Unemployment & Inflation

Unemployment definition

Unemployment definition

 People who are willing and able to work but don’t have a job. (Students, housewives/husbands, disabled people, retired people, etc… are not unemployed)

% Unemployment calculation

(No. of unemployed / labour force) x 100

Problems with measuring unemployment

Hidden unemployment; underemployment; regional, gender, ethnic, and age disparities.

Hidden unemployment

Discouraged workers: People who have given up looking for a job. Not actively seeking employment so NOT “unemployed”. Unemployment will be understated. 

Falsely claim to be unemployed: To gain unemployment benefits. Might be the case if they are working in the illegal/informal economy or simply do not want to declare their income to avoid paying tax. Unemployment will be overstated.

Underemployment

• People who are working part time jobs that wish to be full time.

• People working below their skill level.

• Causes unemployment to be understated. 

Regional, gender, ethnic, and age disparities.

Average figure does not give information about the unemployment levels of certain groups. The national figure may disguise the true level of unemployment among certain groups.

Additional notes on measuring unemployment

• Unemployment figures are politically sensitive and many countries may attempt to lower the figure.

• Only people registered for unemployment benefits might be counted.

Costs of Unemployment

Unused resources, crime, more unequal distribution of income…

Benefits of unemployment

• Lowers inflationary pressures.

• (Neoclassical) Should help the working of the free market as long as wages fall and labour follows the price signalling function and reallocates itself to sectors where labour is more in demand.

Types of uneployment

1. Cyclical Unemployment

2. Structural Unemployment (exists in Yfe)

3. Frictional Unemployment (exists in Yfe)

4. Seasonal Unemployment (exists in Yfe)

Cyclical unemployment

Caused by downswings in the economic cycle i.e. falls in rGDP (deflationary gap).

Structural unemployment

• Caused by changes in the structure of the economy resulting in jobs disappearing entirely or moving to a different region in the country or world. Often caused by changes in technology, replacing jobs. Tends to affect relatively unskilled/semi-skilled people and can be long term.

• A mismatch of skills and jobs.

Frictional unemployment

Caused by people leaving one job in order to find a better one. The more friction in the labour market, the longer it takes to find a job. It is usually short-term unemployment and the people who have better qualifications.

Seasonal unemployment

E.g., tourism industry, agriculture, ski instructors.

Full employment

• Structural + frictional + seasonal.

• LRAS = AS at full employment.

• No cyclical unemployment. 

• “Natural rate of unemployment”/”equilibrium unemployment”

Note: Disequilibrium unemployment exists when there is cyclical unemployment.

Solutions to cyclical unemployment

AD has to be raised (fiscal or monetary policy). Keynesians believe it is very necessary (prices are downwardly sticky and the economy may be stuck at a GDP level below full employment). Some neoclassical economists may argue that the economy will naturally reach full employment due to prices of g&s and factor prices falling.)

Solutions to structural unemployment

• Allow the labour market to work (people should move to new jobs). Can be encouraged by cutting benefits and/or retraining them.

• Intervene. Bring jobs to people if people won’t go to the jobs. Governments can encourage new industries into the depressed area by offering incentives such as tax breaks and/or subsidies.

Solutions to frictional unemployment

• Increase labour mobility (provide better information) to reduce search time. 

• Reducing benefits will also speed up the process.

Solutions to seasonal unemployment

• Encourage people to seek alternative unemployment during off-season.

• Lower benefits.

Inflation definition

A sustained rise in the general/average price level.

Inflation measurement

• CPI (measures the changes in prices of a weighted basket of goods bought by consumers over a given time period). 

• PPI (more than just goods and services, includes intermediate goods in the production process and equipment used).

• GDP deflator(used to convert GDP nominal figures to real figures, includes goods and services produced by governments (public education, healthcare, military, etc…) rGDP = nominal GDP / deflator.

Inflation rate

Percentage change in prices from one period in time to the next, usually one year.

Deflation

A persistent fall in the general price level.

Disinflation

A general rise in levels BUT at a slower rate of inflation.

Hyperinflation

This is essentially inflation that is out of control.

Creeping inflation

Inflation that is persistently at 2 to 3%. Desirable.

Skimpflation

Reducing the quality of ingredients.

Shrinkflation

Reducing the quantity but keeping the price the same. (330 mL to 300 mL)

Consequences of inflation

• Uncertainty and growth: Uncertainty about future prices which may discourage investment, growth is therefore likely to be lower. 

• Redistributes incomes: 

  • People on fixed incomes lose.

  • People on profit incomes simply raise their prices in line with inflation, so they may not be affected.

  • Borrowers benefit. 

  • Lenders lose.

  • Importers benefit (makes prices of domestic goods less competitive compared to imported goods).

  • Exporters lose (makes exports less competitive).

• Resource costs: Changing prices means new menus, price lists, price labels, etc…

• Fiscal drag (Tax drag): Inflation may push people’s income into a higher tax bracket in a progressive tax system.

• Erodes functions of money:

  • Commodity of exchange - acceptable medium (gold, diamonds, etc… (has intrinsic value). Inflation causes problems with acceptability.)

  • Means of deferred payment - credit. (Able to borrow and repay).

  • Store of wealth - saving. (Possible to accumulate in terms of money.)

  • Unit of account - measure of value. (“Equals 15 dollars” not “Equals ½ goat, 3 chickens, ⅛ of a hen”.)

• Prices may change arbitrarily. (Some rise faster than others. This distorts the price mechanism, resource allocation, and the signalling function of price.)

Consequences of deflation

• Falling GDP and rising unemployment. Possible to get stuck in a deflationary trap.

• Falling prices and expectations of lower future prices. Causes delayed consumption at present, AD will fall further (Trap).

• Business profits will fall. They will have to accept lower prices but are unlikely to be able to reduce their costs by as much.

• Real debt values will increase.

• Indebtedness discourages firms from making new investments.

• Monetary policy (expansionary) becomes ineffective. Interest rates are already close to zero.

• On the positive side, exports might become more competitive and as X is a component of AD, it could increase AD. (APL rises, Px falls, X rises, AD rises.)

Types of inflation

1. Demand Pull

2. Cost Push

Demand pull

• Caused by an increase in AD causing a rise in the APL.

• AD shifts to the right. rGDP rises, inflation rises, unemployment falls.

Causes of demand pull

• Monetary policy (I and interest sensitive consumption).

• Fiscal policy (G + C (because of taxes)).

• Changes in net wealth.

• Changes in foreign income. (FI rises, X rises).

• Expectations.

• Changes in technology.

Cost push

• Caused by rising costs of production. (Stagflation).

• SRAS shifts to the left. Worst case scenario. rGDP falls, inflation rises, unemployment rises.

Causes of cost push

• Oil shocks. 

• Unions demanding higher wages without an accompanied rise in labour productivity.

• Falling exchange rate (higher import prices).

• Increase in indirect taxes.

• Decrease in supply of finite non-renewable resources.

• Monopoly profit push (causing higher prices).

• Weather.

• Increased trade barriers (e.g., tariffs)

Combined cost push and demand pull

Causes a wage price spiral. (prices go up (SRAS to the left), wages go up (AD to the right)

Demand pull solutions

Contractionary monetary or fiscal policy. (Unrealistic & unlikely because of political biases.)

Cost push solutions

• Supply side policies that aim to move SRAS to the right. 

  • Reduce power of trade unions.

  • Anti-monopoly policies to reduce prices. 

  • Lower business taxes.

  • Improve labour productivity.

• Income policies.

  • A freeze on wage increases. (Can only be used in the government sector and is discriminatory.)

The Phillips curve

A clear inverse relationship between inflation rates and unemployment rates.

Deflationary Trap/Spiral

A deflationary spiral is a downward price reaction to an economic crisis leading to lower production, lower wages, decreased demand, and still lower prices.