UNIT I - Inflation And Unemployment

Price stability is one of the goals in the economy, the failure to attain it may mean a problem
of inflation or deflation. Inflation is a sustained or continuous rise in the general price level
while deflation is a decrease in the general price level. An increase Inflation risk will generate
significant welfare losses for most households, certain of permanent consumption. Households
preference may increase/decrease consumption that will eventually affect wealth distribution.
Labor economics favors payment of higher salaries and wages as this increases productivity,
thus generate employment.

Causes of Inflation

 Demand-pull inflation – demand in the economy is in the form of consumption,

investment, government expenditures and exports. Excess demand occurs when the
level of spending in the economy exceeds the amount firms are capable of producing.
Excess demand pulls the general price level upward.

 Cost-push inflation – the term is used when the cost of production increases especially
associated with increase in energy gasoline and even an increase in wages. It is
inflation from the supply side.

 Structural inflation – This type of inflation happens when some sectors of the economy
is unable to adjust to changes in the level and composition of aggregate demand.

For example, when supply is unable to respond for an abrupt increase in demand, like
when an earthquake hit Baguio in 1990.  
Harmful effects of Inflation

1. Anticipated Inflation - An increase in the general level of prices that was expected
by most decision-makers on the economy.

2. Unanticipated Inflation - An increase in the general level of prices that was not
expected by most decision-makers on the economy.

Inflation distorts the information contained in prices and alters the outcome of long-term
projects, increases the risk of long term investment activities, and reduces the amount of
long-term investment undertaken. Less investment today is likely to lead to lower levels
and growth of output in the future. On the other hand, high and variable rates of inflation
lead people to try to protect themselves from inflation risk.
Budget Deficits, Inflation, and Real Interest Rates
In theory, higher government budget deficits should lead to higher real interest rates by
loanable funds market analysis. In practice, effect is not as strong as expected.
Higher government budget deficits may lead to higher inflation rates and higher interest
rates, if government finances deficit by printing money.

Output and Employment

The use of index leading economic indicators is a composite index of 11 key variables that
generally turn down prior to a recession and a turn up prior to recovery. The changes in the
index are used to forecast future changes in the state of the economy, but there is a significant
variability in the lead time of the index ; hence, the index is not always an accurate indicator
of the economy’s future.
1. Length of average work week in hours
2. First partial weekly claims for unemployment compensation
3. New orders
4. Percentage of companies receiving slower deliveries from suppliers of manufactured
goods
5. Arrival of new contracts and order of new plant equipment
6. Permits for new structure start
7. Change of material prices
8. Changes in money supply
9. Index of consumer expectations

Key Labor Market Indicators

1. Civilian Labor Force. Number of persons, 16 years of age or greater, who are
either employed or are actively seeking work.
2. Unemployed. A peson who is not currently employed who I either a) actively
looking for a job or b) waiting to begin or to return to a job.
3. Labor Force Participation Rate
4. Unemployment Rate. Percentage of persons in the labor force who are
currently unemployed.

Problems in Measuring Unemployment

a. it doesn’t count discouraged workers as unemployed because they have
given up looking for jobs;
b. it doesn’t adjust for underemployed workers, those working part-time who
would prefer to be working full-time; and
 c. it doesn’t count non-market employment such as stay-at-home
fathers/mothers as employed, though they would be considered employed if
working as maids, cooks, or nannies.
5. Full Employment. Level of employment that results from the efficient use of
the labor force after making allowance for the normal rate of unemployment
consistent with information costs, dynamic changes and structural
characteristics of the economy.
6. Natural Rate of Unemployment.
7. Inflation. The sustained rise in the general level of price of goods and
services in the economy. Annual inflation rate is calculated as the percent
change in a chosen price index (PI).

Inflation Rate is = CPI 2 – CPI1

______________ X 100
CPI1

Unemployment

Unemployment may be defined as a condition. In the economy where a significant

number in the labor force are out-of-work. It is a situation in the economy whereby for
one reason or another, available resources are not fully used for productive purposes.
 
The rate of unemployment may be measured by the ratio of the actual number of
people who are out-of-work by the total who are in the labor force.
 
Number without Work
Unemployment Rate = -----------------------------------
Number in the Labor Force
 
However, not everyone who are alive and kicking are members of the labor force. There
are those who are not not. These are:
1. Retirees who are 65 and above
2. Retardates (physical or mental)
3. Below 15 years old
4. Students who are currently enrolled

Therefore, it is good to say that only those who do not fall in any of the above
characteristics who are out-of-work should be included in counting the number of people who
are unemployed because any person who belongs to any of the above categories is considered
as not belonging to the labor force.
Example.
Given an economy with a labor force of P5,000,000 out of the total population of P15,000,000.
If 2,000,000 are out-of-work, and the breakdown of those who are not working are:
500,000 retirees
130,000 retardates
200,000 below 15 years old
300,000 students presently enrolled
And the remaining do not belong to any of the four categories.

Question:
What is the economy’s unemployment rate?

Solution:

Unemployment Rate = 2,000,000 - 1,130,000

= 870,000 These are the actual number of
People who are counted as unemployed

= 870,000 / 5,000,000

= 17% This is the economy’s unemployment rate

Types of Unemployment
1. Frictional Unemployment
2. Structural Unemployment
3. Cyclical Unemployment
4. Seasonal Unemployment
5. Societal Unemployment

General Theories of Unemployment

1. Classical Theory (Adam Smith)
2. Keynesian Theory (John Maynard Keynes
LESSON ACTIVITY:

Answer the following Questions.

1. Why is it that when inflation has increased beyond normal, it is the debtor that benefits
while the creditor gets the benefit when inflation has decreased? Explain you answer?

2. If all 18 years old are supposed to be a members of the labor force why is it that in the
Philippines more and more 18 years old are not considered a member?

3. Business Cycle is inevitable in business and soon after that, will affect our economy.
Prosperity is an elusive phase if macroeconomic decisions are not implemented. What
are some of the macroeconomic tools that lessen the impact of recession and
depression?

4. What are some of the manifestation of the different business cycles as they transform
from one phase to another.