CHAPTER 6:

MACROECONOMIC PROBLEMS

Inflation

Definition: Continuous increase in general price level of all goods and services or increase in
Consumer Price Index (CPI).

Calculation of inflation rate

• It can be measured using Consumer Price Index: CPI is a measure of change in the
average price of goods and services that consumers normally purchase. In Malaysia,
total goods and services that consumer normally purchased consist of 430 items such as
food, clothing, medicals, fuel, furniture, entertainment, education and others.
• The rate of inflation is calculated using the formula below:
• Example: CPI for year 2000 was 110 and that for year 2001 was 120. Calculate the
inflation rate

INFLATION RATE = 120 – 110 X 100

110
= 9.1%

Source: DOSM (2020)

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Degrees of Inflation

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 Two types of inflation
Demand Pull Inflation Cost Push Inflation
Definition Increasing in General Price Increasing in General Price Level
Level (GPL) due to an (GPL) due to a decrease in
increase in Aggregate Aggregate Supply (AS)
Demand (AD) at full
employment condition
At full employment condition,
all the resources are LIMITED
or FULLY UTILIZED.
So, when there is an increase
in AD, it will not be followed by
an increase in output or
Aggregate Supply (AS) due to
limited resources.
Causes AD increase because: AS decrease because:

1. Increasing in consumption 1. An increase in cost of

production
i. wage push inflation
2. Increasing in investment - it happens at peak/ boom
condition when labour union
demand and increase in wages
(wages increase, cop increase, P
of goods/services increase)
3. Increasing in government
expenditure ii. profit push inflation
- occurs when there is an
increasing in firm desire to
increase profit

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 - firms will reduce supply to
create artificial shortage
-AS↓, P of goods/ services↑

iii. import push inflation

-occurs when there is an
increasing in P of imported
inputs/ output
-Example: ↑P of petrol by
OPEC,↑COP for manufacturers,
↑P of goods/ services

1. Sudden decrease in AS
-caused by bad climatic
conditions
-supply shock inflation happens
when climatic condition
reduces AS
-Example: Drought destroyed
paddy in Malaysia. As a result, AS
of paddy ↓, P of paddy↑
Diagram
General price level General price level
AS
P3 AD3
AS1
P2 E2
P1 E1 AS0
E1 AD2 P1
P0 E0 P0
AD1
E0
AD D ADO
0

Y0 Y1 Y2=YF Income (Y) Y1 Y0 Income (Y)

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Explanation ♦ At the initial, national economic ♦ At the initial, national economic
equilibrium is determined when AD equilibrium is determined when AD
intersects AS at E0. intersects AS at E0.

♦ At E0, National Output (NO)=Y0 and ♦ At E0, National Output (NO)=Y0

General Price Level (GPL)=P0 and General Price Level (GPL)=P0

♦ Before full employment condition, ♦ Suppose there is an increase in

an increase in AD because of labour’s demand to increase wages
expansionary monetary policy will ♦ ↑ wages, ↑ COP, AS ↓
leads to
♦ AS curve will shift to left from AS1
-shift of AD curve to the right from to AS2.
AD0 to AD1
♦ As a result, GPL ↑ from P0 to P1
-Producer will increase output to
meet an increase in AD
-As a result, GPL increase from P0 to
P1 and NO=Y1

♦ When AD increase again from AD1

to AD2,
-Again, producer will increase output
to meet increase in AD
-GPL=P2 and NO=YF

♦ At full employment condition, an

increase in AD from AD2 to AD3 will
not followed by an increase in
output
-this is due to limited resources

-producer will compete among

themselves to get the limited resources

-competition among producer will
increase cost of production
-As a result, GPL will increase from P2 to
P3
-National output remains the same at YF

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 Effects of inflation

1. Distribution of incomes

i. Increasing in general price level will decrease the real income for fixed
income earner (government workers, pensioner). This will reduce the
purchasing power for this group, and they are able to buy less good for
the same fix amount of income earned.
Fixed income earners are the losers due to inflation.

ii. Flexible income earner (businessmen) will earn benefit due to increase in
general price level.
Flexible income earners are the gainers due to inflation.

iii. Creditors will get less value of money when they get back their money in the
future. With high inflation rate, the real value of money or its purchasing
power of money decreases. Creditors are the losers due to inflation.

iv. Borrowers will pay back their loan with the money that has lower value or
lower purchasing power.
Borrowers are the gainers due to inflation.

2. Savings

Savings reduce during inflation due to low and unstable rate of return on their
deposits but savings in terms of fixed assets will gain because the prices of houses
and real estate’s will rise during inflation. High inflation rate will reduce the
purchasing power of money. This will discourage people to save. People will choose
other forms of assets instead of saving.

3. Investment

High profit earn by businessmen will encourage them to reinvest for larger
production of goods and services.

4. Deficit in balance of trade

Inflation will encourage import and discourage export and will cause the deficit in
balance of payment.

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 Unemployment

Definition

Unemployment: People (15-64 years old) in the labour forces that are currently
not working but are actively seeking for job.

Discouraged worker: worker who leaves the labour force and stop looking for a job after
unsuccessfully searching for a job for a certain period of time

Population

Labour force Not in labour force

Employed Unemployed Children 0 – 14 years

Pensioner
Fulltime
People in institutions

Part time Discouraged workers

Calculation of unemployment rate

UNEMPLOYMENT RATE = NUMBER OF UNEMPLOYED X 100

LABOUR FORCE

LABOUR FORCE = LABOUR FORCE X 100

PARTICIPATION RATE POPULATION

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 Types of unemployment

1. Frictional unemployment

Occurs when people are in between jobs, entering and reentering the labour
force. Example for between jobs, Ahmad work as lectures in University
Technology Mara, but he quit and work at University Utara Malaysia because of
the higher salary. For entering such as fresh graduates that is actively seeking for
job. Reentering such as Alia quit job in order to take care of her sick mother and
after her mother get well Alia will be reentering the level market.

2. Cyclical unemployment is occurring when there is a lack of jobs that results

because of a downswing in a business cycle or a recession. For example,
when the economy falls into a downswing or recession, the real GDP falls, the
demand for goods and service decreases, companies close down, and workers
are laid off.

3. Structural unemployment arises due to structural changes in the economy of

country. Structural unemployment exists because the composition of the labour
force does not respond quickly to meet changing demands, technological
changes or competition from imported goods and so on. The workers find that
their skill, talents and experience are obsolete and unwanted due to changes in
technology and consumer demand. For example, in the agricultural sector, many
unskilled and inadequately educated workers are laid off because of modern
mechanization. A structural unemployed person faces difficulties in finding a new
job without undergoing training or having additional education.

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 4. Seasonal unemployment arises due to a seasonal variation in the activities of
industries. This may be caused by climatic changes or changes in fashion
or by inherent nature of the industries themselves. In this type of
employment, the labour force is employed at times and unemployed at other
times. For example, is a fisherman who is unable to catch fish in winter or
rainy weather. Many people are also employed at tourist spots during peak
periods such as during festive periods and are unemployed during off- peak
periods.

5. Technological unemployment

Happens when improvement in technology reduce the demand for labour.

Example, the usage of banking online system has resulted in fewer teller being
hired in the banking industries.

Effects of unemployment

i. Output produced is less than potential output

When unemployment rate is high, output produced by the country cannot

achieve the maximum output and standard of living may decrease. The
production process is not utilizing all the resources available.

ii. Social problem

Unemployed people may involve in illegal activities, social problems and others
to overcome their stress to cope with financial problems.

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 Policies to control macroeconomics problems

Instrument Inflation Unemployment

Monetary Contractionary monetary policy: Expansionary monetary policy:
policy i. reduce money supply by
• BNM reduce money supply i. increase money supply by
• making loans more expensive to • BNM increase money supply
obtain by • making loans less expensive to
-↑interest rates on loans obtain by
-↑cash reserve requirement to -↓interest rates on loans
decrease amount of loans to public -↓cash reserve requirement to increase
ii. selling gov securities to influence amount of loans to public
the size of bank deposits ii. buying gov securities to influence the
iii. restricting the hire purchase size of bank deposits
regulations iii. relaxing the hire purchase
regulations
Fiscal Contractionary fiscal policy: Expansionary fiscal policy:
policy -by implementing budget surplus -by implementing budget deficit
- increase t, reduce G - reduce t, increase G
- As a result, disposable income↓, AD ↓ - As a result, disposable income↑, AD↑, AS
↑, firms will require more labour
Direct Measure taken by gov that aim directly at Measure taken by gov that aim directly at the
control the cause of the problem cause of the problem
i. Fixing ceiling price to limit an i. Provide information on job
increase in P of certain goods/ vacancies
services ii. Provide more training to increase
ii. Prevent an ↑ wages by limit the worker’s skill
maximum percentage of increase iii. Encourage people to be self-
in wages union can bargain at any employed. Example: encourage
time graduates to be entrepreneur
iii. ↑ the AS by giving subsidies
iv. Launch anti-hoarding
campaign to prevent an
artificial shortage

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