Inflation and Unemployment
A2 Economics
Content
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The causes and consequences of unemployment
The natural rate of unemployment hypothesis
The phillips curve
The causes and consequences of inflation
Unemployment
• There are a number of types of unemployment:
– Structural unemployment
– Cyclical unemployment
– Frictional unemployment
• Structural unemployment occurs when the economy
changes and industries die out
• Training is needed to give the unemployed workers
new skills
Unemployment
• Cyclical unemployment is caused by the business
cycle
• Frictional unemployment is caused when people are
temporarily out of work as they are moving jobs
Unemployment and PPF
• Unemployment means that
scarce economic
resources are being
wasted reducing the long
run potential of the
economy
• Where there are high
levels of unemployment an
economy will be operating
inside the perimeters of its
PPF
Unemployment and AD / AS
• As Aggregate demand increases unemployment will
decrease
• Supply side policies can be used to increase
aggregate supply in the economy and thereby
reduce the level of unemployment
• However if the growth in the level of aggregate
demand is less than the underlying trend growth in
output unemployment is likely to occur
Causes and Consequences of
Unemployment
• Unemployment is caused by demand and supply
side factors
• On the demand side if the demand curve shifts
inwards unemployment will rise
• Supply side factors such as an excess of supply of
workers also means unemployment will increase
Policies that increase labour market
flexibility
• A number of policies can be implemented to
increase market flexibility and reduce
unemployment
• Policies can be implemented on the supply side and
the demand side by the government
Supply side policies
• Supply side policies include:
• Reducing the occupational mobility of labour – this
can be through providing training for the
unemployed, increasing the availability and quality
of education and providing incentives for people to
work
Demand side policies
• Employment subsidies can be used by the
government to encourage businesses to give jobs
to the long term unemployed
Effects of Unemployment
• On an individual level unemployment reduces the level of income
that an individual earns
• As their income has been reduced consumption also reduces as they
pay for necessities rather than luxuries
• Goods that are income elastic will be consumed less
• Quality of life will be reduced for the unemployed worker
• Workers may become discouraged and give up searching for jobs
becoming part of the long term structural unemployment in the UK
Effects of Unemployment
• Unemployment can have significance effects on the
performance of the economy as a whole
• The effects are most marked due to long terms
unemployment
• If there is unemployment in the economy resources
are not being used effectively and the economy will
be operating below any points on the PPF curve
Economic effects of unemployment
• If unemployment rates are rising their will be a negative
impact on economic growth potential
• Consumption is likely to fall as consumers will have had a
decrease in income levels
• Government spending will increase as the government will
be responsible for benefit payments
• Taxation levels will decrease as less people are in work and
therefore paying taxes
Natural Rate of Unemployment Hypothesis
• The natural rate of unemployment recognizes that
there will always be some level of unemployment in
an economy
• At the natural rate all unemployment will be
voluntary
• This is the employment rate when the economy is
operating at full employment
Determinants of the natural rate
• The natural rate is determined by the interaction of
the demand for labour and the supply of labour
• At the equilibrium wage rate all people who want a
job can get a job
• However at this wage rate their will be some people
who choose not to work
Determinants of the natural rate
• The natural rate of unemployment is determined by:
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Value of welfare benefits
Trade union power
Taxation system
Migration of labour
Social factors
Natural rate of unemployment and policy
• If governments want to reduce the natural rate of
unemployment they need to concentrate on supply
side policies
• If the benefits system is relatively high in a country it
will cause less people to want to work
The Phillips Curve
• Short run phillips curve is curve shaped
• The long run phillips curve the curve is vertical
• At this rate the where unemployment is at its natural
rate inflation is stable
• In the UK since 1997 there has been low inflation
and low unemployment
Phillips Curve
Inflation
• Inflation- The rise in the general level of prices
• In the long term, inflation erodes consumer purchasing
power.
• That means that accumulated wealth buys less and less,
with the passage of time.
• Where there is high inflation it is difficult for businesses to
plan for the future as there is uncertainty regarding the cost
of raw materials
The causes of inflation
• inflation results when the macro economy has too much
demand for available production. These alternatives fall
under two general categories:
• Demand-Pull Inflation: This inflation occurs when
household, business, government, and foreign industries
collectively try to purchase more output than the economy
is capable of producing. In effect, the demand side of the
aggregate market is "pulling" the price level higher.
• Cost-Push Inflation: Cost-push inflation is inflation
attributable to decreases in supply, primarily due to
increases in production cost
Cost Push Inflation
• As costs rise it causes the
aggregate supply curve to
shift onwards so less is
supplied at each price
level
• Each time the aggregate
supply curve shifts inwards
the price rises causing
inflation
Demand pull inflation
• As aggregate demand
increases then the general
price level rises
• When total demand exceeds
total supply demand pull
inflation occurs
• If the economy is close to full
capacity the effects of demand
pull inflation will be greater
Preventing inflation
• One of the best ways to prevent inflation is through stock,
variable annuities, and variable universal life insurance.
These alternatives provide the potential for returns that
exceed inflation over the long term.
• Central banks place high interest rates using
unemployment and the decline of production to prevent
price increases.
Summary
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There are three main types of unemployment:
– Structural
– Cyclical
– Frictional
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Unemployment means that an economy cant operate on its ppf
As AD increases unemployment decreases
The natural rate of unemployment recognises there will always be some level of
unemployment in the economy
The Phillips curve shows an inverse relationship between unemployment and
inflation
Inflation is a rise in the general level of prices
There are two causes of inflation:
– Cost push
– Demand pull