Prices and Employment

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Inflation

• Definition:– Is a steady an upward

movement in the level of prices decreasing purchasing power over a period of time, usually one year.

Hyper inflation

• Extremely rapid or out of control inflation.

• Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless.

Deflation• A general decline in prices, often

caused by a reduction in the supply of money or credit.

• Deflation can be caused also by a decrease in government, personal or investment spending.

• The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.

Stagflation

• A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation.

• Stagflation occurs when the economy isn't growing but prices are, which is not a good situation for a country to be in.

How to measure inflation?

• The rate of price inflation in an economy is measured by calculating the average percentage change in the price of all goods and services, from one point in time to another, say one month/year.

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Measuring Inflation

• The Consumer Price Index (CPI) is the official measure of inflation.

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Measuring Inflation

• The CPI can be thought of as an imaginary ‘basket’ of selected goods and services bought by a typical capital city household.

• The CPI is merely a measure of the changes in the price of this basket of goods and services.

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Measuring Inflation

• The price of the CPI basket in the base (first) period is given a value of 100 and the prices of subsequent periods are compared against the base year.

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Measuring Inflation

• For example, if the price of the basket had increased 15% since the base year, the CPI would read 115, if the price had fallen by 15% since the base year the CPI would be 85.

Uses of CPI data

• As an economic indicator:• Measure of changes in cost

of living.• Govt. can control price

inflation using macro economic policies.

• Workers seek increase in wages by looking at the CPI.

• Entrepreneurs makes business decision…

Uses of CPI data

• As a price deflator:• Rising prices reduce

purchasing power or real value of money.

• CPI is used to deflate these values and calculate real or inflation-free values.

• Eg: Wage increased by 10%; price inflation is 15%; then the real value of wages fallen by 5%

Uses of CPI data

• Indexation:• Indexation involves tying

certain payments to the rate of increase in CPI.

• Ex: pensions indexed with CPI means they increase by the rate of inflation.

• Other examples: Savings, threshold of income tax etc

Types of goods and services

Proportion of weekly income spent on each category

Average price of goods and services

Weighted average price

Travel and Leisure 15% $20.00 0.15x$20.00=$3.00

Household goods and services

25% $40.00

Clothing and footwear

40% $30.00

Transport 20% $25.00

Total 100%

How to calculate CPITypes of goods and services

Proportion of weekly income spent on each category

Average price of goods and services

Weighted average price

Travel and Leisure 25% $22.00 0.25x$22.00=$5.50

Household goods and services

25% $46.00

Clothing and footwear

35% $38.00

Transport 15% $20.00

Total 100%

Problems with price indices• Over time, “typical” household and

“basket” of goods will tend to change.

• Over time, quality of goods and services and sources of purchase also may change.

• International comparison is difficult.(household composition and spending patterns differ between countries)

• Exclusion of food, energy, house prices and income taxes may give only inaccurate data.

What causes inflation?

1. Over money supply:• “Too much money chasing

too few goods.”• People are able to

increase their spending on goods and services faster than producers can supply goods and services they want to buy.

WHAT CAUSES INFLATION?

• How do money supply increase?• Govt. may allow the supply of money to increase

by: A. issuing more notes and coins B. Allow banking system to create more credit• Govt. may expand the money supply: To increase total demand and reduce unemployment. In response to an increase in demand for G & S In response to demand for higher wages and rise in cost of

production.

Discussion Questions

• If supply of money rises, how this will affect the amount of spending on goods and services?

• If people spend more on goods and services and there are no more available, what will happen their prices and why?

What causes inflation?

• 2. Monetary rule: • If the government wants

to keep inflation low and stable, it should allow the supply of money to expand at the same rate as the increase in real output or real GDP over time.

What causes inflation?

• 3. Government policy: Measures to boost demand and to reduce unemployment, governments allow money supply to expand.

• Inflation reduced purchasing power

Demand for higher wages unemployment = stagflation

What causes inflation?

• 4. Demand-pull Inflation: Inflation caused by increase in total demand is called demand-pull inflation. In aggregate demand borrowing/issue of new currency more money supply Inflation

What causes inflation?

• 5. Cost push inflation:• Inflation caused by

higher cost feeding into higher prices is called cost-push inflation.

• Wage-price spiral: As price demand for wages cost price.

Wage- Price Spiral

Fill in the blank boxes to complete the wage-price spiral

What causes inflation?

• 6. Imported inflation: Rising prices in one country may be exported to other countries through international trade. This is called imported inflation. A fall in the value of one currency against another currency can also lead to imported inflation.($1=Rs.50) falls to ($1=Rs.25)

• ($10 worth import now costs $20)

Costs of inflation

• Points for discussion:How does the inflation affect the amount of

goods and services money can buy?Are people always worse off if prices rise?

Explain.Which groups will affect mostly?

Money income Vs Real income

• Money income: Income in terms of money.(nominal income)

• Real income: Income in terms of what it can buy.

PERSONAL COST OF INFLATIONRising prices reduce the purchasing power of people’s incomes.(Their real income falls)

Pensioners & Government employees(fixed income group)

Professional people and workers in strong trade unions.(better bargaining power)

People who save money(If interest rate is rate of inflation becomes worse off)

Old age pensioners other fixed income earners

Government earns more tax revenue.

Cost of inflation to the economy

• Inflation causes unemployment.

o People save more in times of high inflation.

o More imports and less exports.

• Reduction in the real value of savings

• International competitiveness

Employment

• Employment provides people with income and wealth.

• Unemployment wastes productive resources. Hence:

• Governments always wants to maintain a high and stable level of employment.

Employment Indicators

Labour force

Labour force

participation rate

Employment by

industrial sector

Employment status

Unemployment

Key Employment Indicators

• Labour force: Total number of people of working age in work or actively seeking work

• Labour force participation rate: The labour force as a proportion of the total working age population.

• Employment by industrial sector: How many people work in agriculture and manufacturing industries, relative to services.

• Employment status: The number of people employed full-time, part time or temporary work.

• Unemployment: The number of people registered as being without work, and as a proportion of the total labour force(the unemployment rate)

Labour force

• Labour force/working population of a country represents all those people of working age who are both able and willing to work.

• This forms the supply of labour of a country.

• They include:• Employed by private and public

sector.• The self-employed.• The armed forces.• Those on work-related

government training programmes.• Unemployed, looking for job.

• They exclude:• Students in education.• Retired people.• Stay-at-home parents.• Prisoners.• Voluntarily

unemployed ones…

Labour force participation

• Labour force participation rate is the measure of the proportion of working-age population that is either working or looking for work.

• More number of younger people in education.

• Growing number of old and retired people.

Why decrease in some countries?

Why increase in some countries?

Poverty force them to work.(flow from subsistence sector to paid employment)Rising cost of living(difference between money wages and real wages)Mothers return to work after raising children.Younger women prefer to work.Change in social attitude…

Employment by Industrial sector

• Generally people are employed in Primary, Secondary or Tertiary sectors.

• In developed countries, service sector is the dominating sector (about 71%)

• In developing countries primary sector is the dominating.(about 60%)

• The general trend is agriculture and industry is falling and service sector is rising.

Employment status

• It means how much the workers are working in a week.

• As working conditions improve the average working hours falls.

• There is growth in the part time work.

• It is mainly because of Increase in female participation rate Growth in service sector and retailing.

Unemployment

• People without work but who are looking for work are unemployed.

• It is usually measured by the number of people claiming unemployment benefit (claimant count)

Unemployment rate

• It is the number of unemployed workers divided by the total labour force.

Number of unemployed 100• Unemployment rate (%)=-------------------------------- X ------ Labour force 1

Unemployment

• Unemployment (or joblessness) occurs when people are without work and actively seeking work.

Frictional Unemployment

• This occurs when workers change jobs and spend some time for a new one.

• These are people in-between jobs.

• This will not remain for long time.

Seasonal Unemployment

• This occurs because consumer demand for some goods and services is seasonal. Eg; In tourism industry, jobs in summer and jobs

in winter.

Cyclical Unemployment

• Cyclical unemployment, also known as deficient-demand unemployment.

• When the demand for goods and services falls, the downward multiplier effect brings down the output, employment and income.

Multiplier effect: a small change in spending cause large changes in income, output and

employment.

• Fall in demand for cars

Loss of jobs in Tata

Structural unemployment

• Caused by the long term changes in the structure of economy.

• Industries close down and workers become unemployed.

• Their skills are no longer demanded.• They become occupationally immobile.• Eg; changing of labour intensive

production(ship building, coal mining etc) to high-tech capital intensive production(computers, audio-visual equipments etc)

Imperfections in the labour market

• In a free labour market, demand and supply of labour determines the wages.

• But this may not happen if there are imperfections in the labour market.

Trade Unions

• Trade unions bargain for higher wages.

• This may not match with the improvement in productivity.

• Rise in wages causes unemployment.

Unemployment allowances

• If benefits are too generous, it may reduce the incentive to work.

• A cut in benefits can force voluntarily unemployed to work; but we can’t do it with the involuntarily unemployed people.

Other non-wage costs

• A rise in non-wage costs will lead to less demand for labour.

• (taxes and social contributions for the employees, maternity and paternity costs, recruitment and training costs etc)

Lack of job information

• Searching for jobs, because of lack of information.

Minimum wage laws

• Minimum wages are meant to raise the wages of poorest workers.

• But for producers, it raises the costs.• They cut down the jobs.

Immobility

• Occupational immobility: Different jobs require different skills.

• Geographical immobility: Unwilling to move to another area to take up a job.

The costs of unemployment

• Personal costs: • Economic and emotional.

The costs of unemployment

• Costs to the people in work: • Unemployment benefits are paid from the

tax revenue..this revenue is generated by imposing more taxes on employed people.

The costs of unemployment

• Cost for the whole economy:• Waste of resource, Total output falls,

opportunity costs of fund spent for unemployment benefits…