DM

Part 13

  • Meaning of Inflation:

    • Inflation is defined as an increase in the general price level of goods and services in the economy.

    • Associated terms:

      • Deflation: A decrease in the general price level.

      • Disinflation: A reduction in the rate of inflation.

  • Measurement of Inflation: Consumer Price Index (CPI):

    • The CPI measures changes in the average prices of consumer goods and services.

    • Also known as the cost-of-living index, it includes only consumer goods and services, excluding purchases by businesses and government.

  • Consumer Price Index (CPI):

    • Conducted quarterly by the Australian Bureau of Statistics (ABS).

    • Surveys prices of items typically purchased by an average family (the 'market basket').

    • It is a fixed-weight price index; the basket composition remains unchanged over time.

  • How the CPI is Computed:

    • To calculate CPI, compare the cost of a fixed 'market basket' between two time periods (base year vs. current year).

  • Annual Rate of Inflation:

    • Defined as the percentage change in the CPI from one year to another.

  • Criticism of the CPI:

    • CPI not a perfect measure due to:

      • Use of one average basket.

      • Difficulty adjusting for quality changes.

      • Impact of the substitution effect.

  • Demand–Pull Inflation:

    • Rise in price levels due to excess demand over supply.

    • Generally occurs when the economy operates near capacity.

  • Cost–Push Inflation:

    • Rise in price levels due to increased production costs regardless of demand.

    • Can result from wage increases, raw material costs, etc.

  • The Role of Expectations:

    • Buyer expectations of price increases can lead to immediate purchases.

    • Supplier anticipations of increased costs may lead to price increases (cost–push inflation).

  • Consequences of Inflation:

    • Decreases income.

    • Affects real interest rates, disadvantaging lenders.

    • Influences investment and business decisions.

  • Shrinks Income:

    • Nominal income does not accurately reflect purchasing power.

    • Real income indicates the actual amount of goods/services purchasable with nominal income.

  • Affects Real Interest Rate:

    • Real interest rate = nominal rate - inflation rate.

    • High inflation reduces purchasing power; a negative real interest rate harms lenders.

    • lowers the purchasing power of money

  • Affects Investment and Business Decisions:

    • Low and stable inflation aids efficiency in decision-making.

    • High inflation can cause over-investment in some areas like assets and speculation, and under investment in others like real productive capacity

  • Inflation on a Rampage:

    • Hyperinflation results in drastic price rises, causing socio-economic instability.

    • Motivates immediate spending, jeopardizes financial contracts like debtor lender contracts and encourages investment on non productive things.

  • Meaning of Employment:

    • Employed persons in Australia are over 15, working paid/unpaid hours.

  • Measurement of Unemployment:

    • Unemployment rate is the percentage of labor force actively seeking jobs.

    • Labor force includes those employed and those seeking employment, excluding various groups (e.g., students, discouraged workers)

  • Criticism of the Unemployment Rate:

    • Unemployment rate may overstate/understate actual unemployment due to survey inaccuracies and underemployment.

    • discouraged workers are not counted

  • Types of Unemployment:

    • Four categories of unemployment:

      1. Seasonal

      2. Frictional

      3. Structural

      4. Cyclical

  • Seasonal Unemployment:

    • Resultant from seasonal demand changes or weather conditions, affecting various trades like tourism and retail.

  • Frictional Unemployment (serach unemployment):

    • Arises during job transitions, representing normal economic activity.

    • short term, allows freedom of choice

  • Structural Unemployment:

    • Caused by skills mismatch and economic change over time like tastes, patterns of demand, technology etc.

    • long term, necessitates worker retraining

    • Influenced by economic shifts, educational mismatches, and changing demands.

  • Cyclical Unemployment:

    • Related to insufficient job availability during economic downturns.

    • Rapid increase in unemployment during recessions.

  • The Goal of Full Employment:

    • Full employment does not equal zero unemployment.

    • situation in which an economy operates at an unemployment rate equal to the sum of seasonal, frictional and structural unemployment rates

    • it is the rate of unemployment that involves zero cyclical unemployment

  • Hysteresis:

    • Unemployment hysteresis: full employment rate of unemployment is dependent on the recent path of actually measured unemployment

    • occurs when the full employment rate of unemployment increases/decreases as the actual unemployment rate increases/decreases

    • occurs due to reduction in skills due to long periods of unemployment, insider/outsider phenomenon

  • Consequences of Unemployment:

    • Economic costs: GDP gap (loss of output that could be produced by unemployed).

    • Non-monetary effects: loss of self-worth and unequal burden on labour market groups within the labour force - young people

  • Other Indicators:

    • Labour force participation rate: % of population in the labor force.

    • Employment to population ratio: % of employed population over those 15+.