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2b. Inflation & Deflation
2b. Inflation & Deflation
October, 2018
Inflation and deflation
What is inflation?
Inflation: A
A persistent increase in the level of persistent
prices
increase in the
It is possible to have a declining rate level of prices
of inflation – there is still inflation but it
is growing less rapidly
This is not deflation
Deflation: A
persistent fall in
Deflation is a persistent fall in the
the price level
price level
Aggregate demand & Aggregate supply
Aggregate supply (AS), also known as total output, is the total supply
of goods and services produced within an economy at a given
overall price level in a given period. It is represented by the aggregate
supply curve, which describes the relationship between price levels and
the quantity of output that firms are willing to provide. Normally, there is a
positive relationship between aggregate supply and the price level.
The aim of the tax changes is to stimulate the supply side of the
economy and therefore boost aggregate supply
Causes of inflation –
Demand Pull Inflation
Demand pull inflation is when inflation is
caused by excess demand
Anything that causes aggregate demand
(AD) to increase will cause demand pull
inflation
What are the things that cause AD to
increase?
• Anything that causes any of the components
of AD to increase (C + I + G + (X-M)).
• GDP identified as “Y” in equation form,
include Consumption (C), Investment (I),
Government Spending (G) and Net Exports
(X – M).
• The affect will depend on where the
economy is in the cycle
• If an economy is in a negative output gap
there will be positive effects whereas if there
is a positive output gap an increase in AD
may fuel inflation
Causes of Inflation - Demand Pull
Inflation
AD1 AS
Any further increase in AD to AD2 causes demand pull
inflation C
B
We get an increase in monetary GDP but not real GDP AD
Money loses its value and people lose confidence in money as the
value of savings is reduced
Inflation can get out of control - price increases lead to higher wage
demands as people try to maintain their living standards. This is known
as a wage-price spiral.
Consumers and businesses on fixed incomes lose out because the
their real incomes falls - employees in poor bargaining positions lose
out
Inflation can favour borrowers at the expense of savers – because
inflation erodes the real value of existing debts
Inflation can disrupt business planning and lead to lower capital
investment
Inflation can be a problem because it creates a range of economic and social costs. In assessing the
costs of inflation, we must distinguish between different degrees of inflation, since low stable inflation
has less of a damaging effect on the economy than hyperinflation where prices are out of control.
Costs and Consequences of Inflation
unemployment
reduces
As growth decreases
demand reduces and
unemployment
increases
Recession or
slump – demand
is low and
unemployment
is high
O A B
Timefig
Types of Unemployment – supply-side causes
Structural
This happens when there is a fall in demand within a particular industry
• E.g. if there is a fall in demand for steel there will be a fall in demand for labour within the steel
industry and unemployment will increase within this industry
Over the last couple of decades there has been structural unemployment in the India
primary and secondary sectors such as textiles, coal, shipbuilding and heavy
engineering
Structural unemployment affects some areas worse than others (regional
unemployment) e.g. In England, South Wales has suffered due to the fall in demand for
coal, Scotland due to the fall in demand for ships, Lancashire due to the fall in demand
for British cotton textiles
Labour immobility
Occupational immobility – workers cannot take up a job in another occupation
because they are not trained to do so e.g. a miner could not become an accountant
without training
Geographic immobility – workers do not want to move to other areas where work
may be available because they do not want to move away from their family or the area
where the jobs are available is very expensive to live in.
Types of Unemployment
Technological
This is people that are put out of work by the introduction of new machinery
Agriculture is one industry that has suffered from this type of unemployment
When new machines were made available to plough, sow and harvest barley the hours of labour
required to grow barley on one hectare of land went down from 156 to12
Seasonal
Some people tend to work at some times of the year but not necessarily others
E.g. agricultural workers may find more work in spring and summer than in the winter – an agricultural
worker that cannot find work in the winter is said to be seasonally unemployed.
Frictional
Temporary unemployment while people are out of a job and searching for another
Some of this frictional unemployment may be seen as voluntary unemployment as some people
may deliberately leave jobs to look for a better one.
Some may be involuntary when people are made redundant
Both frictional and structural unemployment are always present as there are always people
between jobs and competition from abroad plus fast changing technology
Firms relocating to cheaper areas of production and to escape high taxes are also likely to
create unemployment
The costs/consequences of unemployment
Wasted resources
Factors of production are lying idle
The resources could be used to produce goods and services that would improve
our standard of living
Unemployed people can become unemployable – why is this?
When people have been out of work for a long time employers may be reluctant to
take them on
People may forget their skills or their skills may become out dated
People are less able to adjust to getting up in the morning and regularly go to work
Some areas of the country become depressed – why is this?
Young, skilled, mobile workers may move out of areas where unemployment is
high leaving the young, unemployed and old people who are low spenders
Demand for goods and services drops further causing firms to close down and
move away from the area
Costs/consequences of unemployment
Men lose their status and feel they are letting their family down
Suicide
A lower level of benefits might persuade the frictionally unemployed to return to work more
rapidly and reduce some of the tightness in the labour market
The quicker the unemployed can be retrained and returned to the labour market the greater
the benefit for the economy
During a negative output gap there will be both demand deficient unemployment and structural
unemployment
Some labour may become discouraged workers thinking they will never find a job – they may
permanently withdraw from the labour market