IB Economics/Macroeconomics/Unemployment and Inflation
Unemployment and Inflation
- Full employment and Underemployment: A society is almost never fully employed, but one of the goals is to reach full employment. Full employment has two conditions: Everyone who wants to work is working, and the rate of inflation is stable. When the economy is at full employment, there is no cyclical unemployment but still frictional and structural unemployment. This is defined as natural unemployment.
- You are only classified as unemployed if you go and register with the government as available for work.
- The labor force is defined as those of 16 years of age or older who are employed plus all those who are unemployed seeking work.
- Unemployment rate: the number of people with no work expressed as % of the labour force
- Cost of unemployment: There are numerous costs of unemployment. For one thing, demand-side unemployment may be a slippery slope. For another thing, there are social costs such as high crime rates. There is a loss in potential output. There is political unrest brought by high levels of unemployment.
Problems with Unemployment
Cost To Individual
- lower income and quality of life
- lower self-esteem, leading to stress and erosion of mental health
Cost To Society
- areas with high unemployment can see increased crime, vandalism and gang activity.
Cost To The Economy
- the average unemployed person costs the British government 8000 pounds a year
- loss of output
- diminished tax base
- increased transfer payments
- increased taxes, increased burden
- increased difficulty for labor market entrants - employers have more choices, they favor experienced workers
- unemployed workers lose their skills
Advantages: spare labour-- could be attractive for investors, wages wont be high - they can pay people less as they know others are available.
Types of unemployment
- Classical Unemployment: your wage is too high, the price of the good goes up and no one buys it so the firm moves to a cheaper country
- Structural: Unemployment caused by the demand for your product falling e.g. coal mining, we use oil now. Some skills are no longer needed e.g. you are a trained draughtsman but we use computers now
- Frictional: This is the desirable process of finding work, employers looking for the right worker. In order to help accelerate this process, governments assist people looking for jobs with programs and qualification surveys.
- Seasonal: Unemployment caused by changes in seasons.e.g a ski resort is only open a few months a year
- Cyclical/Demand-deficient: Unemployment resulting from business recessions that occur when total demand is insufficient to create full employment.
- Regional Unemployment: if there is a coal mining area which closes down there will be large unemployment in that area
- Voluntary Unemployment: you are unemployed by choice, you get money from the government anyway
- real wage: is a form of dis-equilibrium unemployment that occurs when real wages for jobs are forced above the market clearing level. Traditionally, trade unions and wages councils are seen as the institutions causing this type of unemployment.
Solutions to unemployment
- boost aggregate demand e.g. increase gov. spending, increase spending on public works (create more jobs), reduce taxes
- interest rates reduced: more investment, more money borrowed, more money spend, more jobs
- Supply side economics: train the workers make them more skilful. Also reduce taxes to increase working incentives
- Lower the retirement ages/ raise school leaving age: it reduces unemployment however these days is unlikely
- Conscription: the army counts as employment
→Frictional Unemployment: Desirable, reduce state benefits to unemployment
→Structural unemployment: Market oriented approach, interventionist approach
→Seasonal Unemployment: Rural urban migration
→Classical Unemployment: Change social legislation
→Demand deficient unemployment: fiscal monetary policy
- Definition of inflation and deflation
- Inflation is defined as a sustained rise in the average price level and a fall in the value of money.
- Deflation is defined as a sustained fall in the average price level and a rise in the value of money.
- Costs of inflation
- Inflation may harm some individuals and benefit others. Individuals with liquid assets which are not collecting interest may be harmed. Individuals with fixed assets such as paintings, housing, etc. will benefit.
- creates uncertainty
- exports become less competitive
- efficiency of the price mechanism is lost because inflation distorts the signaling power relative price changes. A consumer of firm witnessing the price of good X rising cannot be sure that it is now relatively more expensive as she cannot know whether the prices of other similar good have increased by the same percentage. This confuses the decisions of consumers and firms.
- poor people are more vulnerable to inflation. They have fewer choices to hedge against inflation and, in addition, they cannot borrow money.
- if actual inflation proves higher than expected inflation, then borrowers gain at the expense of lenders. The money they will be paying back will be worth less than expected.
- Costs of deflation
- consumers delay purchases since they come to expect further price decreases. Aggregate demand decreases due to fall in consumption, decreasing more average price level.
- The real value of outstanding debt increases, therefore less consumption.
- Firms are forced to cut prices to win over customers, squeezing their profit margins and forcing them to cut down on costs. Wages fall and layoffs follow so AD shifts further to left.
- Since the real value of indebtedness increase some banks cannot service their loans. Banks accumulate loans that are not repaid and thus the risk of a banking crisis.
- Monetary policies are unsuccessful because interest rates cannot be under zero
- Expansionary fiscal policy may also prove ineffective as households may prefer to save and postpone spending.
- exports become more competitive abroad and AD may increase as a result of a rise in net exports.
- Causes of Inflation
- cost push: Inflation that occurs when there is an increase in the cost of production.
- demand pull: Inflation that occurs when a sector of the economy increases the demand for goods and services.
- excess monetary growth: The money supply increases, and prices increase.
- Methods of measuring inflation
- Problems of the methods of measuring inflation
- Phillips Curve
- Natural rate of unemployment
- Non-Accelerating Rate of Unemployment (NAIRU) - excluded from IB syllabus in 2003.