CHAPTER 5

INFLATION AND
UNEMPLOYMENT
 Chapter Review
• Definition
• Types (Cost Push, Demand Pull, Imported)
• Effects
• Inflation rate formula
• Method to control (Monetary Policy, Fiscal
Policy, Direct Control)
 Inflation
Definition
• Inflation can be defined as a situation where
there is a continuous increase in general
price level over time.
 Inflation
The sign of inflation
• There is too much money chasing too few
goods.
• Cost of living has increased.
• Prices are rising continuously.
 Inflation
Investment versus Inflation
 Inflation
Types of Inflation

• Demand pull inflation

• Cost push inflation
• Imported inflation
 Types of Inflation
Demand Pull Inflation

BUT

Demand
Supply less
more
 Types of Inflation
Demand Pull Inflation
• The basic cause of inflation
• Comes from the demand side
• Often expresses as “too much money chasing
too few goods”
• Sellers unable to supply all the goods and
services in the economy, they respond by
raising the price
 Types of Inflation
Cost Push Inflation

• Rising costs of production (increase in wage

rate & prices of raw materials)
• Rising production costs, firms push prices up
• The pressure on prices can be caused by cost
of labor, raw materials, construction,
equipment, cost of borrowing and price of
output
 Types of Inflation
Cost Push Inflation

CAUSE
S

Cost of Firms increase

production price
increase
Cost Push Inflation Graph

Shift AS curve to the left –

price increase
 Types of Inflation
Imported Inflation
• Inflation due to an increase in the price of imports
• As the price of imports increase, prices
of domestic goods using imports as raw materials
also increase
• Causing an increase in the general prices of all
goods and services
• Example: Inflated prices of oil from Middle East
Formula of Inflation
 Measurement of Inflation
CPI Index
• CPI index
• What is CPI?
• The most widely data used to calculate
inflation
– Includes only consumer goods & services in order
– Does not consider item purchased by business &
government
 What is CPI?
• The most widely
data used to calculate
inflation
• Data from: an
average price of a
basket of goods in a
year
• Includes only
consumer goods &
services
 What is CPI? (cont.)
• Shows the change in
the average price of
consumer goods &
services
• Sometimes called as
cost-of-living index
• to determine how rising
prices affect the income
of consumer
 Formula of CPI
CPI in year K =

Cost of basket in year K

X 100%
Cost of basket in base year
 Calculate CPI

2011 = RM 200 2012 = RM 250

CPI 2011 = (RM200/RM200) x 100 = 100
CPI 2012 = (RM250/RM200) x 100 = 125
 Formula of Inflation Rate
Now by using CPI formula, we can obtain inflation
rate:
 Formula of Inflation Rate

CPI t  CPI t 1
t  100   
CPI t 1
 Question
• In December 1999, CPI was 118.9, and
December 1998, it was 115.7, so the inflation
rate for 1999 was?
www.thestar.com.my
The Effects of
Inflation
 The Effects of Inflation
• The effects of inflation can be describe as a
positive effects and negative effects.
• There are TWO groups that one side get
benefits from inflation and another side suffer
from inflation.
 The Effects of Inflation
Positive
• Businessman because get higher profits from
rising in prices
• Property owners / real estate owners because
the value of assets (house/land) tend to
increase as the price increases
 The Effects of Inflation
Positive
• Property owner/real estate owner
– Example: consider a home purchased in 1980 for
RM 100,000. By the early of 2000, this home
might sell for RM200,000 result of inflation
– BUT ----- > young couple that might lose from the
increases in assets price
 The Effects of Inflation
Positive
• During inflation, the general level of prices
rises and producers make higher profits
• Lead the producers to increase their level of
production and investment
• Create more jobs opportunities
 The Effects of Inflation
Negative

• People dependent on fixed incomes

• Because their money buys a little less each
month and increase their fees.
 The Effects of Inflation
Negative
• Export now less attractive to foreigners
• Arises because imported products are now
cheaper than domestic products
• Import now start to increase
• (X-M = negative)
 Methods to control
 Fiscal policy
 Monetary policy
 Direct control measure
Methods to Control
Fiscal Policy

Contractionary Fiscal Policy

Cut in tax Government

expenditure
 Methods to Control
Monetary Policy

Contractionary Monetary Policy

BNM withdraw the

cash from banking
system
(decrease Ms)
Statutory Discount
reserve rate
Money Minimum
Interest
Supply liquidity
rate
requirement
 Methods to Control
Direct Control Measure
• Price control Price controls for 20 items ahead of
Aidilfitri
– By fixing a floor August 02, 2012

price and ceiling PUTRAJAYA, Aug 2 — The Ministry of

Domestic Trade, Cooperatives and
price to curb Consumerism has put 20 food items
inflation under the price control scheme for
Aidilfitri.

Its minister, Datuk Seri Ismail Sabri

Yaacob, said today that the price control
scheme will be implemented for 15 days,
from Aug 12 to Aug 26. – Bernama

Source: Malaysian Insider.com

 Methods to Control
Direct Control Measure
• Rationing
– By using coupons or
s where consumers
can purchase limited
goods
 Methods to Control
Direct Control Measure
• Rationing
– restricted the limit of
consumer purchase
 Methods to Control
Direct Control Measure
• Anti-hoarding campaign
– Campaign that against storing goods which
can cause a shortage and push up in price
Anti-Hoarding Campaign
 Methods to Control
Direct Control Measure
– Compulsory savings
– A compulsory deduction from salary workers that is
credited to worker’s accounts
– In Malaysia, 24% (13% from employer, 11% from
employee) of the workers wages are deducted into
Employee Provident Fund (EPF) upon retirement