MACRO ECONOMICS

Inflation And Unemployment

Hashim Riaz (SP19-BBA-145)

Haziq Hussain (SP19-BBA-149)
Mehwish Khan (SP19-BBA-179)
Ali Afaq (SP19-BBA-165)
INFLATION

Definition
 Sustained increment in the general value level of merchandise and ventures in an economy over
some undefined time frame
 A general increment in costs and fall in the acquiring estimation of cash.
 Decline in the real value of money
 Caused by the excessive growth by money supply (Economist generally believe)

“Once prices have increased, they rarely go back, even if the taxes are late reduced.”

“Inflation is as violent as a mugger, as frightened as an armed robber and as deadly as a hitman.”

(Ronald Reagan)

Causes of Inflation

 Inflation can arise from internal and external events

 Some inflationary pressures direct from the domestic economy, for example the decisions of
utility businesses providing electricity or gas or water on their tariffs for the year ahead, or the
pricing strategies of the food retailers based on the strength of demand and competitive pressure
in their markets.
 Inflation can also come from external sources, for example a sustained rise in the price of crude
oil or other imported commodities, foodstuffs and beverage

Demand-pull Inflation

 Demand pull inflation occurs when aggregate demand is growing at an unsustainable rate leading
to increased pressure on scarce resources and a positive output gap

 Main Causes of Demand- Pull Inflation

 A depreciation of the exchange rate increases the price of imports and reduces
the foreign price of a country's exports.
 Higher demand from a fiscal stimulus e.g. lower direct or indirect taxes or higher
government spending. If direct taxes are reduced, consumers have more
 disposable income causing demand to rise. Higher government spending and
increased borrowing creates extra demand in the circular flow
 Monetary stimulus to the economy: A fall in interest rates may stimulate too
much demand

Cost-Push Inflation
 Cost-push inflation is a type of inflation caused by substantial increases in the cost of important
goods or services where no suitable alternative is available

 Main Causes of Cost-Pull Inflation

 Monopoly
 Wage inflation
 Natural Disasters
 Government Regulation and Taxation
 Exchange Rates

Built-in inflation

 It is a type of inflation that results from past events and persists in the present.

 The built-in inflation originates from either persistent demand-pull or large cost-push (supply-
shock) inflation in the past. It then becomes a "normal" aspect of the economy, via inflationary
expectations and the price/wage spiral.

Effects Of Inflation

1) Effects on Distribution of Income and Wealth

The impact of inflation is felt unevenly by the different groups of individuals within the
national economy—some groups of people gain by making big fortune and some others
lose.
  Creditors and debtors
During inflation creditors lose because they receive in effect less in goods and services than
if they had received the repayments during a period of low prices. Debtors, on other hand,
as a group gain during inflation, since they repay their debts in currency that has lost its
value.

 Producers and workers

Producers gain because they get higher prices and thus more profits from the sale of their
products. As the rise in prices is usually higher than the increase in costs, producers can earn
more during inflation. But, workers lose as they find a fall in their real wages as their money
wages do not usually rise proportionately with the increase in prices. They, as a class,
however, gain because they get more employment during inflation.

 Fixed income-earners
Fixed income-earners like the salaried people, rent-earners, landlords, pensioners, etc.,
suffer greatly because inflation reduces the value of their earnings.

 Investors
The investors in equity shares gain as they get dividends at higher rates because of larger
corporate profits and as they find the value of their shareholdings appreciated. But the
bondholders lose as they get a fixed interest the real value of which has already fallen.

 Traders, speculators, businesspeople and black-marketers

They gain because they make more profits from the persistent rise in prices.

 Farmers
Farmers also gain because the rise in the prices of agricultural products is usually higher
than the increase in the prices of other goods.

Thus, inflation brings a shift in the pattern of distribution of income and wealth in the
country, usually making the rich richer and the poor poorer. Thus during inflation there is
more and more inequality in the distribution of income.

2) Effects on Production:
The rising prices stimulate the production of all goods—both of consumption and of capital
goods. As producers get more and more profit, they try to produce more and more by
utilizing all the available resources at their disposal.

But, after the stage of full employment the production cannot increase as all the resources
are fully employed. Moreover, the producers and the farmers would increase their stock in
the expectation of a further rise in prices. As a result, hoarding and cornering of
commodities will increase.
 But such favorable effects of inflation upon production are not always found. Sometimes,
production may come to a standstill position despite rising prices, as was found in recent
years in developing countries like India, Thailand and Bangladesh. This situation is described
as stagflation.

3) Effects on Income and Employment:

Inflation tends to increase the aggregate money income (i.e., national income) of the
community as a whole on account of larger spending and greater production. Similarly, the
volume of employment increases under the impact of increased production. But the real
income of the people fails to increase proportionately due to a fall in the purchasing power
of money.

4) Effects on Business and Trade:

The aggregate volume of internal trade tends to increase during inflation due to higher
incomes, greater production and larger spending. But the export trade is likely to suffer on
account of a rise in the prices of domestic goods. However, the business firms expand their
businesses to make larger profits.

During most inflation since costs do not rise as fast as prices profits soar. But wages do not
increase proportionate with prices, causing hardships to workers and making more and
more inequality. As the old saying goes, during inflation prices move in escalator and wages
in stairs.

5) Effects on the Government Finance:

During inflation, the government revenue increases as it gets more revenue from income
tax, sales tax, excise duties, etc. Similarly, public expenditure increases as the government is
required to spend more and more for administrative and other purposes. But the rising
prices reduce the real burden of public debt because a fix sum has to be paid in instalment
per period.

6) Effects on Growth:
A mild inflation promotes economic growth, but a runaway inflation obstructs economic
growth as it raises cost of development projects. Although a mild dose of inflation is
inevitable and desirable in a developing economy, a high rate of inflation tends to lower the
growth rate by slowing down the rate of capital formation and creating uncertainty.
Controlling Inflation

1) Monetary measures

 Credit Control
Central bank of the country adopts a number of methods to control the quantity and
quality of credit. For this purpose, it raises the bank rates, sells securities in the open
market, raises the reserve ratio, and adopts a number of selective credit control
measures, such as raising margin requirements and regulating consumer credit.

 Demonetization of Currency
One of the monetary measures is to demonetize currency of higher denominations. Such
a measures is usually adopted when there is abundance of black money in the country.

 Issue of New Currency

The most extreme monetary measure is the issue of new currency in place of the old
currency. Under this system, one new note is exchanged for a number of notes of the old
currency.

2) Fiscal Measures

 Reduction in Unnecessary Expenditure

The government should reduce unnecessary expenditure on non-development activities
in order to curb inflation. This will also put a check on private expenditure which is
dependent upon government demand for goods and services.

 Increase in Taxes
To cut personal consumption expenditure, the rates of personal, corporate and
commodity taxes should be raised and even new taxes should be levied, but the rates of
taxes should not be so high as to discourage saving, investment and production.
 Increase in Savings
Another measure is to increase savings on the part of the people. This will tend to reduce
disposable income with the people, and hence personal consumption expenditure. But
due to the rising cost of living, people are not in a position to save much voluntarily.

 Surplus Budgets
An important measure is to adopt anti-inflationary budgetary policy. For this purpose, the
government should give up deficit financing and instead have surplus budgets. It means
collecting more in revenues and spending less.

 Public Debt
At the same time, it should stop repayment of public debt and postpone it to some future
date till inflationary pressures are controlled within the economy. Instead, the
government should borrow more to reduce money supply with the public.

 Other Measures
 To Increase Production
 Rational Wage Policy
 Price Control
 Rationing
Unemployment
 Unemployment occurs when workers who want to work are unable to find jobs, which means
lower economic output, while still requiring subsistence.
 High rates of unemployment are a signal of economic distress, but extremely low rates of
unemployment may signal an overheated economy.
 Unemployment can be classified as frictional, cyclical, structural, or institutional.
 Unemployment data are collected and published by government agencies in a variety of ways.

Types of Unemployment

1. Frictional Unemployment
Frictional unemployment arises when a person is in between jobs. After a person leaves a
company, it naturally takes time to find another job, making this type of unemployment short-
lived. It is also the least problematic from an economic standpoint. Frictional unemployment is a
natural result of the fact that market processes take time and information can be costly. Searching
for a new job, recruiting new workers, and matching the right workers to the right jobs all take
time and effort to do, resulting in frictional unemployment.

2. Cyclical Unemployment
Cyclical unemployment is the variation in the number of unemployed workers over the course of
economic upturns and downturns, such as changes to oil prices. Unemployment rises
during recessionary periods and declines during periods of economic growth. Preventing and
alleviating cyclical unemployment during recessions is a major concern behind the study of
economics and the purpose of the various policy tools that governments employ on the downside
of business cycles to stimulate the economy.

3. Structural Unemployment
Structural unemployment comes about through technological change in the structure of the
economy in which labor markets operate. Technological change such as automation of
manufacturing or the replacement of horse-drawn transport by automobiles, lead to
unemployment among workers displaced from jobs that are no longer needed. Retraining these
workers can be difficult, costly, and time consuming, and displaced workers often end up either
unemployed for extended periods or leaving the labor force entirely.
3) Institutional Unemployment
Institutional unemployment is unemployment that results from long term or permanent
institutional factors and incentives in the economy. Government polices such as high minimum
wage floors, generous social benefits programs, and restrictive occupational licensing laws; labor
market phenomena such as efficiency wages and discriminatory hiring; and labor market
institutions such as high rates of unionization can all contribute to institutional unemployment.

4. Measuring Unemployment
In the United States, the government uses surveys, census counts, and the number
of unemployment insurance claims to track unemployment.
The US Census conducts a monthly survey on behalf of the Bureau of Labor Statistics called
the Current Population Survey (CPS) in order to produce the primary estimate of nation’s
unemployment rate. This survey has been done every month since 1940. The sample consists of
about 60,000 eligible households, translating to about 110,000 people each month. The survey
changes one-fourth of the households in the sample so that no household is represented for more
than four consecutive months in order to strengthen the reliability of the estimates.

Causes of unemployment

Unemployment is caused by various reasons that come from both the demand side, or employer,
and the supply side, or the worker.
From the demand side, unemployment may be caused by high interest rates, global recession,
and financial crisis. From the supply side, frictional unemployment and structural employment
play a great role.

A look at the main causes of unemployment – including demand deficient, structural, frictional
and real wage unemployment.
Effects of unemployment

 Not Enough Money

This is one of the adverse effects on the individual. Everything in the world costs money. If there
is no source of income, you're going to have to settle and go without. If an unemployed
individual has a family, it's difficult. Sure, there are unemployment benefits, but they aren't
going to pay for extra things to do with your family and travel to new places.

 Health Issues:

This is another individual negative effect, but an important one. Being unemployed can lead to
depression, low self-esteem, anxiety and other mental health issues, especially if an individual
truly wants a job but can't find employment. Tension can occur, causing stress and strain on the
body.

 Economic Issues:

During unemployment, there is no income, which leads to poverty. The burden of debt will
increase, leading to economic problems. When there is unemployment, the state and the
federal governments have to step in and pay unemployment benefits. By needing to pay more
of these benefits, the government must borrow money to pay the benefits or reduce spending
in other areas.

 Social Issues:

Many crimes are committed by individuals who are unemployed and living in poverty. When
unemployment rates increase, crime rates tend to rise. According to the study in the Journal of
Quantitative Criminology in 2016, individuals who are unemployed for socially unacceptable
reasons and don't wish to seek out job opportunities are more likely to engage in burglary or
robbery.

Long-term unemployment vs. Short-term unemployment:

Unemployment that lasts longer than 27 weeks’ even if the individual has sought employment in
the last four weeks is called long-term unemployment. Its effects are far worse than short-term
unemployment for obvious reasons, and the following are noted as some of its effects.

 A huge 56% of the long-term unemployed reported a decrease in their income.

 It seems that financial problems are not the only effects of long-term unemployment as 46%
of those in such a state reported experiencing strained family relationships. The figure is
relatively higher than the 39% percent who weren’t unemployed for as long.
 Another 43% of the long-term unemployed reported a significant effect on their ability to
achieve their career goals.
 Sadly, long-term unemployment led to 38% of these individuals to lose their self-respect and
24% to seek professional help.

Conclusions

In reality low inflation rate and upward economic growth is never possible. Low inflation rate
means slow economic growth. From the various monetary, fiscal and other measures discussed
above, it becomes clear that to control inflation, the government should adopt all measures
simultaneously. Inflation is like a hydra- headed monster which should be fought by using all the
weapons at the command of the government.

Moreover, Unemployment is a serious social and economic issue that results in a tremendous
impact on everything but is often overlooked. A stronger system of assessing unemployment
should be put in place in order to determine its causes and how to address it better.