persists for a long period, individuals will lose their job skills, causing a loss in human capital. (ii) Loss of output of goods and services An economy with high unemployment is not using all of their resources, especially labour. The economy is operating below its potential national output, reducing the economy’s efficiency and production. So, national income will fall. ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. 29-23 UNEMPLOYMENT (cont.) (iii) Loss in government revenue High unemployment means that the government will receive less tax revenue and will have to pay more on unemployment benefits. (iv) Social problems Unemployment results in lower morale and human suffering. The family unit will be affected if the sole bread-winner lose his job. Social problems arise if the unemployed turn to drugs or crime. (crime and drug rate in the country will rise) ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. 29-24 UNEMPLOYMENT (cont.) (i) Open market operation The central bank buys government securities, short term bonds or treasury bills in the open market from the public to increase money supply. Consumption and investment will increase, increasing aggregate demand and production and reducing unemployment. (ii) Lowering the reserve requirement When the reserve ratio is decreased, the credit creation and money supply will increase to stimulate aggregate spending and reduce unemployment. ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. 29-25 UNEMPLOYMENT (cont.) (iii) Lowering the bank rate /discount rate A decline in the bank rate and discount rate makes loans less costly to borrow and firms will increase investment by employing more workers. This will increase agg demand, output and decrease unemployment in the country. (iv) Credit control - Ref to Chap – Public Policies. 29-26 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. UNEMPLOYMENT (cont.) (B) Expansionary Fiscal Policies (i) Increase government expenditure (G) Increase government expenditure (G) through creating more development projects will increase agg. demand (AD). Production will increase, hence reducing the unemployment. (ii) Decrease in taxes (T) Decrease in taxes (T), such as a reduction in service tax, sales tax, income tax or corporate tax, will increase the consumption on goods and services and also increase investment. Hence, agg. Demand (AD) will increase and production will increase. Thus, unemployment will fall. 29-27 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. UNEMPLOYMENT (cont.) (3) Direct Control Policies This refers to all direct measures other than monetary and fiscal policy taken by the government. For example: Providing training and technical education. -Set up training centres to retrain workers in new skills to improve occupational mobility. Disseminate information on job vacancies to the unemployed Encourage people to be self-employed. Migration of labour . Encourage workers to move to regions and industries where job are available. 29-28 ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education.
