Chapter

Inflation6
&

Unemployme
nt
Lecturer: Pn. Azizah Isa 1
 BUSINESS CYCLE
Aggregate Econ. Activity
(% 
Boom/Inflation Potential
in
real Growth
GDP) Path
Actual Growth
Path
Trough/Depression/Slump/
Unemployment
years

Lecturer: Pn. Azizah Isa 2

 RELATIONSHIP OF
INFLATION AND BOOMING
ECONOMY
 The higher the growth of an economy, the
higher is the inflation rate.
 Inflation is related to the development of an
economy.
 During expansionary phase all economic
variables such as output (GDP), employment,
income, productivity, money supply, interest
rates, investment and prices tend to rise

Lecturer: Pn. Azizah Isa 3

 NATIONAL INCOME
EQUILIBRIUM
Expenditure Y=E
Y1=C+I+G+(X-M)
(RM)
e1

Yfe=C+I+G+(X-M)
Inflationary Gap
Y0 = C+I+G+(X-M)
ef
Deflationary Gap 
e0
45°
Y0 Yfe Y1 Real Output
(National Income)
Lecturer: Pn. Azizah Isa 4
 KEYNESIAN EQUILIBRIUM
NATIONAL INCOME
 Keynesian assume that equilibrium
output can be reached not necessarily
at the full-employment.
 The equilibrium can be less or more
than the full-employment equilibrium,
causing the economy with the
inflationary or deflationary-gap.

Lecturer: Pn. Azizah Isa 5

 Definition of Inflation
 as a criteria of a continuous
increase in the general price level
of all goods in an economy for a
specific time period.

 only occurs when overall average

price on almost all consumption
goods in an economy increases.

Lecturer: Pn. Azizah Isa 6

 Measurement Of Inflation
 The Rate Of Inflation:
is measured by the rate of increase in
the price index, CPI.
(as a percentage change in CPI)

Inflation Rate = (CPI1  CPI0) X 100

CPI0

Negative Inflation is Deflation

Lecturer: Pn. Azizah Isa 7

 INFLATION IN MALAYSIA
Year Consumer Price Index (CPI) Annual Change
(%)
1998 95.8 5.3
1999 98.5 2.8
2000 100.0 1.5
2001 101.4 1.4
2002 103.2 1.8
2003 104.4 1.1
2004 105.9 1.5
 
2005 108.9 3.1
 
  2006 112.4 3.6
 
  2007 114.6 2.0
   
  2008
  120.8 5.4
 
 
2009
 
 
121.5 0.6
 
Table 8.1: The Consumer
Lecturer: Pn. AzizahPrice
Isa Index (2000 = 100)
and Inflation Rate
Inflation as shown by the
% change in CPI

Lecturer: Pn. Azizah Isa 9

 TYPES/ CAUSES OF
INFLATION
 1. DEMAND-PULL INFLATION
 2. COST-PUSH INFLATION

Lecturer: Pn. Azizah Isa 10

 1. Demand-Pull Inflation
 ‘TOO MUCH MONEY CHASING FOR
TOO FEW GOODS’
Fisher

AD > AS at full-employment,
causes to shortage of goods and
price hike.
Lecturer: Pn. Azizah Isa 11
 Fisher’s Equation:
MV = PT
where,
M = money supply
V = velocity of money in circulation
P = general price level
T = total transaction of outputs
 
V and T are assumed constant;
therefore, Money Supply, Prices
(inflation)

Lecturer: Pn. Azizah Isa 12

 Demand-pull Inflation
General AS
Price

P1

AD 1
P0
AD 0

real output
YFE

Diagram: Demand– Pull Inflation as shown by the change in the

General Prices caused by an increase in The Aggregate
Demand.

Lecturer: Pn. Azizah Isa 13

 2. Cost-Push Inflation
• is caused by the high rise in the cost of production.
• The cost increases can be caused by various factors:
 higher wage rate.
 larger profit mark-up.
 expensive raw materials domestically
or from imported sources
(imported inflation).
 increase prices of intermediate (capital)
goods such as machineries, factories,
transportations etc..
 higher taxes.

Lecturer: Pn. Azizah Isa 14

General
Cost-Push Inflation
Price Level

AS1 AS0

P1

P0
AD

Q1 Q0 real output

Diagram: Cost-push Inflation

Lecturer: Pn. Azizah Isa 15

 The effect of Inflation on
the Value of Money
An increase in inflation relates to a higher
cost of living,
• which means households will have a
lower purchasing power of money on
goods and services.

Lecturer: Pn. Azizah Isa 16

 Nominal Money and
Real Money
Nominal money income spent on a same
‘basket of goods’ is much larger now.
• you need more Ringgit to pay for the
same number of goods bought.
Households’ real money income will fall as
inflation rises.
Thus, it also explains why there is a fall in the
value of money when price increases.

Lecturer: Pn. Azizah Isa 17

 The Degree of Inflation
 Mild Inflation
 Creeping Inflation
 Spiral Inflation
 Hyper Inflation
Special term:
STAGFLATION refers to a situation
where there is inflation and at the same
time occurs recession.
Lecturer: Pn. Azizah Isa 18
 To measure the Value of
Money using Price Index
Real Value of Money

= Nominal Money X CPI0

CPI1

 
Real GNP = nominal GNP X CPI0
CPI1

Lecturer: Pn. Azizah Isa 19

 Example:
 If currently RM 1000 is saved in a year which
is considered as the base year, it was
noticed that inflation has risen as shown by
an increase in the CPI to 120. Thus the real
value of money now is given by;
 
Real Value of Money = RM1000 X CPI0

CPI1
= RM1000 x 100

120
= RM833.3
Lecturer: Pn. Azizah Isa 20
 Real GNP
Given Year 1995 as base year. GNP for 1995 is
RM5,100 million. Assuming Consumer Price
Index for year 2002 is 112 and GNP for 2002 is
RM6,110 million.
 
Based on the above information:
a)   Calculate Real GNP for the year 2002
b)   Calculate the growth rate between the
year 1995 to 2002.

Lecturer: Pn. Azizah Isa 21

 Solution
 
a)    Real GNP for year 2002
= nGNP X PI0

PI1
= 6,110m X 100
112
= RM5, 455.36 million
 
b) g = (5455.36 – 5100) X 100
5100
= 6.96%
 

Lecturer: Pn. Azizah Isa 22

 Effects of Inflation
1. Effects on the individuals as gainers and
losers:
Gainers are: 
 Debtors: pay back loan, with less value of
money.
 Shareholders: higher dividend
 Property owners: higher prices of assets
owned.
 Businessmen: making larger profit as prices for
their goods produced and sold is higher.
Lecturer: Pn. Azizah Isa 23
 Effects of Inflation
Losers are: 
 Creditors: received less value for loans
given out earlier.
 Savers: lower value of money saved.
 Fixed income earners: lower purchasing
value of money.
 Pensioners: value of money falls.

Lecturer: Pn. Azizah Isa 24

 Other Effects of Inflation
may cause also to:
2. Savings depreciated in value (lower
purchasing power of money).
3. Deficit in Balance of Trade (domestic price
increases and become less competitive in
the international market) .
4. Production of goods increases (higher
prices is a motivation to suppliers).
5. Depreciation of Ringgit

Lecturer: Pn. Azizah Isa 25

 To curb the problem of
inflation
Using:
1) Monetary Policy
2) Fiscal Policy
3) Direct Measures

Lecturer: Pn. Azizah Isa 26

 To curb the problem of
inflation
Using:
1) Monetary Policy –
Contractionary M/Policy
2) Fiscal Policy -
Contractionary F/Policy
3) Direct Measures – directives &
regulations : Price Controls,
Rationing System and
Encouraging Savings
Lecturer: Pn. Azizah Isa 27
 To reduce Inflation:
with a Surplus Budget or
Tight Monetary Policy 
Since inflation is related to the booming of an
economy, therefore to reduce inflation,
economic growth has to be slowed down.
Thus, reduces the aggregate demand and
closed-down the inflationary-gap while the real
output (Y) falls.

Lecturer: Pn. Azizah Isa 28

 Try to answer Q3 from:
Question To Ponder
 3.

Lecturer: Pn. Azizah Isa 29

 NATIONAL INCOME
EQUILIBRIUM
Expenditure Y=E
AD1=C+I+G+(X-M)
(RM)
e1

ADfe=C+I+G+(X-M)
Inflationary Gap
ef

45°
Yfe Y1 Real Output
(National Income)
Lecturer: Pn. Azizah Isa 30
 Keynesian AD-AS
Diagram
Effect of Surplus
General Prices Budget (G falls)
AS or Tight
Monetary
(increased
P1 interest rate)
policies to reduce
inflation
P2 G or I
AD1
AD2
Real GDP
Lecturer: Pn. Azizah Isa 31
 Unemployment in Malaysia
“The unemployment rate is lowest in the year
1997 but increase again in 1998 that is
from 2.7% to 3.2% due the slowdown of the
economy caused by the Asian Financial
Crisis whereby our economy is hit by the
large depreciation of Ringgit Malaysia (RM)
relative to American Dollar (US$)[1] “

[1 ] Economic Report 1999/2000. Ministry of Finance

Malaysia, 1999.

Lecturer: Pn. Azizah Isa 32

UNEMPLOYMENT IN MALAYSIA
YEAR UNEMPLOYMENT
RATE (%)
1997 2.7
1998 3.2
1999 3.4
2000 3.1
2001 3.6
2002 3.5
2003 3.6
2004 3.5
2005 3.5
Source: Economic Planning Unit and Ministry of Human Resources .
Lecturer: Pn. Azizah Isa 33
 Unemployment
with Business Cycle
Unemployment rate is high during recession.

The negative impact of the slowdown of the economic

growth during recession may:
 less job opportunities.
 bankruptcies,
 closing down factories,
 delay of constructing new plants etc.
thus, may reduced the number of economic activities in
the economy.

Lecturer: Pn. Azizah Isa 34

 Natural Rate of Unemployment
The natural rate of unemployment is the level of
voluntary unemployment when the labour market is
in equilibrium.
Natural rate of unemployment is normally rated as
4% .
Full-employment is related to this natural rate of
unemployment, which includes the frictional and
seasonal unemployment.
It is not easy to omit this natural rate of
unemployment in an economy. Therefore an
economy at this natural rate of unemployment is said
to be at full-employment.

Lecturer: Pn. Azizah Isa 35

Actual Rate and Natural Rate
of Unemployment
If the actual rate of unemployment is
more than the natural rate of
unemployment, than it is said that
the economy is with the real problem
of unemployment.

Lecturer: Pn. Azizah Isa 36

Who are considered
as unemployed?
.

Lecturer: Pn. Azizah Isa 37

 DEFINITIONS
UNEMPLOYMENT:
are people who are considered under the
labour force but being unemployed
(jobless).

Lecturer: Pn. Azizah Isa 38

Who are included in the
Labour Force?
Lecturer: Pn. Azizah Isa 39
LABOUR FORCE:
are people of age group 15 – 64 years
and are willing and able to work either
has been holding a job or yet searching
for a job.

Lecturer: Pn. Azizah Isa 40

LABOUR FORCE: age group 15 – 64
years POPULATION
Those not considered under the labour force
includes: university
School students
children Ue
LABOUR FORCE

employed
Sick bed, old
housewives
aged

Lecturer: Pn. Azizah Isa 41

 LABOUR FORCE

= no. of employed + no. of unemployed

(willing and able to work of age 15 - 64yrs.

either working or jobless)

Lecturer: Pn. Azizah Isa 42

 Measurement of Unemployment

Unemployment Rate
= no. of unemployed X 100%
labour force

Unemployed people are jobless labour force

Lecturer: Pn. Azizah Isa 43

 LABOUR FORCE
PARTICIPATION
RATE
= Labour Force X 100%
Adult Population

Lecturer: Pn. Azizah Isa 44

 TOTAL POPULATION
CONSTITUTES ALL OF THE:
- CHILDREN
- ADULT
- OLD AGED
- HOUSEWIVES
(that are not considered under the labour force).
Therefore, for calculating the rate of
participation make sure that only adult
population is considered into the measurement.

Lecturer: Pn. Azizah Isa 45

 For example:
Data collected from the year 1999 given as:

125.6 million employed people and 4.5 million

was unemployed and the adult population was
205.8 million.

Therefore:
 Labour Force = 125.6 + 4.5 = 130.1 million
 Unemployment rate = ( 4.5 / 130.1 ) x 100
= 3.6%
 Labour Force Participation rate =
( 130.1 /205.8) x 100 = 63.2%

Lecturer: Pn. Azizah Isa 46

 EXERCISE 1:
. The table below shows the total labor force and
number of employed
people for country Semasa.

Total labor
Year force Employed
(‘ 000) (‘ 000)
2004
85,400 82,100

2005 96,750 86,500

A. Define labour force

B. Calculate the unemployment rate for the year
2004 and 2005
Lecturer: Pn. Azizah Isa 47
 Question To Ponder
The table below shows the labor force, number of employed
and unemployed people for country Kembangan
Year Total Labour Employed Unemployed
Force (‘000) (‘000) (‘000)

2005 8,500 850

2006 8,600 1,450
a. Fill in the blanks with appropriate answers.
b. Calculate the unemployment rate for 2005 and 2006.
c. State two (2) types of unemployment.

Lecturer: Pn. Azizah Isa

48
 Question To Ponder
a. Year Total Labour Employed Unemployed
Force (‘000) (‘000) (‘000)

2005 8,500 7,650 850

2006 10,050 8,600 1,450
b.Calculate the unemployment rate for 2005 and
2006:
U 2005 = 850 X 100% = 10%
8,500
U 2006 = 1,450 X 100% = 14.4%
10,050
Lecturer: Pn. Azizah Isa
49
 TYPES OF
UNEMPLOYMENT
 FRICTIONAL UNEMPLOYMENT
 STRUCTURAL UNEMPLOYMENT
 CYCLICAL UNEMPLOYMENT
 DISGUISED UNEMPLOYMENT/
HIDDEN UNEMPLOYMENT.
 SEASONAL UNEMPLOYMENT

Lecturer: Pn. Azizah Isa 50

 FRICTIONAL
UNEMPLOYMENT
 who are temporarily out of work; can be either;
 those who leave their jobs voluntarily to seek for new and better
jobs.
 or those who are being sacked and reentering the labor force to
search for new jobs
 or first time job seekers or school leavers whom are just looking for
jobs.
 it takes time for those individuals to search for suitable jobs
that best suit their taste and skills.
 problem of meeting the job seekers and the employers who
seek for workers since we lack of good communication and
information systems that might help the meetings.

Lecturer: Pn. Azizah Isa 51

 STRUCTURAL
UNEMPLOYMENT
 due to changes in the structure or
technology of the economy.

i. Structural changes from labour intensive to

capital intensive– use of robotics and
highly sophisticated machineries).

ii. Structural changes from agricultural base

to industrial sectors – those lack of skills
and less educated were ignored.

Lecturer: Pn. Azizah Isa 52

 CYCLICAL
UNEMPLOYMENT
 Caused by the downturn of the
business cycle - economy moves
towards recession.
 Disruption of the economic growth
causes the slowdown in all sectors of
the economy, alas reduction in job
opportunities.

Lecturer: Pn. Azizah Isa 53

DISGUISED UNEMPLOYMENT/
HIDDEN UNEMPLOYMENT.

 where the industries are overstuffed

with unnecessary additional workers –
sharing jobs available and does not
contribute to extra productivity.
i) in agriculture sectors
ii) in cottage/rural industries.

Lecturer: Pn. Azizah Isa 54

 Impact of
Unemployment
can be a cost to an economy.
Unemployment can affect:
i) the individuals: lost source of income, distressed,
lose self-esteem, mentally disturbed.
ii) the family/society: lost family income, domestic
violence, family splitting.
iii) the economy: create social and economic cost.
curing social problems, training courses, special
benefits, capital incentives. A cost to the economy
because the economy is not at the stage of fully
utilising the resources (underutilization).

Lecturer: Pn. Azizah Isa 55

POLICIES TO CURE
Government measures:
1. FISCAL POLICY
2. MONETARY POLICY
3. DIRECT MEASURES

Lecturer: Pn. Azizah Isa 56

 NATIONAL INCOME
EQUILIBRIUM
Expenditure Y=E
(RM)
Yfe=C+I+G+(X-M)

Y0 = C+I+G+(X-M)
ef
Deflationary Gap 
e0
45°
Y0 Yfe Real Output
(National Income)
Lecturer: Pn. Azizah Isa 57
 POLICY MEASURES
Fiscal Policy attempts to regulate the economy by varying
the level of government spending and the rate of taxation.,
while monetary policy is to regulate the interest rate and
money supply.

1. EXPANSIONARY FISCAL POLICY

(Deficit Budget) G–T>0 G > T
2. EXPANSIONARY MONETARY POLICY
(LOWER INTEREST AND INCREASES
MONEY SUPPLY.
3. DIRECT POLICY

Lecturer: Pn. Azizah Isa 58

 To reduce Unemployment/recession:
1) Expansionary Fiscal Policy /
Deficit Budget

When government collects less tax revenue

but spends more on expenditure, G > T.
 Therefore, it cause to a larger effects on real

output.
 Deficit Budget is implemented to raise-up the
economic activities.

Lecturer: Pn. Azizah Isa 59

 2. Balanced Budget Policy
 When government expenditure is just equivalent to
the tax revenue collection
(G = T)

 A balanced budget is also used to increase real

output and economic growth.
 Its multiplier is equivalent to one (1).
  Y = 1 . G
 Thus, the resulting increase in the equilibrium Y is
exactly equal to the increase in G or T itself.

∆Y = ∆G = −∆T

Lecturer: Pn. Azizah Isa 60

EASE MONETARY POLICY
 To cure recession/unemployment:
Ease / Expansionary monetary policy.

 To reduce inflation:
Tight / Contractionary monetary policy.

Lecturer: Pn. Azizah Isa 61

 Keynesian AD-AS Diagram
Effect of
DEFICIT Budget
or EASE
General Prices AS Monetary Policy
to reduce
unemployment.
P2

P1 I, G
AD2
AD1
Real GDP
Lecturer: Pn. Azizah Isa 62
THANK YOU
FOR LEND ME YOUR
EARS.

Lecturer: Pn. Azizah Isa 63

Lecturer: Pn. Azizah Isa 64