3.

10301

FOUNDATION
ECONOMICS

TOPIC 9 :

INFLATION AND
UNEMPLOYMENT

Objectives
At the end of the lesson, you should be able to:
1. define unemployment and employment.
2. explain how and why employment and
unemployment exist.
3. explain the causes and cures of unemployment
4. measure unemployment
5. contrast between the Classical and Keynesians
theory of employment.
6. Identify types of inflation, causes, etc..

Introduction
Economic growth or GDP expansion is not an
end in itself. It is a means to achieve certain
ends and the ends are: poverty reduction,
reduction in unemployment and inequality.
In this unit, the concept of unemployment and
income inequality will be discussed, defined,
measured and, finally you will know and
understand what causes them to occur and what
can be done to remedy them.

Unemployment
Human resources are seen as the most
important economic resource. The reason being
that, human beings are:
Durable and renewable resources
Quality of human material is the ultimate
determinant of economic success or failure of
nations. Without humans manmade resources
will not be produced and other natural resources
will remain idol.

Unemployment
Human beings are seen as factors of production,
and therefore must be utilized as much as
possible in anyway so as to enhance
productions levels in the economy.
The under-utilization of this resource brings
about unemployment and therefore declining
levels of GDP. Since the level of population
supports the level of GDP, it has a direct effect
on the level of GDP.

Unemployment
When a large proportion of a countrys
population is unemployed, GDP level becomes
relatively less as compared to a smaller
proportion being unemployed.
Unemployment is a state of joblessness that
can cause social problems such as law and
order, rural-urban drift, growth of urban
slums/squatter settlements, urban crime,
poverty, malnutrition, ill health, low level of
education, etc. This is because people need to
be employed to earn income and support
themselves to meet basic needs.

Unemployment
Besides social problems, unemployment can also cause
economic problems. The reasons stand from the fact
that the level of employment influences the level of
demand (aggregate demand).
If employment level increases, more people will earn
income, which will then increase their level of demand on
goods and services on the aggregate.
The increase in demand then fosters increases in supply.
That is, increases in demand must be met by increases
in supply to meet and clear market conditions.
To increase supply, production levels must then be
increased which means increases in the level of GDP.

Unemployment
The level of unemployment of labour can
be measured when the size of the labour
force is known. The size of the labour
force can be measured from many fronts,
as to how much labour should be included
in the labour force depends on how
countries define the extent of it.

Labour Force
The labour force consists of only the
economically active population that are readily
available. These are:
Those who are between age group of 15-65
years
Those that are able to work physically and
mentally
Those that are willing to work at the existing
wages
Those that are actively looking for work.

Labour Force
If more people are unemployed, they become
socially and economically handicapped and
become dependent on other people who are
fortunate.
Such people are known as dependents. A
large number of dependents can deteriorate
the lives of the rest of the population by
placing an extra burden on them. This problem
is mostly experienced in developing countries.

Types of Unemployment
1.

2.

Unemployables - People who cannot be

employed. These includes those who are too
young and too old (below 10 or 15 years and
above 65 years). Also, those who are too sick,
disabled, physically and mentally
handicapped, and serving prison sentences..
Voluntary unemployment - Consists of
people who are able to work but not willing to
work. They do not want to work at prevailing
wage rate

Types of Unemployment
3. Frictional Unemployment
People quit one job and take up another
job. Before taking up the next job, they
are unemployed.
4. Seasonal Unemployment
This is unemployment due to seasonal
nature of activity or industry. E.g. coffee
picking season

Types of Unemployment
5.

6.

Cyclical Unemployment
This type of unemployment depends on the business
cycle. During an economic boom, unemployment will
fall, and will increase during times of economic
recessions.
Technological Unemployment
This type of unemployment occurs When a particular
job or work is capital intensive or labour intensive, that
is, it requires more capital than labour to do the job,
then more labour will be unemployed. On the other
hand, when a particular job or work is labour intensive,

Types of Unemployment
7. Structural Unemployment
This is another type of involuntary unemployment, which is
caused by a number of factors.
Firstly, some people can be forced out of employment because
the economy experiences structural changes within itself. For
instance, locally owned companies or firms who produce tinnedmackerel can lay off their workers if imported (foreign) tinnedmackerel puts them out of business.
Secondly, a structural change can happen if there is a mismatch
between demand for and supply of labour
Thirdly, changes in tastes and fashions of consumers can also
cause structural changes within the economy.
Finally, structural changes can also be caused by technological
changes. That is the introduction of modern technology can
replace labour in the production of goods and services.

Types of Unemployment
8. Disguised Unemployment
A situation where people are working in an office or
industry but they are not contributing much by way of
productivity because they are seen to be redundant.
9. Demand-deficit Unemployment
This is the typical Keynesian type of unemployment,
where unemployment is caused by deficiency in
aggregate demand. When aggregate demand falls,
unemployment increases, and when aggregate demand
increases, unemployment falls.
Note, aggregate demand refers to total demand in the
economy. That is the total of domestic demand (C + I +
G) and foreign demand (X M), and not the demand of
consumption (C) goods and services only.

Remedies For Unemployment

Classicals and Keynesians Theory of
Employment
Remedies for unemployment can be seen from two
different schools of thought.
These are the Classical and Keynesian theory of
employment, which are the two main schools of thoughts
in economics where most of the economic ideologies
began.
The Classicals cover believe is that, market works best if
let to forces of supply and demand,
while the Keynesians believe that the government should
intervene in the market to correct market failures.

Classical-Neoclassical Theory of
Employment
According to the classicals, the labour market should be
left on its own, and forces of supply and demand for
labour should determine the equilibrium wage rate and
the level of employment. The government or trade union
bargaining should not in any way intervene in the labour
market in setting wage rates that it thinks is best for the
market. They believe that wage adjustments set above
the market equilibrium wage rate will cause
unemployment, and the remedy for unemployment is to
cut wage rates to clear the labour market. This will result
in full employment. They believe that employment levels
determined by the demand and supply of labour is the
full employment level in the economy.

The Problems And Remedies For

Unemployment in Less Developed
Countries
It is quite difficult to measure the level of unemployment
in developing countries. The strategies that the
Classicals and Keynes postulated are not enough o
address the issue of unemployment in developing
countries. The first reason being that there is lack of
entrepreneurship and productive investment. These
investment opportunities must be created to help assist
the problem of unemployment in developing countries.
Also, most developing countries depend too much on
foreign goods and services, which fosters a downward
effect on actual GDP. In addition, modern technologies
have replaced labour to a greater extent causing excess
labour in the labour market. Given this situation, the
unskilled-labour bears the most burden of this effect

The Problems And Remedies For

Unemployment in Less Developed
Countries
The Classicals and the Keynesian theories
of employment can be used to address
unemployment problems if the causes of
unemployment are consistent to what the
respective theories suggests. Otherwise,
what is appropriate on specific accounts of
addressing unemployment problems in
different developing countries must be
prioritized that suits each countries needs
in this regard.

INFLATION

Inflation
Inflation is the increase in the overall level of prices,
expressed as a percentage. The opposite of inflation is
deflation, a general decline in the overall price level.
Price Indices are constructed to represent price levels of
goods and services. The price index that captures the
price changes of all goods and services provided in the
economy is the GDP price index or GDP deflator.
The most common price index is the consumer price
index (CPI), a fixed weight index, representative of an
average household consumption basket of goods and
services.

Two Types
Cost-Push Inflation Caused by the pressure
from the cost of production where producer is
faced with a high cost to which it pushes up the
price of its products resulting in general increase
in price levels.
Demand-pull Inflation Caused by the high
demand from the consumers attracts the prices
of certain products to rise causing a pull up of
prices leading to general increase in price levels

Inflation

The Causes of Inflation

The long run determinants of the price level and inflation.
Development of Ideas/Steps towards the Quantity Theory of
Money.
-Over a period of time, the price of a packet (1kg or 2kg) of rice
has gone up from K0.50 to K3.00. What do we draw from the
fact that people are willing to give up more money in exchange
for a packet of rice.

Insight.
It is possible that people have come to enjoy rice more (new
flavour developed) that they are willing to pay that much.
Yet it is also possible that the quality of rice has remained roughly
the same, and over that time, the money used to buy the rice has
become less valuable.

Inflation

This insight helps toward understanding a theory of inflation.

Price rise can be viewed in two ways.
(a) People pay more for goods and services, or
(b) A measure of the value of money. A rise in the price level
means a lower value of money because each kina will now buy
a smaller quantity of goods and services.

Mathematically P, measures the number of dollars needed to

buy a basket of goods and services.
Turn this around. The quantity of goods and services that can
be bought with K1.00 equals (1/P), which is the value of money
measured in terms of goods and services. Thus, when the
overall price level rises, the value of money falls.

Inflation
Money Supply, Money Demand and
Monetary Equilibrium
The question then is what determines the value
of money.
The answer, as in many things in economics, is
supply and demand (in this case, of money).

Inflation

Next step in developing the Quantity Theory of Money then is to consider the
determinants of money supply and money demand.

Supply of Money
Through open market operations (OMO), the Central Bank (BPNG) can change the
quantity of reserves available to banks, which in turn influences the quantity of money
that the banking system can create. For our purpose now, we will take the supply of
money as a policy variable that the Central Bank can control directly.

Demand for Money

There are many determinants of the quantity of money demanded. These include
interest rate, credit cards, etc. The one variable that stands out is the average level of
prices in the economy. People hold money because it is the medium of exchange.
Unlike other assets such as bonds or stocks (shares), people hold money to pay for
goods and services, and the amount they hold is influenced by the prices. The higher
the prices the more money they will hold. A higher price level (a lower value of
money) increases the quantity of money demanded.

Inflation
What ensures the quantity of money the
BPNG supplies equals the quantity of
money people demand? It depends on the
time horizon. In the long run, the overall
level of prices adjusts to the level at which
demand for money equals the supply.
The next slide shows us some facts on
inflation in PNG

Inflation
Quarterly headline inflation, as measured by the
Consumer Price Index (CPI), was 1.2 percent in the
December quarter of 2009, compared to 1.8 percent in
the September quarter. There were increases in all
expenditure groups, except the household equipment
& operations expenditure group, with the largest
increases recorded in the Rents, council charges, fuel
and power and Transport and communication
expenditure groups, which mainly reflected an increase
in fuel prices. By region, all urban areas recorded
increases, except Lae.
The quarterly exclusion-based
and trimmed-mean inflation recorded increases of 0.8
percent and 1.2 percent, respectively, in the December
quarter of 2009, compared to an increase of 0.9 and 1.4
percent, respectively, in the previous quarter.

Inflation
Annual headline inflation was 5.7 percent in the
December quarter of 2009, a drop from 11.2
percent in the December quarter of 2008.
The lower inflation mainly reflected the decline in
international food and fuel prices, low inflation in
PNGs main trading partners and fall in the
prices of seasonal produce.

Inflation

Headline Consumer Price Index (CPI)

A measure of inflation as calculated and published quarterly by the National
Statistical Office (NSO), which measures the total price movements in
goods and services in the basket.

Exclusion-based CPI measure

An underlying inflation measure which involves zero
weighting of volatile sub-groups or items such as fruit
& vegetables, betelnut and prices that are largely
determined by non-market (seasonal) forces, as well
as alcoholic drinks, cigarettes & tobacco, etc.

Trimmed-mean CPI measure

A fixed proportion of prices at each end of the distribution
of price changes are zero weighted and the mean
of the remaining price changes recomputed.

References
H.G.Mannur, Foundation Economics,
1995, Economics Department, University
of Papua New Guinea