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Inflation

Inflation- The rise in the general level of prices

In the long term, inflation erodes consumer purchasing

power.

That means that accumulated wealth buys less and less,

 with the passage of time.

Where there is high inflation it is difficult for businesses to

plan for the future as there is uncertainty regarding thecost of raw materials

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The causes of inflationThe causes of inflation

• inflation results when the macro economy has too much demand foravailable production. These alternatives fall under two generalcategories:

• Demand-ull Inflation: In effect, the demand side of the aggregatemar!et is "pulling" the price level higher.

• #ost-ush Inflation: #ost-push inflation is inflation attributable to

decreases in supply, primarily due to increases in production cost.• $oney supply increase

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#ost ush Inflation#ost ush Inflation

%s costs rise it causes the%s costs rise it causes the

aggregate supply curve toaggregate supply curve to

shift onwards so less isshift onwards so less is

supplied at each price levelsupplied at each price level &ach time the aggregate&ach time the aggregate

supply curve shifts inwardssupply curve shifts inwards

the price rises causingthe price rises causing

inflationinflation

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Demand pull inflationDemand pull inflation

%s aggregate demand%s aggregate demand

increases then the generalincreases then the general

price level risesprice level rises

When total demand e'ceedsWhen total demand e'ceeds

total supply demand pulltotal supply demand pull

inflation occursinflation occurs

If the economy is close to fullIf the economy is close to full

capacity the effects of demandcapacity the effects of demand

pull inflation will be greaterpull inflation will be greater

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COSS O! "#!$A"O# "%fla&'o% 's l'e a &a *shoe lea&her

cos& +he% '%fla&'o% e%coura,es-eo-le &o reduce mo%ey hold'%,s *more freue%& &r'-s &o ba%s.

/e%u cos&scos&s of -r'ce

adus&me%&2 -r'%&'%, %e+ -r'cel's&2ca&alo,s2ad3er&'seme%& e&c.

a,,era&es ca-'&al ,a'%s a%d'%creases &a l'ab'l'&y. ou bou,h&a share a& 10 '% 10 a%d sold a&50 '% 8010. Ca-'&al ,a'% 's 40 &o

be &aed. Bu& 'f '%fla&'o% hasdoubled2 &he% you ha3e '%3es&edeu'3ale%& of 80 '% 80109.

:ed's&r'bu&es '%come

$e%ders loose2 borro+ers,a'%

;'s&or&s resource alloca&'o% * as '%fla&'o% affec&s rela&'3e-r'ces

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INFALTION AFFECTS GDPINFALTION AFFECTS GDP

↑ → ↑ → ↑ → ↓ → ↓ → ↓ P M r I A E d 

 

Y 

he "m-ac& of a% "%crease '% &he Pr'ce $e3el o% &heco%omy * Assum'%, #o Cha%,es '% G2 T 2 a%d M s

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reventing inflationreventing inflation

(ne of the best ways to prevent inflation is through stoc!,(ne of the best ways to prevent inflation is through stoc!,

variable annuities, and variable universal life insurance.variable annuities, and variable universal life insurance.

These alternatives provide the potential for returns thatThese alternatives provide the potential for returns that

e'ceed inflation over the long term.e'ceed inflation over the long term. 

#entral ban!s place high interest rates using#entral ban!s place high interest rates using

unemployment and the decline of production to preventunemployment and the decline of production to prevent

price increases.price increases.

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MEASURING INFLATIONMEASURING INFLATION

 The consumer price index (CPI) is mesure o! "he o#er$$ The consumer price index (CPI) is mesure o! "he o#er$$

cos" o! "he %oods nd ser#ices &ou%h" &' "'pic$ consumercos" o! "he %oods nd ser#ices &ou%h" &' "'pic$ consumer

(s)(s)

S"ep * Fix "he &s+e" &' consumer sur#e' ,- ho" do%s. /S"ep * Fix "he &s+e" &' consumer sur#e' ,- ho" do%s. /&ee! &ur%ers&ee! &ur%ers

S"ep /*Find "he price in ech poin" in "imeS"ep /*Find "he price in ech poin" in "ime

 0er Price o! ho" do%s(1) Price o! &ur%er (1) 0er Price o! ho" do%s(1) Price o! &ur%er (1)

/223 //223 /

/224 / 5/224 / 5

/226 5 -/226 5 -

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MESURING INFLATIONMESURING INFLATION

(Con"d)(Con"d) S"ep 5* Compu"e "he cos" o! "he &s+e" !or ech 'er*S"ep 5* Compu"e "he cos" o! "he &s+e" !or ech 'er*

/223* (1 per 78 9 - 78) : (1/ per ;; 9 / ;;) , 1< per &s+e"/223* (1 per 78 9 - 78) : (1/ per ;; 9 / ;;) , 1< per &s+e"

/224* (1/ per 78 9 - 78) : (15 per ;; 9 / ;;) , 1- per &s+e"/224* (1/ per 78 9 - 78) : (15 per ;; 9 / ;;) , 1- per &s+e"

/226/226

15 per 78) 9 - 78) : (1- per ;;) 9 /;;),1/2 per &s+e"15 per 78) 9 - 78) : (1- per ;;) 9 /;;),1/2 per &s+e"

S"ep -* Choose one s &se 'er (/223) nd compu"e "he index)S"ep -* Choose one s &se 'er (/223) nd compu"e "he index)

/223* (1

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MEASURING INFLATION (Con"d)MEASURING INFLATION (Con"d)

CPI, Prices o! &s+e" o! %oods nd ser#ices no=prices o! &s+e" inCPI, Prices o! &s+e" o! %oods nd ser#ices no=prices o! &s+e" in

&se 'er922&se 'er922

In>"ion r"e in 'er /* CPI in 'er / B CPI in 'er =CPI in 'erIn>"ion r"e in 'er /* CPI in 'er / B CPI in 'er =CPI in 'er

922922

Pro&$ems i"h CPI* Su&s"i"u"ion &is B xed &s+e"D ne %oodsDPro&$ems i"h CPI* Su&s"i"u"ion &is B xed &s+e"D ne %oodsDu$i"'u$i"'

G8P de>"or (R"io o! nomin$ G8P "o re$ G8P) nd CPI "e$$ smeG8P de>"or (R"io o! nomin$ G8P "o re$ G8P) nd CPI "e$$ sme

s"or' &u" dieren" on "o coun"s*s"or' &u" dieren" on "o coun"s*

8e>"or considers $$ prices produced domes"ic$$' hi$e CPI $$8e>"or considers $$ prices produced domes"ic$$' hi$e CPI $$

%oods &ou%h" &' consumer ($so impor"ed) Thus. rise in irp$nes%oods &ou%h" &' consumer ($so impor"ed) Thus. rise in irp$nesprice shos up in de>"or no" in CPID rise in price o! A$$ion cr shosprice shos up in de>"or no" in CPID rise in price o! A$$ion cr shos

up in CPI no" in de>"or Simi$r$' oi$ pricesup in CPI no" in de>"or Simi$r$' oi$ prices

;s+e" chn%es i"h de>"or s G8P %ros &u" no" CPI;s+e" chn%es i"h de>"or s G8P %ros &u" no" CPI

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)nemployment)nemployment

There are a number of types of unemployment:There are a number of types of unemployment: *tructural unemployment*tructural unemployment

#yclical unemployment#yclical unemployment

+rictional unemployment+rictional unemployment

*tructural unemployment occurs when the economy*tructural unemployment occurs when the economy

changes and industries die outchanges and industries die out

Training is needed to give the unemployed wor!ersTraining is needed to give the unemployed wor!ers

new s!illsnew s!ills

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)nemployment)nemployment

#yclical unemployment is caused by the business#yclical unemployment is caused by the business

cyclecycle

+rictional unemployment is caused when people+rictional unemployment is caused when people

are temporarily out of wor! as they are moving obsare temporarily out of wor! as they are moving obs

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)nemployment and +)nemployment and +

)nemployment means that)nemployment means thatscarce economicscarce economicresources are beingresources are being

 wasted reducing the long wasted reducing the longrun potential of therun potential of theeconomyeconomy

Where there are highWhere there are high

levels of unemployment anlevels of unemployment aneconomy will be operatingeconomy will be operatinginside the perimeters of itsinside the perimeters of its++

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7O UNEMPLO0MENT IS

MEASURE8H L&or !orce , Num&er o! emp$o'ed

: num&er o! unemp$o'ed

Unemp$o'men" r"e , Num&er o!

unemp$o'ed=L&or !orce922

L&or !orce pr"icip"ion r"e,

L&or !orce=Adu$" popu$"ion922

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)nemployment and %D %*)nemployment and %D %*

%s %ggregate demand increases unemployment will%s %ggregate demand increases unemployment will

decreasedecrease

*upply side policies can be used to increase*upply side policies can be used to increase

aggregate supply in the economy and therebyaggregate supply in the economy and thereby

reduce the level of unemploymentreduce the level of unemployment

owever if the growth in the level of aggregateowever if the growth in the level of aggregate

demand is less than the underlying trend growth indemand is less than the underlying trend growth in

output unemployment is li!ely to occuroutput unemployment is li!ely to occur

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#auses and #onse/uences of#auses and #onse/uences of

)nemployment)nemployment

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olicies that increase labour mar!et

fle'ibility

% number of policies can be implemented to

increase mar!et fle'ibility and reduce

unemployment olicies can be implemented on the supply

side and the demand side by the government

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*upply side policies

*upply side policies include:

0educing the occupational mobility of labour 1 this

can be through providing training for theunemployed, increasing the availability and /uality

of education and providing incentives for people to

 wor!

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Demand side policiesDemand side policies

&mployment subsidies can be used by the&mployment subsidies can be used by the

government to encourage businesses to give obsgovernment to encourage businesses to give obs

to the long term unemployedto the long term unemployed

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&ffects of )nemployment&ffects of )nemployment

< (n an individual level unemployment reduces the level of income that(n an individual level unemployment reduces the level of income thatan individual earnsan individual earns

< %s their income has been reduced consumption also reduces as they%s their income has been reduced consumption also reduces as theypay for necessities rather than lu'uriespay for necessities rather than lu'uries

< 2oods that are income elastic will be consumed less2oods that are income elastic will be consumed less< 3uality of life will be reduced for the unemployed wor!er3uality of life will be reduced for the unemployed wor!er

< Wor!ers may become discouraged and give up searching for obsWor!ers may become discouraged and give up searching for obsbecoming part of the long term structural unemployment in the )4becoming part of the long term structural unemployment in the )4

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&ffects of )nemployment

)nemployment can have significance effectson the performance of the economy as a whole

The effects are most mar!ed due to long termsunemployment

If there is unemployment in the economy

resources are not being used effectively andthe economy will be operating below any pointson the + curve

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&conomic effects of unemployment&conomic effects of unemployment

If unemployment rates are rising their will be a negativeIf unemployment rates are rising their will be a negative

impact on economic growth potentialimpact on economic growth potential

#onsumption is li!ely to fall as consumers will have had a#onsumption is li!ely to fall as consumers will have had a

decrease in income levelsdecrease in income levels2overnment spending will increase as the government will2overnment spending will increase as the government will

be responsible for benefit paymentsbe responsible for benefit payments

Ta'ation levels will decrease as less people are in wor! andTa'ation levels will decrease as less people are in wor! andtherefore paying ta'estherefore paying ta'es

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5atural 0ate of )nemployment ypothesis5atural 0ate of )nemployment ypothesis

The natural rate of unemployment recogni6es thatThe natural rate of unemployment recogni6es that

there will always be some level of unemployment inthere will always be some level of unemployment in

an economyan economy

%t the natural rate all unemployment will be%t the natural rate all unemployment will be

voluntaryvoluntary

This is the employment rate when the economy isThis is the employment rate when the economy is

operating at full employmentoperating at full employment

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Determinants of the natural rate

The natural rate is determined by the interaction

of the demand for labour and the supply of labour

%t the e/uilibrium wage rate all people who want a ob can get a ob

owever at this wage rate their will be some

people who choose not to wor!

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Determinants of the natural rate

The natural rate of unemployment is

determined by:

7alue of welfare benefits Trade union power

Ta'ation system

$igration of labour *ocial factors

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5atural rate of unemployment and policy5atural rate of unemployment and policy

If governments want to reduce the natural rate ofIf governments want to reduce the natural rate of

unemployment they need to concentrate on supplyunemployment they need to concentrate on supply

side policiesside policies

If the benefits system is relatively high in a countryIf the benefits system is relatively high in a country

it will cause less people to want to wor!it will cause less people to want to wor!

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The hillips #urve

*hort run phillips curve is curve shaped

The long run phillips curve the curve is vertical

%t this rate the where unemployment is at its

natural rate inflation is stable

In the )4 since 899 there has been low

inflation and low unemployment

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hillips #urve