Download Unit 7 Unemployment and inflation Objectives Calculate the

Unit 7
Unemployment and inflation
Objectives
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Calculate the unemployment rate
Distinguish between the different types of unemployment
Define inflation
Calculate the inflation rate
Distinguish between demand pull and cost push inflation
Describe policy measures that can be used to combat unemployment and inflation
1.
Unemployment
Definition
Unemployment is a situation in which people who want to work cannot find work at prevailing rates.
The unemployment rate is the number of unemployed persons expressed as a percentage of the labour force. Thus:
No. of unemployed persons
Unemployment rate = ----------------------------------------- x 100
Labour force
The labour force is the sum of all:
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unemployed persons, plus
full time employed persons, plus
part time employed persons.
People who do not want to work and are not looking for work are not unemployed; they are also not part of the labour
force. For instance, a full time student is not unemployed and is also not part of the labour force.
Activity
Unemployment and employment data
Million
170
95
5
3
60
Population
Employed
Unemployed and looking for work
Discouraged workers
Retired
Calculate:
(a)
(b)
the size of the labour force, and
the unemployment rate
Feedback
(a)
Size of the labour force: 95 + 5 = 100 million.
(b)
5
Unemployment rate = ------ x 100
100
= 5%
Types of unemployment
Economists classify unemployment according to its causes.
Four different types of unemployment:
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frictional unemployment
cyclical unemployment
structural unemployment
seasonal unemployment
Frictional Unemployment
Frictional unemployment is sometimes called search unemployment. It arises from the normal operation of the labour
market. It includes:
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People who are moving from one job to another. It is not always possible to find a new job immediately.
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People who enter the labour force and are looking for a first job, for instance students who have just finished
their studies.
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People who get fired.
Frictional unemployment is normally short term.
Cyclical Unemployment
Cyclical unemployment is also referred to as demand deficient unemployment.
It occurs when there is a temporary decrease in aggregate demand caused by a slump or recession in the economy.
Periods of prosperity may be followed by a temporary decrease in aggregate demand (consumption, investment and
exports). We refer to this as a business cycle.
Sales may decrease during a recession and firms may have to reduce production. They will then reduce their demand
for inputs, including labour, and workers may lose their jobs. When demand increases again, the unemployment
situation may improve.
Cyclical unemployment may be short- or long-term.
Structural unemployment
This type of unemployment is caused by structural changes in the economy or the way in which the economy is
organised.
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Workers may lack the necessary skills, education or training required to get a job.
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Changes in production methods or techniques where workers are replaced by machines.
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Changes in consumer preferences that cause a fall in the demand for certain products.
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Increased foreign competition as a result of trade liberalization and globalization, e.g. textile industry.
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The decline in certain industries, e.g. the closing of a mine.
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Discrimination and job reservation.
Structural unemployment is normally long term.
The sum of structural and frictional unemployment is referred to as the natural unemployment rate.
Seasonal Unemployment
Seasonal unemployment is caused by seasonal shifts in labour supply and demand. Certain businesses require
workers only for part of the year.
Examples:
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Workers in the fishing industry work only certain months of the year because catches are not allowed during
the breeding season.
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Workers can be employed for the picking and processing of fruit and vegetables only after the growing
season.
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Tourist regions and resorts have more jobs available during the peak season.
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Some businesses employ more people during Christmas and Easter because of increased sales.
Activity
In each situation, identify the type of unemployment:
1.
The steel industry suffers a slump – as import competition increases, unemployment rises.
2.
Tracy quits her job in Swakopmund and moves to Windhoek in search of a new job.
3.
The mechanization of agriculture displaces thousands of farm workers who cannot find employment
elsewhere in the economy.
4.
Grape pickers in the Western Cape work only 5 months of the year helping the farmers to bring in their yearend harvest.
5.
A car assembly worker is retrenched because car sales decreased during a slump in the economy.
Solutions to unemployment
Solutions to unemployment will depend on the type of unemployment.
Our government can use expansionary fiscal and monetary policies to increase the aggregate demand for goods and
services.
Solutions for structural unemployment
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Reserve jobs as far as possible for Namibians.
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Develop the rural areas to create more jobs in agriculture.
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Develop small, labour intensive industries.
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Adapt the educational system to the requirements of the industries.
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Retrain workers.
2. Inflation
Definition of inflation:
Inflation is a sustained or continuous rise in the general price level.
Please note:
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Inflation refers to the movement of the general level of prices. Some prices may rise and some prices may
fall, but with inflation the rising prices will outweigh the falling prices and this will increase the general price
level.
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The rise in the price level must be substantial and continue over a long period.
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Inflation also points to the persistent decrease in the real value of money. In other words, it causes a
decrease in the purchasing power of a fixed amount of income.
Definition of Deflation:
Deflation is a fall in the general price level.
If rising prices are a problem, why are falling prices not a positive? Deflation is almost always a sign that an economy
is in trouble. Falling prices are an indication of a decrease in the demand for goods and services. A drop in demand
will reduce production and eventually cause unemployment.
The calculation of the inflation rate
The inflation rate in Namibia is calculated on the basis of the National Consumer Price Index (NCPI).
The NCPI is an index that reflects the cost of a “basket” of goods and services that the typical household in Namibia
purchases. The number of goods and services covered in the sample is 259 (220 goods and 39 services).
The Central Bureau of Statistics (CBS) is responsible for calculating the inflation rate in Namibia. To construct the
NCPI, the CBS must follow the following steps:
1.
It selects the goods and services to be included in the basket.
2.
It assigns a weight to each good or service to indicate its relative importance in the basket, e.g. bread 0.28%,
milk 1.38% etc. Larger weights are given to goods and services on which households spend more money.
The greater the weight, the greater the impact of price increases.
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It decides on a base year for calculating the NCPI. The base year is the year in which the survey of
household expenditure is done and the NCPI = 100. The current base year in Namibia is December 2001.
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It decides on a formula for calculating the NCPI.
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It collects prices each month to calculate the NCPI.
National consumer price index
Component
Food & non-alcoholic beverages
Alcoholic beverages and tobacco
Clothing and footwear
Housing, water, electricity, gas and others
Furniture, household equipment and maintenance
Health
Transport
Communication
Recreation and culture
Education
Hotels, cafes and restaurants
Miscellaneous goods and services
Total weights of all items
Weight
29.63
3.26
5.13
20.59
5.61
1.15
14.79
0.9
2.5
7.36
1.62
7.11
100.00
The table above shows all the items that are included in the NCPI. Items such as food & non-alcoholic beverages,
housing, water, electricity, gas & others and transport have the largest weights. This indicates that they are the most
important items in the budget of the typical household.
The total of all the weights is 100. Please note that these weights can change over time because the spending
patterns of consumers may change.
Definition of the inflation rate
The inflation rate is the percentage change in the CPI from one period to the next.
It is common practice to compare the CPI for a particular month with the index of the corresponding month in the
previous year.
Formula:
CPI last year – CPI first year
Inflation rate = ---------------------------------------- x 100
CPI first year
Month
January
110.7
2003
118.4
2004
February
111.2
118.6
March
111.6
118.6
Inflation rate
7.0%
Calculate the inflation rate for the period January 2003 to January 2004. In this example 2003 is the first year and
2004 is the last year.
Example:
118.4 – 110.7
Inflation rate = ------------------- x 100
110.7
= 7.0%
Calculate the inflation rates for February and March using the statistics given in the table above.
Feedback
February:
118.6 – 111.2 / 111.2 x 100 = 6.7%
March:
118.6 – 111.6 / 111.6 x 100 = 6.3%
The causes of inflation
Inflation is a very complex process and can be caused by several factors. We will examine two of the causes.
Demand-pull inflation
Demand-pull inflation occurs when there is an increase in aggregate demand (C+I+G+X-M) but aggregate supply
remains the same.
Businesses cannot increase supply because all the available resources are fully employed. Businesses then respond
by increasing prices.
Demand-pull inflation is often described as a situation in which “too much money chases too few goods.”
Demand-pull inflation can be caused by an increase in any of the components of aggregate demand:
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Lower interest rates may cause an increase in consumption spending (C).
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Lower interest rates or better profit expectations may cause an increase in investment spending by
businesses (I).
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Government expenditure (G) may be increased to provide better services or to combat unemployment.
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Improved economic conditions in other countries or higher prices on international markets may increase the
export earnings (X) of businesses.
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An increase in demand will be accompanied by an increase in the money supply.
Demand-pull inflation
An increase in aggregate demand shifts the demand curve to the right from AD to AD.
This result is an increase in the price level from P0 to P, while output increases from Y0 to Y1.
Cost-push Inflation
Cost-push inflation is caused primarily by an increase in production costs resulting in a decrease in supply.
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Increases in wages and salaries.
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Increases in the prices of imported capital and intermediate goods such as machinery, equipment and oil
(imported inflation).
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Increases in the profit margins of businesses.
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Natural disasters such as droughts and floods.
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Decreases in the productivity of production factors while they still receive the same remuneration.
Stagflation results from a decrease in aggregate supply that results in decreased output, increased unemployment
and rising prices.
Producers respond to higher costs by cutting back on production.
The supply curve shifts from AS to AS, the price level rises from P0 to P1 while output decreases from Y to Y1.
The combination of higher prices and lower output is referred to as stagflation.
Cost-push inflation
The cost of inflation
Inflation can affect our standard of living and it can have a great impact on the economy. Inflation influences the
following groups in the economy:
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Creditors (lenders) are harmed by inflation because the real value of the money (or the purchasing power of
the money) repaid to them is reduced.
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Debtors (borrowers) benefit from inflation because the money paid back to them is worth less than the money
borrowed. In this way, income is redistributed from the creditor to the debtor.
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Cost of living salary increases should be more than the inflation rate for workers to benefit. Increased salaries
put people in higher tax brackets. This redistributes income from the taxpayer to the government. The
taxpayer is harmed while the state benefits from an increase in tax revenue.
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People with fixed incomes, like pensioners, are harmed by inflation. Their incomes stay the same while prices
continue to rise.
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Savers are harmed by inflation if the interest rate on their investment is lower than the inflation rate. The real
value of their money decreases and on top of that tax must be paid on the interest earned.
Activity
What is the influence of inflation on the following individuals?
1.
A student heavily indebted with loans.
2.
A retired nurse receiving a fixed pension.
3.
An individual with a savings account.
4.
An individual who receives a salary increase.
Feedback
1.
The student is a debtor (borrower) and benefits from inflation.
2.
The nurse with a fixed pension is harmed by inflation.
3.
The real value of the money in the saving account decreases and the person must pay tax on the interest.
4.
The individual will pay more tax and will not really benefit. The government will benefit more in this case.
Solutions to the problem of inflation
To reduce inflation, policy makers must decrease the growth in aggregate demand by using restrictive monetary policy
measures to decrease the growth rate of the money supply, for instance, by increases in the Repo rate.
Restrictive fiscal policy measures such as a decrease in government spending or an increase in taxes could be used
together with restrictive monetary policy.
Since 2000, inflation targeting has formed the cornerstone of South Africa’s monetary policy framework and antiinflation policy.
In very simple terms, the target is to achieve an average inflation rate of between 6% and 3% per year. If the inflation
rate rises above 6%, restrictive monetary policy will be implemented. If the inflation rate falls below 3%, expansionary
monetary policy will be implemented.
The most important goal of this policy is, therefore, price stability.