Inflation-and-unemployment

1. Inflation and Unemployment
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2. Chapter Learning
 Definition of Inflation
 Causes of inflation
 Consequences of inflation
 Deflation
 What is Unemployment?
 Types of unemployment
 Causes of unemployment
 Effects of unemployment
 Philip curve
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3. Inflation
 Inflation is the rate at which the general level of
prices for goods and services is rising and,
consequently, the purchasing power of currency
is falling.
 Inflation is the long term rise in the prices of
goods and services caused by the devaluation
of currency.
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4. Causes of Inflation
1. The Money Supply:
Inflation is primarily caused by an increase in
the money supply.
A more macroeconomic way of looking at the
negative effects of an increased money supply is
that there will be more dollars chasing the same
amount of goods in an economy, which will
inevitably lead to increased demand and
therefore higher prices.
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5. Causes of Inflation
2. The National Debt:
 The reason for this is that as a country’s debt increases,
the government has two options: they can either raise
taxes or print more money to pay off the debt.
 A rise in taxes will cause businesses to react by raising
their prices to offset the increased corporate tax rate.
Alternatively, should the government choose the latter
option, printing more money will lead directly to an
increase in the money supply, which will in turn lead to
the devaluation of the currency and increased prices.
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6. Causes of Inflation
3. Demand-Pull Effect:
The demand-pull effect states that as wages increase
within an economic system (often the case in a
growing economy with low unemployment), people
will have more money to spend on consumer goods.
This increase in liquidity and demand for consumer
goods results in an increase in demand for products.
As a result of the increased demand, companies will
raise prices to the level the consumer will bear in
order to balance supply and demand.
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7. Causes of Inflation
4. Cost-Push Effect:
 Another factor in driving up prices of consumer goods
and services is explained by an economic theory
known as the cost-push effect. Essentially, this theory
states that when companies are faced with increased
input costs like raw goods and materials or wages,
they will preserve their profitability by passing this
increased cost of production onto the consumer in
the form of higher prices.
 A simple example would be an increase in milk prices,
which would undoubtedly drive up the price of
sweets.
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8. Consequences of inflation
High inflation rate may result in the following
adverse effects on the economy:
 Greater uncertainty: There may be greater
uncertainty for both firms and households.
Firms will postpone their investment due to
uncertainty in the market. This will result in
negative implications on the economic growth
in the economy
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9. Consequences of inflation
 Redistributive effects: High rate of inflation will affect
people who have constant incomes, such as retired
people, students, and dependents. Moreover, rise in
prices of essential commodities (food & clothing) will
affect the poor segment of the society as they spend a
major part of their income on these good. This will lead
to increased inequality in the economy.
 Less saving: High rate of inflation will have an adverse
effect on the savings in the economy. As people spend
more to sustain their present standard of living, less is
being saved. This will result in less loanable funds being
available to firms for investment.
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10. Consequences of inflation
 Damage to export competitiveness: High rate of
inflation will hit hard the export industry in the
economy. The cost of production will rise and the
exports will become less competitive in the
international market. Thus, inflation has an adverse
effect on the balance of payments.
 Social unrest: High rate of inflation leads to social
unrest in the economy. There is increase dissatisfaction
in among the workers as they demand higher wages to
sustain their present living standard. Moreover, high
rate of inflation leads to a general feeling of discomfort
for the household as their purchasing power is
consistently falling. 10

11.  Interest rates: The Central Bank might use
monetary tools to control high inflation rate by
increasing interest rates. This will increase the
cost of borrowing and will have a negative
effect on both consumption and investment.
Consequences of inflation
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12. Deflation
 When the overall price level decreases so
that inflation rate becomes negative, it is
called deflation. It is the opposite of the
often-encountered inflation.
 A reduction in money supply or credit
availability is the reason for deflation in most
cases. Reduced investment spending by
government or individuals may also lead to
this situation. Deflation leads to a problem
of increased unemployment due to slack in
demand.
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13. What is Unemployment?
 Unemployment occurs when a person
who is actively searching for employment
is unable to find work.
 Unemployment is often used as a
measure of the health of the economy.
 The most frequent measure of
unemployment is the unemployment
rate, which is the number of unemployed
people divided by the number of people
in the labor force.

14. Measuring Unemployment
population = labor force + not in labor force
labor force = employed + unemployed
unemployment rate =
unemployed
employed + unemployed

15. Types of Unemployment
• The two broadest categories of unemployment
are voluntary and involuntary unemployment.
• When unemployment is voluntary, it means that
a person has left his job willingly in search of
other employment.
• When it is involuntary, it means that a person
has been fired or laid off and must now look for
another job.

16. Causes of Unemployment
Companies moving abroad
Downsizing
Cheaper imported products
Fall off in demand for local goods
Closure of local firms
Low wages- little incentive for long term
unemployed
Automation and new technologies
Seasonal variation

17. EFFECTS OF UNEMPLOYMENT ON THE
INDIVIDUAL
• Social isolation
• Social life and leisure restricted by limited
finance
• Health problems
• Depression, Anxiety, Stress
• Alcohol abuse
• Increase in anti-social behavior
• Cost to the state

18. Philip Curve
• The Phillips curve shows the
relationship between
unemployment and inflation in
an economy. Since its ‘discovery’
by British economist AW Phillips,
it has become an essential tool
to analyze macro-economic
policy. A lower rate of
unemployment is associated
with higher wage rate or
inflation, and vice versa. In other
words, there is a tradeoff
between wage inflation and
unemployment.
• Reason: during boom, demand
for labour increases. Due to
greater bargaining power of the
trade union, wage increases.