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Chap 29 Inflation and Unemployment
Chap 29 Inflation and Unemployment
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INFLATION
Measuring Inflation Rate
In Malaysia the CPI is based on the prices of more than 400 items which
are grouped into categories such as food, beverages, clothing and
footwear, transport and communication, fuel and power, medical and
health expenses etc.
Rate of inflation can be measured as a % change in CPI from one year to
another.
Inflation rate this year = CPI this year - CPI previous year x 100
CPI previous year
29-3
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INFLATION (cont.)
Types of Inflation
There are 2 types of inflation – demand-pull and cost-push inflation.
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Demand-pull inflation (cont.)
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INFLATION (cont.)
Causes of demand-pull inflation
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INFLATION (cont.)
(B) Cost-Push Inflation
-This type of inflation is caused by a decrease in aggregate supply
due to an increase in cost of production.
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INFLATION (cont.)
b) Greed for profit.
- Happens when firms gain more power and able to increase price to make
more profits.
- Can also happens when firms stock up on goods and create artificial
shortage to increase price to earn more profits.
-Eg OPEC increase oil prices from USD65 in 2006 to over USD100per barrel in
2008.
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Cost-Push Inflation (cont.)
AD
to P2 and output falls from Y1
AS1
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INFLATION (cont.)
(iii) Deficit in the balance of payments
-As price of goods increase during inflation exports may fall when
foreign demand for the country’s products fall.
-Inflation will also make price of imported goods cheaper.
-Fall in exports and rise in imports will lead to balance of payments
deficit.
(iv)Fall in production
-Inflation can cause trade union to demand for higher wages.
-If their demand is not met, they may go on strikes, pickets etc and
these may cause productivity to fall. 29-11
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INFLATION (cont.)
Measures/Methods to Control Inflation
(A) Contractionary Fiscal Policy (Budget Surplus: T > G)
(i)Increase in taxes (↑T )
An increase in tax will reduce the disposable income of individuals
income and their consumption on goods and services. This is turn
will lead to a fall in prices.
(ii)Decrease in govt expenditure (↓G)
A reduction in government spending will directly affect aggregate
demand. The government will cut the salary of its civil servant and
postpone development projects to reduce the purchasing power of
the public. 29-12
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INFLATION (cont.)
(B) Contractionary Monetary Policy
(i) Open Market Operations
The central bank may sell government securities, short-term bonds or
treasury bills in the open market to the public to reduce bank
deposits and credit creation of commercial banks.
Money supply will reduce, hence reducing aggregate demand and
price level.
(ii) Raising Reserve Requirement
In the event of inflation, the central bank will increase the required
reserve ratio of all commercial banks.
29-13
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INFLATION (cont.)
(iii) Raising the discount rate/bank rate (Interest on loan)
A rise in the bank rate will cause an increase in the cost of
borrowing. Loans become costly to borrow and firms will reduce
borrowing and spending. Aggregate demand will reduce and
inflation rate will drop.
The high interest rates will also encourage the public to increase
saving and this will decrease the aggregate demand and price
level.
(iv) Credit control
Ref to Chap – Public Policies (Slide p. )
29-14
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INFLATION (cont.)
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UNEMPLOYMENT
29-16
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UNEMPLOYMENT (cont.)
Population
Outside
Labour force
labour force
Une
Emp
mpl
loye
oye
d
d
29-17
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UNEMPLOYMENT (cont.)
Labour Force
All persons above the age of 16 and older who are
employed or are actively seeking employment.
The labour force consists of employed and unemployed
persons.
Is everyone above 16 years of age included in the labour
force?
-No, because students, housewives, pensioners are
considered as outside of labour force.
29-18
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UNEMPLOYMENT (cont.)
Types of Unemployment
(1)Frictional Unemployment
This is a short-term or temporary unemployment.
Occurs when people enter the labour market to look for jobs or
people leave their jobs, either voluntarily or from being sacked, and
are unemployed for a period of time while they are looking for a new
job.
Includes new entrants such as school-leavers, fresh graduates and re-
entrants, such as people who quit their jobs for a better position or
higher wages, or former homemakers. 29-19
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UNEMPLOYMENT (cont.)
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UNEMPLOYMENT (cont.)
(3) Structural Unemployment
This unemployment results from structural decline of industries,
unable to compete or adapt to changing demand and new
products, or changing method of production.
introduction of new products or technology made the existing
product obsolete, hence the skills of workers are no longer
suitable with the jobs available.
Eg. telegraph operators that lose their jobs due to the use of
telephones and internet.
29-21
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UNEMPLOYMENT (cont.)
(4) Cyclical Unemployment
This unemployment is caused by a decrease in agg. demand, due to a
downswing of the business cycle (recession).
When an economy is under recession, agg. demand falls and national income
falls further. Hence, consumption falls, production reduces, companies may
close down and workers are laid off, resulting in cyclical unemployment.
Cyclical unemployment is a serious form of unemployment.
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UNEMPLOYMENT (cont.)
Effects of Unemployment
(i) Loss of job skills
If unemployment persists for a long period, individuals will lose
their job skills, causing a loss in human capital.
(ii) Loss of output of goods and services
An economy with high unemployment is not using all of their
resources, especially labour.
The economy is operating below its potential national output,
reducing the economy’s efficiency and production. So, national
income will fall. 29-23
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UNEMPLOYMENT (cont.)
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UNEMPLOYMENT (cont.)
Methods / Measures to Control Unemployment
(A) Expansionary Monetary Policy
(i) Open market operation
The central bank buys government securities, short term bonds or treasury
bills in the open market from the public to increase money supply.
Consumption and investment will increase, increasing aggregate demand and
production and reducing unemployment.
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UNEMPLOYMENT (cont.)
A decline in the bank rate and discount rate makes loans less costly to
borrow and firms will increase investment by employing more workers.
This will increase agg demand, output and decrease unemployment in the
country.
29-26
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UNEMPLOYMENT (cont.)
(B) Expansionary Fiscal Policies
(i) Increase government expenditure (G)
Increase government expenditure (G) through creating more development
projects will increase agg. demand (AD). Production will increase, hence
reducing the unemployment.
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UNEMPLOYMENT (cont.)
(3) Direct Control Policies
This refers to all direct measures other than monetary and fiscal policy taken
by the government. For example:
Providing training and technical education.
-Set up training centres to retrain workers in new skills to improve
occupational mobility.
Disseminate information on job vacancies to the unemployed
Encourage people to be self-employed.
Migration of labour . Encourage workers to move to regions and industries
where job are available.
29-28
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