Lecturer: Pn. Azizah Isa1 Chapter 6 Inflation & Unemployment.

Lecturer: Pn. Azizah Isa 1

Chapter 6Chapter 6Inflation &

Unemployment


BUSINESS CYCLEBUSINESS CYCLE

Aggregate Econ. Activity

Boom/Inflation

Trough/Depression/Slump/Unemployment

Potential Growth Path

Actual Growth Path

years

(% in real GDP)


NATIONAL INCOME NATIONAL INCOME EQUILIBRIUMEQUILIBRIUM

Real Output (National Income)

Expenditure(RM)

Y0 = C+I+G+(X-M)

Y1=C+I+G+(X-M)Y=E

45°

Yfe=C+I+G+(X-M)

Y0 Yfe Y1

Inflationary Gap

Deflationary Gape0

e1

ef


KEYNESIAN EQUILIBRIUM KEYNESIAN EQUILIBRIUM NATIONAL INCOMENATIONAL INCOME

Keynesian assume that equilibrium output can be reached not necessarily at the full-employment.

The equilibrium can be less or more than the full-employment equilibrium, causing the economy with the inflationary or deflationary-gap.


RELATIONSHIP OF RELATIONSHIP OF INFLATION AND BOOMING INFLATION AND BOOMING

ECONOMYECONOMYThe higher the growth of an economy,

the higher is the inflation rate.Inflation is related to the development

of an economy.


Definition of InflationDefinition of Inflation

as a criteria of a continuous increase in the general price level of all goods in an economy for a specific time period.

as measured by the increased in CPI.


Measurement Of Measurement Of InflationInflationThe Rate Of Inflation: is measured by the rate of increase of

price index, CPI.

Inflation Rate = (CPI1 CPI0) X 100

CPI0

Negative Inflation is Deflation


INFLATION IN MALAYSIAINFLATION IN MALAYSIA

Table 8.1: The Consumer Price Index (2000 = 100) and Inflation Rate

Year Consumer Price Index (CPI)Consumer Price Index (CPI) Annual Change Annual Change (%)(%)

1998 95.8 5.3

1999 98.5 2.8

2000 100.0 1.5

2001 101.4 1.4

2002 103.2 1.8

2003 104.4 1.2

2004 105.9 1.4

2005 108.9 2.8


Inflation as shown by the Inflation as shown by the % change in CPI% change in CPI


TYPES/ CAUSES OF TYPES/ CAUSES OF INFLATIONINFLATION

1. DEMAND-PULL INFLATION2. COST-PUSH INFLATION


1. Demand-Pull Inflation1. Demand-Pull Inflation

‘TOO MUCH MONEY CHASING FOR TOO FEW GOODS’ Fisher

AD AD > AS AS at full-employment,

causes to shortage of goods and

price hike.


Fisher’s Equation:Fisher’s Equation:MV = PTMV = PT

where, M = money supply V = velocity of money in circulation P = general price level T = total transaction of outputs V and T are assumed constant; therefore, Money Supply, Prices (inflation)


Demand-pull InflationDemand-pull Inflation General AS Price P1 AD1 P0 AD0

real output YFE

Diagram: Demand– Pull Inflation as shown by the change in the General Prices caused by an increase in The Aggregate Demand.


2. Cost-Push Inflation2. Cost-Push Inflation• is caused by the high rise in the cost of

production. • The cost increases can be caused by various

factors: higher higher wage wage rate. larger profit larger profit markmark-up. expensive raw materials domestically or from imported sources. increase prices of intermediate intermediate (capital) (capital) goods. goods. higher taxes. taxes.


Cost-Push InflationCost-Push Inflation General Price Level AS1 AS0 P1 P0 AD Q1 Q0 real output Diagram: Cost-push Inflation


Effects of InflationEffects of Inflation

1. On the individuals as gainers and losers:

Gainers are: Debtors: pay back loan, with less value of

money. Shareholders: higher dividend Property owners: higher prices of assets

owned. Businessmen: making larger profit as prices

for their goods produced and sold is higher.


Effects of InflationEffects of Inflation

Losers are: Creditors: received less value for loans

given out earlier.Savers: lower value of money saved.Fixed income earners: lower purchasing

value of money. Pensioners: value of money falls.


Other Effects of InflationOther Effects of Inflation

may cause also to:

2. Production of goods increases

3. Savings depreciated in value (lower purchasing power of money)

4. Deficit in Balance of Trade (domestic price increases and become less competitive in the international market)


To curb the problem of To curb the problem of inflationinflation

Using:

1) Monetary PolicyMonetary Policy

2) Fiscal PolicyFiscal Policy


To To reducereduce InflationInflation:: with with Surplus Surplus BudgetBudget oror Tight Tight Monetary PolicyMonetary Policy Since inflation is related to the booming of an

economy, therefore to reduce inflation, economic growth has to be slowed down.

Thus, reduces the aggregate demand and closed-down the inflationary-gap while the real output (Y) falls.


Keynesian AD-AS Diagram

General Prices AS

AD1

AD2

Real GDP

P2

P1

G or I

Effect of Surplus Budget (G falls) or Tight Monetary (increased interest rate) policies to reduce inflation

NATIONAL INCOME EQUILIBRIUM


Expenditure(RM)

Y0 = C+I+G+(X-M)

Y1=C+I+G+(X-M)Y=E

45°

Yfe=C+I+G+(X-M)

Y0 Yfe Y1

Inflationary Gap

Deflationary Gape0

e1

ef

-GDPGap


UnemploymentUnemployment in in MalaysiaMalaysia

“The unemployment rate is lowest in the year 1997 but increase again in 1998 that is from 2.7% to 3.2% due the slowdown of the economy caused by the Asian Financial Crisis whereby our economy is hit by the large depreciation of Ringgit Malaysia (RM) relative to American Dollar (US$)[1] “

[1 ] Economic Report 1999/2000. Ministry of Finance Malaysia, 1999.


UNEMPLOYMENT IN MALAYSIAUNEMPLOYMENT IN MALAYSIA

YEAR UNEMPLOYMENT RATE (%)

1997 2.7

1998 3.2

1999 3.4

2000 3.1

2001 3.6

2002

2003

3.5

3.6

2004

2005

3.5

3.5Source: Economic Planning Unit and Ministry of Human Resources.


Unemployment Unemployment with Business Cycle with Business Cycle

Unemployment rateUnemployment rate is high during recession.recession.

The negative impact negative impact of the slowdown of the economic growth during recession may: less job opportunities. bankruptcies, closing down factories, delay of constructing new plants etc.

thus, may reduced the number of economic activities in the economy.


Natural Rate Natural Rate of of UnemploymentUnemployment The natural rate of unemployment is the level of

voluntary unemployment when the labour market is in equilibrium.

Natural rate of unemployment is normally rated as 4% .

Full-employment is related to this natural rate of unemployment, which includes(+) the frictional and seasonal unemployment.

It is not easy to omit this natural rate of unemployment in an economy. Therefore an economy at this natural rate of unemployment is said to be at full-employment.


Actual Rate and Natural RateActual Rate and Natural Rateof Unemploymentof Unemployment

If the actual rate of unemployment is more than the natural rate of unemployment, than it is said that the economy is with the real problem of unemployment.


Who are Who are considered as considered as unemployed?unemployed?


DEFINITIONSDEFINITIONS

UNEMPLOYMENT:

are people who are considered under the labour force but being unemployed (jobless).


Who are included Who are included in the Labour in the Labour

Force?Force?


LABOUR FORCE:LABOUR FORCE:

are people of age group 15 – 64 years and are willing and able to work either has been holding a job or yet searching for a job.

Those that are not considered under the labour force includes:

School children and university students although aged more than 15.

Sick bed, old aged and housewives .


LABOUR FORCELABOUR FORCE

(willing and able to work of age (willing and able to work of age 15 - 64yrs. 15 - 64yrs. either either workingworking or or joblessjobless))

= no. of employed + no. of unemployed= no. of employed + no. of unemployed


Measurement of UnemploymentMeasurement of Unemployment

Unemployment Rate

= no. of unemployedunemployed X 100%

labourlabour force

Unemployed people are jobless labour force


LABOUR FORCE LABOUR FORCE PARTICIPATION PARTICIPATION

RATERATE

= Labour Force X 100% Adult Population


TOTAL POPULATION

CONSTITUTES ALL OF THE:

- CHILDREN

- ADULT

- OLD AGED

- HOUSEWIVES

(that are not considered under the labour force).

Therefore, for calculating the rate of participation make sure that only adult population is considered into the measurement.


For example:For example:Data collected from the year 1999 given as:

125.6 million employed people and 4.5 million

was unemployed and the adult population was 205.8 million.

Therefore: Labour Force = 125.6 + 4.5 = 130.1 million Unemployment rate = ( 4.5 / 130.1 ) x 100 = 3.6% Labour Force Participation rate = ( 130.1 /205.8) x 100 = 63.2%


EXERCISE 1:EXERCISE 1:. The table below shows the total labor force and

number of employed people for country Semasa.

Year Total labor

force (‘ 000)

Employed

(‘ 000) 2004

85,400 82,100

2005

96,750

86,500

A. Define labour force B. Calculate the unemployment rate for the year 2004 and 2005


TYPES OF TYPES OF UNEMPLOYMENTUNEMPLOYMENT

FRICTIONAL UNEMPLOYMENTSTRUCTURAL UNEMPLOYMENTCYCLICAL UNEMPLOYMENTDISGUISED UNEMPLOYMENT/

HIDDEN UNEMPLOYMENT.SEASONAL UNEMPLOYMENT


STRUCTURAL STRUCTURAL UNEMPLOYMENTUNEMPLOYMENT

Changes in the structure or technology of the economy may lead to reduction in the number of job opportunities.

i. Structural changes from labour intensive to capital intensive (furthermore with high technology – use of robotics and highly sophisticated machineries).

ii. Structural changes from agricultural base to industrial sectors – those lack of skills and less educated were ignored.


CYCLICAL CYCLICAL UNEMPLOYMENTUNEMPLOYMENT

Caused by the downturn of the business cycle - economy moves towards recession (kemelesetan).

DisruptionDisruption of the economic growth economic growth causes the slowdown in all sectors of the economy, alas reduction in job opportunities.


DISGUISED UNEMPLOYMENT/ DISGUISED UNEMPLOYMENT/ HIDDEN UNEMPLOYMENT. HIDDEN UNEMPLOYMENT.

where the industries are overstuffed with unnecessary additional workers – sharing jobs available and does not contribute to extra productivity.

i) in agriculture sectors

ii) in cottage/rural industries.


Impact of Impact of UnemploymentUnemployment can be a cost to an economy.

Unemployment can affect:i) the individuals: distressed, lose self esteem,

mentally disturbed.ii) the family/society: lost family income, domestic

violence, family splitting.iii) the economy: create social and economic cost. curing social problems, training courses, special

benefits, capital incentives. A cost to the economy ‘cos economy is not at the stage of fully utilising the resources (underutilization).


POLICIES TO POLICIES TO CURECURE

Government measures:

1. FISCAL POLICY

2. MONETARY POLICY


NATIONAL INCOME NATIONAL INCOME EQUILIBRIUMEQUILIBRIUM


Expenditure(RM)

Y0 = C+I+G+(X-M)

Y1=C+I+G+(X-M)Y=E

45°

Yfe=C+I+G+(X-M)

Y0 Yfe Y1

Inflationary Gap

Deflationary Gape0

e1

ef


FISCAL POLICY FISCAL POLICY

1. CONTRACTIONARY FISCAL POLICY

(surplus budget) G – T < 0 G < T

2. EXPANSIONARY FISCAL POLICY

(deficit budget) G – T > 0 G > T

3. BALANCED BUDGET POLICY

G – T = 0 G = T

Fiscal Policy attempts to regulate the economy by varying the level of government spending and the rate of taxation.


To reduce To reduce Unemployment/recession: Unemployment/recession:

Expansionary Fiscal Expansionary Fiscal Policy / Policy /

Deficit Deficit BudgetBudget When government collects less tax revenue

but spends more on expenditure, G > T. Therefore, it cause to a larger effects on real

output. Deficit Budget Deficit Budget is implemented(dilaksanakan) to

raise-up the economic activities.


Balanced Budget Balanced Budget PolicyPolicy

When government expenditure is just equivalent to the tax revenue collection

(G = T)

A balanced budget is also used to increase real output and economic growth.

Its multiplier is equivalent to one (1). Y = 1 . G Thus, the resulting increase in the

equilibrium Y is exactly equal to the increase in G or T itself.

∆Y = ∆G = −∆T


MONETARY POLICYMONETARY POLICY

To cure recession/unemployment:

Ease / Expansionary monetary policy.

To reduce inflation:

Tight / Contractionary monetary policy.


Keynesian AD-AS DiagramKeynesian AD-AS Diagram

General Prices AS

AD1

AD2

Real GDP

P2

P1

I, G

Effect of Surplus Budget OR Tight Monetary Policy to reduce inflation


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Lecturer: Pn. Azizah Isa1 Chapter 6 Inflation & Unemployment.

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