1. 1. Inflation &
unemployment

2. INFLATION & PHILLIPS CURVE: THE INFLATION RATE IS
THE PERCENTAGE CHANGE IN THE PRICE LEVEL.
THE PHILLIPS CURVE SHOWS THE RELATIONSHIP
BETWEEN THE INFLATION RATE AND THE
UNEMPLOYMENT RATE.

3. CAUSES OF INFLATION
DEMAND-PULL INFLATION IS INFLATION
INITIATED BY AN INCREASE IN AGGREGATE
DEMAND.
COST-PUSH, OR SUPPLY-SIDE, INFLATION IS
INFLATION CAUSED BY AN INCREASE IN
COSTS.

4. DEMAND PULL :
INCREASE IN AD CAN BE DUE TO A FISCAL OR MONETARY POLICY, THUS
INCREASING PRICES

5. 5. COST PUSH:
UPWARD SHIFT OF THE AS WILL BE DUE TO INCREASE IN COSTS DUE TO INCREASE
IN PRICE OF INPUTS

6. Stagflation:
• STAGFLATION OCCURS WHEN OUTPUT IS FALLING AT THE SAME TIME THAT
PRICES ARE RISING.
• ONE POSSIBLE CAUSE OF STAGFLATION IS AN INCREASE IN COSTS.

7. Costs of inflation:
 REDISTRIBUTION OF INCOME AND WEALTH- BORROWERS GAIN AND CREDITORS
LOSE FIXED INCOME EARNERS LOSE.
 BALANCE OF PAYMENTS EFFECT- EXPORTS BECOME EXPENSIVE. HENCE
EXCHANGE RATE DEPRECIATES.
 UNCERTAINTY ABOUT THE VALUE OF MONEY
 RESOURCE COST OF CHANGING PRICES – MENU COSTS
 ECONOMIC GROWTH AND INVESTMENT SUFFERS

8. Philips Curve:
• IT IS A STATISTICAL RELATIONSHIP BETWEEN UNEMPLOYMENT AND MONEY
WAGE INFLATION.
• RATE OF INFLATION= RATE OF WAGE GROWTH LESS RATE OF PRODUCTIVITY
GROWTH.

9. Phillips Curve:
 1958 – PROFESSOR A.W. PHILLIPS
 EXPRESSED A STATISTICAL RELATIONSHIP BETWEEN THE RATE OF GROWTH OF
MONEY WAGES AND UNEMPLOYMENT FROM 1861 – 1957
 RATE OF GROWTH OF MONEY WAGES LINKED TO INFLATIONARY PRESSURE
 LED TO A THEORY EXPRESSING A TRADE-OFF BETWEEN INFLATION AND
UNEMPLOYMENT

10. The Philips Curve
WAGE GROWTH % (INFLATION) UNEMPLOYMENT (%) THE PHILLIPS CURVE SHOWS
AN INVERSE RELATIONSHIP BETWEEN INFLATION AND UNEMPLOYMENT. IT
SUGGESTED THAT IF GOVERNMENTS WANTED TO REDUCE UNEMPLOYMENT IT HAD
TO ACCEPT HIGHER INFLATION AS A TRADE-OFF. MONEY ILLUSION – WAGE RATES
RISING BUT INDIVIDUALS NOT FACTORING IN INFLATION ON REAL WAGE RATES.
1.5% 6% 4% 2.5% PC1

11.  THE CURVE CROSSES THE HORIZONTAL AXIS AT A POSITIVE VALUE OF
UNEMPLOYMENT. HENCE IT IS NOT POSSIBLE TO HAVE ZERO INFLATION AND
ZERO UNEMPLOYMENT
 THE CONCAVE SHAPE IMPLIES THAT LOWER THE LEVEL OF UNEMPLOYMENT
HIGHER THE RATE OF INFLATION.
 GOVT. SHOULD BE ABLE TO USE DEMAND MANAGEMENT POLICIES TO TAKE THE
ECONOMY TO ACCEPTABLE LEVELS OF INFLATION AND UNEMPLOYMENT.
 IN ORDER TO ACHIEVE FULL EMPLOYMENT, SOME INFLATION IS UNAVOIDABLE.
 HOWEVER, THIS RELATIONSHIP BROKE DOWN AT THE END OF 1960S WHEN
BRITAIN BEGAN TO EXPERIENCE RISING INFLATION AND UNEMPLOYMENT.
 THIS RAISED A QUESTION ON THE APPLICATION OF PHILLIPS CURVE IN THE
LONG RUN.

12. Long run Phillips curve:
 DP/DT = F(1/U) + DP E /DT
 TO KEEP UNEMPLOYMENT BELOW THE NATURAL RATE, INFLATION MUST KEEP ON
INCREASING EVERY YEAR. IN THE LONG RUN PHILIPS CURVE WILL BE VERTICAL
AT THE RATE OF UNEMPLOYMENT WHERE REAL AGGREGATE DEMAND EQUALS
REAL AGGREGATE SUPPLY. THIS RATE IS CALLED THE NATURAL RATE OF
UNEMPLOYMENT. IT IS ALSO CALLED NAIRU OR LOWEST SUSTAINABLE
UNEMPLOYMENT RATE (LSUR).

13. inflation
THE PHILIPS CURVE UNEMPLOYMENT LONG RUN PC PC1 PC2 PC3 ASSUME THE
ECONOMY STARTS WITH AN INFLATION RATE OF 1% BUT VERY HIGH UNEMPLOYMENT AT
7%. GOVERNMENT TAKES MEASURES TO REDUCE UNEMPLOYMENT BY AN
EXPANSIONARY FISCAL POLICY THAT PUSHES AD TO THE RIGHT (SEE THE AD/AS
DIAGRAM ON SLIDE 15) 7% 2.0% 1.0% THERE IS A SHORT TERM FALL IN UNEMPLOYMENT
BUT AT A COST OF HIGHER INFLATION. INDIVIDUALS NOW BASE THEIR WAGE
NEGOTIATIONS ON EXPECTATIONS OF HIGHER INFLATION IN THE NEXT PERIOD. IF
HIGHER WAGES ARE GRANTED THEN FIRMS COSTS RISE – THEY START TO SHED LABOUR
AND UNEMPLOYMENT CREEPS BACK UP TO 7% AGAIN. 3.0% TO COUNTER THE RISE IN
UNEMPLOYMENT, GOVERNMENT ONCE AGAIN INJECTS RESOURCES INTO THE
ECONOMY – THE RESULT IS A SHORT-TERM FALL IN UNEMPLOYMENT BUT HIGHER
INFLATION. THIS HIGHER INFLATION FUELS FURTHER EXPECTATION OF HIGHER INFLATION
AND SO THE PROCESS CONTINUES. THE LONG RUN PHILLIPS CURVE IS VERTICAL AT THE
NATURAL RATE OF UNEMPLOYMENT. THIS IS HOW ECONOMISTS HAVE EXPLAINED THE
MOVEMENTS IN THE PHILLIPS CURVE AND IT IS TERMED THE EXPECTATIONS AUGMENTED
PHILLIPS CURVE.

14. Types of Unemployment:
 FRICTIONAL UNEMPLOYMENT:
 UNEMPLOYMENT CAUSED WHEN PEOPLE MOVE FROM JOB TO JOB AND CLAIM
BENEFIT IN THE MEANTIME
 THE QUALITY OF THE INFORMATION AVAILABLE FOR JOB SEEKERS IS CRUCIAL
TO THE EXTENT OF THE SERIOUSNESS OF FRICTIONAL UNEMPLOYMENT

15. Types of Unemployment
 STRUCTURAL UNEMPLOYMENT:
 UNEMPLOYMENT CAUSED AS A RESULT OF THE DECLINE OF INDUSTRIES AND THE
INABILITY OF FORMER EMPLOYEES TO MOVE INTO JOBS BEING CREATED IN
NEW INDUSTRIES
 SEASONAL UNEMPLOYMENT:
 UNEMPLOYMENT CAUSED BECAUSE OF THE SEASONAL NATURE OF
EMPLOYMENT – TOURISM, AGRICULTURE, SPORTS ETC.

16. CYCLICAL UNEMPLOYMENT:
 CAUSED BY A GENERAL LACK OF DEMAND IN THE ECONOMY – THIS TYPE OF
UNEMPLOYMENT MAY BE WIDESPREAD ACROSS A RANGE OF INDUSTRIES AND
SECTORS
 KEYNES SAW UNEMPLOYMENT AS PRIMARILY A LACK OF DEMAND IN THE
ECONOMY WHICH COULD BE INFLUENCED BY THE GOVERNMENT

17. Okun’s Law:
1. THIS LAW STATES THAT 1 EXTRA POINT OF UNEMPLOYMENT COSTS 2%OF GDP
2. CONSEQUENCES OF UNEMPLOYMENT:
3. LOSS OF POTENTIAL OUTPUT
4. LOSS OF HUMAN CAPITAL
5. INCREASING INEQUALITIES AND DISTRIBUTION OF INCOME
6. SOCIAL COSTS