Unemployment and inflation (Topic 9)

Question 1

Unemployment

Answer 1

Unemployment is the situation when a person who is actively searching for employment is unable to find work

Question 2

Total population

Answer 2

Under 15 yrs and institutionalised
Not working as they are
→ Underaged
→ Mentally or physically incapable of work

Working age population (15 yrs and above)

1) Economically inactive population
→ Can work but are not working nor looking for work
→ Retirees, students

2) Economically active population (Labour force)
→ Employed
→ Unemployed (not working but are actively looking for work)

Question 3

Unemployment rate

Answer 3

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

Unemployment rate = unemployed / labour force X 100%

Question 4

Labour force participation rate (LFPR)

Answer 4

Refers to the proportion of the country’s population (aged 15 yrs and above) who are in the labour force

LFPR = Labour force / Population aged 15 yrs and above x 100%

Question 5

1st type of unemployment

Answer 5

Frictional unemployment

→ Temporary
→ Voluntary
→ Enough jobs but time is needed to find the right job and employee

Caused by the normal search time from imperfect information on the job market

(changing jobs, initially entering the labour force, or re-entering the labour force)

Solution: Improve methods of distributing job information
→ e.g. job listing on the internet

Question 6

2nd type of unemployment

Answer 6

Structural unemployment
→ Long-term
→ Enough jobs but workers do not have the skills that are needed to take up the jobs available

Caused by a skills mismatch between unemployed workers and available job opportunities

→ Technological changes, new skills needed to handle new technology

→ Changes in demand, new skills being needed as new industries arise and old industries disappear

Solution: Retraining and re-education, relocation to where skill is needed

Question 7

3rd type of unemployment

Answer 7

Cyclical unemployment
→ Unpredictable and in voluntary
→ Lack of jobs because outputs is low

Caused by the downturn in the business cycle. During recessions, when spending falls, less goods and services will be produced, resulting in less workers being employed (retrenchment)

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

Question 8

4th type of unemployment

Answer 8

Seasonal unemployment

Seasonal changes in employment, workers must search for new jobs

Question 9

Limitations of the official unemployment rate

Answer 9

Will understate the real problem of unemployment if there are:

Underemployment
→ refers to a condition where factors of production are operating below their capacity or potential

1) Underemployed workers
→ When a person has to accept a job that is way below what he is trained for

→ When a person wants to work full time but is forced to work a shorter work week

2) Discouraged workers
Someone who was initially unemployed but has given up looking for work because of repeated failure in getting a job

Question 10

Full employment

Answer 10

An economy is said to be at full employment, when whoever wants to work the full time work week will be able to find work

Unemployment is not zero. Unemployment rate is positive. The natural rate of unemployment exists in a full employment situation

In full employment cyclical unemployment must be ZERO only frictional and structural unemployment can occur as both can occur even when enough jobs are available

Question 11

Inflation & deflation

Answer 11

Inflation
A sustained and continuous increase in the general price levels of goods and services in the economy.

(Not all prices need to increase at the same time)

Deflation
A decrease in the general price level of goods and services in the economy

Question 12

Causes of inflation

Answer 12

Demand-pull inflation
→ A rise in the general price level resulting from an excess of total spending

AD = C + I + G + (X-M)

→ When AD increases (shift right), there will be a new higher equilibrium price level and quantity

Cost-push inflation
→ A rise in general price level resulting from an increase in the cost of production

Rise of production cost
→ Normal increases in the prices of factors of production (labour, rental, raw material cost)
→ Weakening of country’s exchange rate

→ AS decreases (shift left), there will be a new high equilibrium price level and lower equilibrium quantity

Question 13

CPI

Answer 13

The consumer price index is an index that measures changes in the average prices of consumer goods.

CPI = Cost of market basket, cy / cost of market basket, by x 100

ALWAYS USE BASE YEAR QUANTITY

→ Index for base year is always 100, current year is also the base year

→ An index of more than 100, prices in current year > base year

Question 14

Inflation rate

Answer 14

Inflation rate = CPI cy - CPI py / CPI py x 100%

Question 15

Consequences of inflation

Answer 15

Inflation → real income decreases → cost of living increases → purchasing power decreases → standard of living decreases

Real income = Money income / (price index / 100)

Question 16

Inflation penalizes and benefits

Answer 16

Penalizes
1) Fixed income earners
→ Money income is constant, when price increases, their real income falls

2) Savers
→ This is particularly true if the interest earned is less than the inflation rate

3) Creditors
→ Did not anticipate the inflation rate and charged a lower interest rate on their loans. The money they are repaid is worth less than when they first made the loan.

Benefits

1) Debtors
→ The money that was first borrowed had a certain amount of purchasing power, but when there is inflation, the loan that they repay is now of lesser value than when they first borrowed it

2) Flexible income earners
→ Income are indexed to the inflation rate

Question 17

Limitations of CPI

Answer 17

1) CPI does not consider substitution
→ Overstate the inflation rate

When calculating the CPI, the quantity is held constant at the base year level, assuming consumers buy the same amount of goods despite price changes.

In reality, consumers adjust their purchases based on price changes, buying more of cheaper goods and less of expensive ones. Thus, by maintaining a constant market basket, the CPI tends to overstate the inflation rate

2) CPI does not consider qualitative improvement

When there is quality improvement, the CPI tends to overstate inflation

3) CPI is not a total representative measure

Changes in the CPI are based on a typical basket of goods, which may not match the actual goods consumers buy.

If a person buys goods not in the basket and their prices rise faster, the CPI understates his inflation rate.

If the prices of the goods he buys rise slower, the CPI overstates his inflation rate.