Inflation and unemployment are the two most talked-

CHAPTER 7 about words in the contemporary society.

These two are the big problems that plague all the
INFLATION AND UNEMPLOYMENT economies.

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1. INFLATION
1.1 Definition
Inflation is the rate at which the general level of
prices for goods and services is rising and,
consequently, the purchasing power of currency is
falling.
 General level of prices is a quantitative measure
of the rate at which the average price level of a
basket of selected goods and services in an
economy increases over a period of time.
 It is the constant rise in the general level of
prices where a unit of currency buys less than it
did in prior periods. Often expressed as a
percentage, inflation indicates a decrease in
the purchasing power of a nation’s currency 3 4

1. INFLATION 1.2 Inflation Rate (CPI, annual variation in %)

• Inflation refers to an overall increase in the Consumer
Deflation is the general decline in prices for Price Index (CPI), which is a weighted average of prices for
goods and services occurring when the inflation different goods.
rate falls below 0%.
• The set of goods that make up the index depends on
which are considered representative of a common
consumption basket.

• Depending on the country and the consumption habits of

the majority of the population, the index will comprise
different goods.

• Annual inflation, refers to the percent change of the CPI

5 compared to the previous year. 6

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 1.2 Inflation Rate (CPI, annual variation in %) 1.3 Types of inflation

• Annual inflation, refers to the percent change of the CPI •Moderate Inflation: Takes place when the prices of
compared to the previous year. goods and services rise at a single digit rate
annually.
•Moderate inflation is also termed as
creeping inflation. When an economy passes
CPI (t) – CPI (t-1)
through moderate inflation, the prices of goods
Inflation rate (t) =
and services increase but at moderate rate.
CPI (t-1)

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1.3 Types of inflation

1.3 Types of inflation
• Galloping Inflation is a type of inflation that occurs
when the prices of goods and services increase at two- • Hyperinflation is an extremely rapid period of inflation,
digit or three-digit rate per annum. usually caused by a rapid increase in the money supply.
• Galloping inflation is also known as jumping inflation. Usually due to unrestrained printing of fiat currency.

• Classic examples are the Hyperinflation of Weimar

Germany and the more recent Zimbabwean
Hyperinflation which reached 2.2 Million Percent.

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Hyperinflation 1.4 Causes of Inflation

• Inflation means a sustained increase in the general price
• …But as it went on, things got worse, dentists and doctors stopped
asking for currency, seeking payment in butter or eggs instead. level. However, this increase in the cost of living can be
Prices rose not just by the day, but by the hour — or even the caused by different factors. The main two types of
minute. If you had your morning coffee in a café, and you preferred inflation are:
drinking two cups rather than one, it was cheaper to order both • Demand-pull inflation – this occurs when the economy
cups at the same time…
grows quickly and starts to ‘overheat’ – Aggregate
demand (AD) will be increasing faster than aggregate
• During times of Hyperinflation people know the money will be supply (AS).
worth less tomorrow so they exchange any cash they have for any
physical good they can get their hands on (whether they need it or • Cost push inflation – this occurs when there is a rise in
not). After all, a bar of soap will still be a bar of soap tomorrow but the price of raw materials, higher taxes, e.t.c
it may take twice as many dollars to buy it.

• In Zimbabwe, by 2008 the (hyper)inflation rate had reached 2.2

million percent. Eggs sold for a million dollars each. 11 12

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 1.4 Causes of Inflation
• Demand-pull inflation – this occurs when the Demand-pull Inflation
economy grows quickly and starts to ‘overheat’ –
Aggregate demand (AD) will be increasing faster than
aggregate supply (AS).

P AD’ Demand-
Increased Additional Increase in
AD AS pull
Income Demand Price Level
Inflation

P2

P1

Q
Yp Y1

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1.4 Causes of Inflation

• Cost push inflation: Cost of production may rise due to an Cost push Inflation
increase in the prices of raw materials, wages, etc. Often
trade unions are blamed for wage rise since wage rate is
not completely market-determinded. Higher wage means
high cost of production. Prices of commodities are
thereby increased. Increased cost
Increase in Cost push
P AS’ for Inputs and
AD AS Price Level Inflation
Raw materials

P2

P1

Q
Y1 Yp

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The GDP deflator

Consumer Price Index (CPI)
The GDP deflator is a price index that measures inflation
or deflation in an economy by calculating a ratio of
nominal GDP to real GDP.

ΣPit x Qi0
CPI = GDPnominal ΣPit x Qit
ΣPi0 x Qi0 GDPdef = =
Trong đó : GDPreal Σ Pi0 x Qit
Qi0 : Quantity of goods i in base year.
Pio : Price of goods i in base year.
Pit : Pricce of goods i in year t.

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 1.4 The effects of inflation:
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.
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
utilising all the available resources at their disposal.
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.
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1.4 The effects of inflation: Cost of Inflation

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.

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2. UNEMPLOYMENT
•Unemployment occurs when a person who is
• Unemployment rate:
actively searching for employment is unable to find
work.
Unemployed people
•Unemployment is often used as a measure of the
Unemployment rate(%) = x100%
health of the economy.
People in the labor force
•The most frequent measure of unemployment is the
unemployment rate, which is the number of • Okun Law:
unemployed people divided by the number of Yp – Yt 100 %
people in the labor force. Ut = Un + ------------- x -----
Yp 2
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 The Phillip’s curve:

•The Phillips curve is an economic concept

developed by Alban William Housego Phillips (A.
W. Phillips) stating that inflation and
unemployment have a stable and inverse
relationship.

•The theory claims that with economic growth

comes inflation, which in turn should lead to more
jobs and less unemployment.

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The Phillip’s curve:

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