INFLATION &

UNEMPLOYMENT
Unemployment
 Measures of Unemployment
 Kinds of Unemployment
 Equilibrium Employment
 Okun’s Law
Unemployment Rate: Measure
Measuring Unemployment In India
 Current Weekly Status

CMIE
Equilibrium in Labour Market
Equilibrium in Labour Market -
Classical
Types of Unemployment:
 Frictional Unemployment:
 Unemployment caused when workers leave their
jobs to find better ones.
 Friction is the time, effort, and expense it takes the
worker to find a new job.
 The quality of the information available for job
seekers is crucial to the extent of the seriousness of
frictional unemployment.
 Also known as Search Unemployment.
 Types of Unemployment:
 Structural Unemployment:
 Unemployment caused as a result of the decline of industries and the
inability of former employees to move into jobs being created in new
industries.
 One cause of structural unemployment is technological advances in an
industry. That often happens in manufacturing.
 Second is unskilled workers who are generally unemployed or the first
to lose employment.

 Seasonal Unemployment:
 Unemployment caused because of the seasonal nature of employment
– tourism, agriculture, sports etc.
Cyclical Unemployment
 Caused by a general lack
of demand in the economy
– this type of
unemployment may be
widespread across a range
of industries and sectors
 Keynes saw
unemployment as
primarily a lack of
demand in the economy
which could be influenced
by the government.
 Natural Rate of Unemployment
 The natural rate of
unemployment is a
combination of frictional
and structural
unemployment.
 Even a healthy economy
will have this level of
unemployment because
workers are always coming
and going, looking for better
jobs.
 Okun’s Law
 This law states that 1
extra point of
unemployment costs
2%of GDP
 Consequences of
unemployment:
1. Loss of potential output
2. Loss of human capital
3. Increasing inequalities
and distribution of
income
4. Social costs
Question Mid Sem 2021
 Inflation
 Inflation is a sustained increase in the general price level
of goods and services in an economy over a period of
time.
 Kinds of Inflation:
o Creeping - prices rise 3 percent a year or less
o Walking - strong inflation is between 3-10 percent a year
o Galloping - rises to 10 percent or more, it wreaks absolute havoc on
the economy.
o Hyperinflation - prices skyrocket more than 50 percent a month.
o Stagflation - economic growth is stagnant but there still is price
inflation
 Measuring Inflation
 India used WPI as the measure for inflation but new
CPI(combined) is declared as the new standard for
measuring inflation ( April 2014).
 The WPI measures the price of a representative basket of
wholesale goods composed of three groups:
o Primary Articles (20.1% of total weight): Food Articles account for
14.3% of the total weight.
o Fuel and Power (14.9%) and
o Manufactured Products (65%): are Chemicals and Chemical products
(12%); Basic Metals, Alloys and Metal Products (10.8%); Machinery
and Machine Tools (8.9%); Textiles (7.3%) and Transport, Equipment
and Parts (5.2%).
Wholesale Price Index (WPI)
 Wholesale Price Index
(WPI) is computed by the Office
of the Economic Adviser in
Ministry of commerce &
Industry, Government of India.
 Current WPI Base year is 2011-
12=100. Its worth note that the
base year for CPI is 2012
currently.
 There are total 676 items in WPI
 Consumer Price Index
 Consumer Price Indices (CPI) released at national level are:
o CPI for Industrial Workers (IW)
o CPI for Agricultural Labourers (AL)/ Rural Labourers (RL)
o CPI (Rural/Urban/Combined).
 While the first two are compiled and released by the Labour
Bureau in the Ministry of Labour and Employment, the third by the
Central Statistics Office (CSO) in the Ministry of Statistics and
Programme Implementation.
 In India, RBI uses CPI(combined) released by CSO for inflation
purpose. Base year for CPI (Rural, Urban, Combined) is 2012=100.
 Consumer Price Index
 The number of items in CPI basket include 448 in
rural and 460 in urban.
 The items in CPI are divided into 6 main groups as

follows:
 Key differences between WPI and
CPI
 Primary use of WPI is to have inflationary trend in the economy as a whole. CPI is
used for adjusting income and expenditure streams for changes in the cost of living.
 WPI is based on wholesale prices for primary articles, administered prices for fuel
items and ex-factory prices for manufactured products. On the other hand, CPI is
based on retail prices, which include all distribution costs and taxes.
 Prices for WPI are collected on voluntary basis while price data for CPI are
collected by investigators by visiting markets.
 CPI covers only consumer goods and consumer services while WPI covers all goods
including intermediate goods transacted in the economy.
 WPI weights primarily based on national accounts and enterprise survey data and
CPI weights are derived from consumer expenditure survey data.
Causes of Inflation: Demand-Pull
Inflation

Increase in AD
can be due to
a fiscal or
monetary
policy, thus
increasing
prices
Causes of Inflation: Cost-Push
Inflation

Upward shift of
the AS will be
due to increase
in costs due to
increase in price
of inputs.
Combination of both
Stagflation:
 Stagflation occurs when output is falling at the
same time that prices are rising.
 One possible cause of stagflation is an increase in
costs.
Costs of inflation:
 Redistribution of income and wealth- borrowers gain
and creditors lose, fixed income earners lose.
 Balance of payments effect- exports become
expensive. Hence exchange rate depreciates.
 Uncertainty about the value of money
 Resource cost of changing prices – menu costs
 Economic growth and investment suffers
 Distortion in tax rates
 Phillips Curve
 1958 – Professor A.W.  Theory expressing a trade-off
Phillips between inflation and
 Expressed a statistical unemployment
relationship between the
rate of growth of money
wages and unemployment
from 1861 – 1957
 Rate of growth of money
wages linked to inflationary
pressure
 Phillips Curve
Wage growth %
(Inflation) The Phillips Curve shows an
inverse relationship between
inflation and unemployment. It
suggested that if governments
wanted to reduce unemployment
it had to accept higher inflation as
2.5% a trade-off.
Money illusion – wage rates rising
but individuals not factoring in
inflation on real wage rates.
1.5%

4% 6% Unemployment (%)
PC1
 Phillips Curve
 The curve crosses the horizontal axis at a positive value of
unemployment. Hence it is not possible to have zero inflation and zero
unemployment
 The shape implies that lower the level of unemployment higher the
rate of inflation.
 Govt. should be able to use demand management policies to take the
economy to acceptable levels of inflation and unemployment.
 In order to achieve full employment, some inflation is unavoidable.
 However, this relationship broke down at the end of 1960s when
Britain began to experience rising inflation and unemployment.
 This raised a question on the application of Phillips curve in the long
run.
 The Phillips Curve
To counter the rise in unemployment,
 inflation Long Run PC government once again injects resources
into the economy – the result is a short-term
fall There
inAssume
unemployment
is athe
short
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with an inflation
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1% ofbuthigher
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Individuals atnow
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This higher inflation fuels further expectation
wage
Government
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expectations
to reduce
of higher inflation
of higher inflation
inunemployment
the next period. and
byIfan
higherso the
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wages arefiscal
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then
continues. The long run Phillips Curve is
firms
that costs
pushes rise
AD– to
they
thestart
rightto
(see
shedthe
labour
AD/AS and
unemployment
diagram on slide creeps
15) back up to 7% again.
vertical at the natural rate of unemployment.
3.0% This is how economists have explained the
movements in the Phillips Curve and it is
termed the Expectations Augmented
Phillips Curve.
2.0%

1.0%
PC1
7% PC2 Unemployment
PC3
 Non-Accelerating Inflation Rate
Of Unemployment - NAIRU
 The non-accelerating inflation
rate of unemployment (Nairu) -
also referred to as the long-run
Phillips curve - is the specific
level of unemployment that is
evident in an economy that does
not cause inflation to rise up.
NAIRU often represents
equilibrium between the state of
the economy and the labor
market.
 Countering inflation
Demand -pull Reduce demand by higher taxation, lower govt. expenditure,
lower govt borrowing, higher interest rates

Cost push Take steps to reduce production costs by deregulating labour

markets, encouraging greater productivity, apply control over
wages and prices

Import factors reduce quantity of imports or their prices via trade policies.
 Controlling inflation
Excessive growth Reduce money supply by cutting down on public sector
on money supply borrowing
Funding Govt borrowing from non bank
Reduce bank lending
Maintain interest rates

Expectations of Pursue policies which indicate Govt’s determination to reduce

inflation inflation