Topic no. 9: Unemployment and inflation

Question 1

What is unemployment?

Answer 1

It is the situation when a person who is actively searching for employment but is unable to find work.

Question 2

How to classify the population?

Answer 2

Total population: Everyone

Under 15 yrs & Institutionalised:
not working due to:
i) underage
ii) mentally or physically incapable of work

Working age population (15 yrs & above):
- Economically inactive population [can work but not working or not looking for work] (e.g. retirees, students)
- Economically active population:
i) employed
ii) unemployed [not working but actively seeking for work]

Outside of labour force:
i) Under 15 yrs & Institutionalised
ii) Economically inactive population

Question 3

What is the unemployment rate?

Answer 3

The proportion of a country’s labour force that is unemployed.

Formula:

UN rate: (UN [number]/Labour force) x 100%

Question 4

What is the labour force participation rate?

Answer 4

Proportion of the country’s population (aged 15 yrs & above) who are in the labour force.

Formula:

LFPR: (Labour Force [number]/pop. aged 15 yrs and above) x 100 %

Question 5

What are the four types of unemployment?

Answer 5

a) Frictional unemployment
b) Structural unemployment
c) Cyclical unemployment
d) Seasonal unemployment

Question 6

What is frictional unemployment?

Answer 6

Caused by normal search time required by workers with marketable skills whoa re either changing jobs, initially entering the labour force, or re-entering the labour force to find a job. Search time needed because job information is not completed/imperfect.

Key features:
- Temporary
- Voluntary
- Enough jobs in the market but time is needed to find the right job and employee
- Results in a better match of worker and job
- Not serious but good to minimise waiting waiting between jobs

Solution: Improve methods of distributing job information. [e.g. through job listing on the internet]

Question 7

What is structural unemployment?

Answer 7

A long-term unemployment that is caused by a mismatch of skills of workers out of work and skills required for existing job opportunities.

• Technological changes
• Old industries disappearing and new industries appearing

Solution:
- Retraining & re-education
- Relocation to where skill is needed

Question 8

What is cyclical unemployment?

Answer 8

Lack of jobs caused by downturn in business cycles. During recessions, when spending falls, less goods and services will be produced, resulting in less workers being employed. (Retrenchment)

Key features:
i) unpredictable and involuntary;
ii) a situation where there are not enough jobs because output is low

Solution: Government involvement is necessary to bring the economy out of recession.

Question 9

What is seasonal unemployment?

Answer 9

Unemployment due to seasonal changes in employment. Inevitable in farming and skiing.

Question 10

What are the limitations of the Official Unemployment Rate?

Answer 10

a) Underemployment
[Factors of production are operating below their capacity or potential]
- a person accepting a job that is way below what he trained for; or
- a person who wants to work full time but forced to work a shorter work week

b) Discouraged worker
[Initially unemployed but has given up looking for work because of repeated failure in getting a job. Drops out of unemployed and labour force]

Question 11

What is full employment? [Natural Rate of Unemployment]

Answer 11

Condition of economy in which all available resources are used in the production of goods & services.

a. Economy at full employment when whoever wants to work full time work week able to find work

b. Unemployment is NOT zero but actually positive. [Natural rate of unemployment]

c. Two types of unemployment can still exist:
i) Frictional unemployment
ii) Structural unemployment
[Cyclical unemployment must be zero]

Question 12

What is inflation?

Answer 12

A sustained and continuous increase in the general (average) level of prices of goods and services in the economy.
[Not all prices need to increase at the same time. A one-time increase in price is not inflation → must be sustained & continuous]

One of the indicators of a country’s economic health.

Question 13

What is deflation?

Answer 13

A decrease in general (average) price level of goods and services in the economy.

Question 14

What is the cause of inflation?

Answer 14

As inflation can be classified into whether prices are rising because Aggregate Demand (AD) rose or Aggregate Supply (AS) fell.

Inflation due to AD is referred to as demand-pull inflation.

Inflation due to AS is referred to as cost-push inflation. [Caused by an increase in production cost]

Question 15

What is hyperinflation?

Answer 15

Occurs when there is an extremely rapid rise in the general price level.

Question 16

What is price stability?

Answer 16

Occurs when the average price level is neither moving up nor down.

Question 17

What are the four main expenditure components in any country?

Answer 17

AD = C + I + G + X - M

C: Consumption (demand by consumers)
[Household sector]

I: Investment (demand by investors)
[Business sector]

G: Government spending (demand by government)
[Government sector]

X-M: Exports - Imports [Net exports]
(demand by foreigners - what is demanded to them)

Question 18

What is demand-pull inflation?

Answer 18

A rise in the general price level resulting from an excess of total spending (aggregate demand).

• ↑ in AD can be brought about by increases in C, I, G, or X - M

“Demand-pull inflation due to ↑ in AD in any ↑ in [C+I+G+(X-M)] → AD → ↑ AD curve shifts right → ↑ price of final goods and services.”

• When AD ↑ / shifts to the right, there will be a new higher equilibrium price level and quantity.

Question 19

What is cost-push inflation?

Answer 19

An increase in the general price level resulting from an increase in the cost of production. An increase in the cost of production causes the AS curve to shift left, resulting in inflation.

“When AS ↓ / shifts to the left, there will be a new higher equilibrium price level and lower equilibrium quantity.”

Production cost can rise due to:
i) Normal increases in the price of factors of production. [e.g. higher labour costs, higher rental cost and higher costs of raw materials such as coal and natural gas]
ii) Weakening of a country’s exchange rate

Question 20

How to measure inflation?

Answer 20

Using the Consumer Price Index.

Measures changes in the average prices of consumer goods. Only includes consumer goods and services in order to determine how rising prices affect the income of consumers. [Cost-of-living index]

** It indicates what is happening to price at the retail level.

Question 21

How to compute CPI?

Answer 21

Using base year for reference.

Formula:
CPI (Price change) = (Cost of market basket, cy / cost of market basket, by) x 100
cy - Current year
by - Base year

Market basket = consumer goods total
[Price x Quantity]

Question 22

How to interpret a price index?

Answer 22

i) Index for the base year is always 100. Reason being is that the current year is also the base year.

ii) An index of more (less) than 100 indicates that prices in the current year is higher (lower) than that in the base year.

Question 23

How to calculate inflation rate?

Answer 23

Inflation rate = [(CPIcy - CPIpy)/CPIpy] x 100%

cy - Current year
py - Previous year

Question 24

What is the consequences of inflation?

Answer 24

Affects a person’s standard of living. It reduces a person’s standard of living as it reduces the purchasing power of money.

“The ↑ the rate of inflation, the ↓ in the quantity of goods and services money income can buy.”

Question 25

What is real income?

Answer 25

Purchasing power is measured by looking at a person’s real income:

Real income = Money income ÷ (Price index ÷ 100)

e.g.
Money income = $40000
2007 CPI = 167
2005 base year CPI = 100, chicken rice $1 per plate
Real income 2007 = $40000 ÷ 1.67
= $23952

Question 26

Who does inflation penalize?

Answer 26

i) Fixed income earners [e.g. pensioners]
Money income of this group is constant. When price ↓, their real income ↓.

ii) Savers
Particularly true if interest earned is less than inflation rate.

iii) Creditors
If they did not anticipate inflation rate and charge lower interest rate on their loans. Money repaid worth less than when loan was first made due to inflation.

Question 27

Who does inflation benefit?

Answer 27

i) Debtors
Money first borrowed had a certain amount of purchasing power but when there is inflation, loan to be repaid is lesser value than when first borrowed it.

ii) Flexible income earners [e.g. unionised workers]
Income indexed to inflation rate.

Question 28

What are the limitation of the CPI?

Answer 28

i) Does not consider substitutions.
[Assumes consumer buy same amount of goods as before. CPI overstates the inflation rate.]

ii) Does not consider qualitative improvement.
[Quality improvement not consider = CPI overstates inflation rate]

iii) Not a total representative measure
[Based on typical basket of goods purchased, does not match what the actual bundle of goods consumers would buy. Can either overstate or understate the inflation rate]