Unemployment and Inflation

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Define Demand Pull Inflation

Demand-pull inflation occurs when aggregate demand within the economy increases. Often, the economy is almost at their productive capacity and therefore instead of increase productivity and supply, there is a price increase, therefore increasing inflation.

Define Cost Push Inflation

Cost-push inflation occurs when the costs of production are increased (e.g. wages or oil) and the supplier forwards those costs onto consumers. As inflation is a general rise in prices over time, this increases inflation.

Define Inflation

Inflation is a persistent and appreciable rise in the general level of prices.

How is Inflation Measured?

The most widely used measure of Inflation in Australia is the Consumer Price Index (CPI). As an index number the CPI summarises the overall change in the prices of a large number of goods and services. Compiled on a quarterly basis. Inflation is measured by the percentage change in the CPI CPI 2 (yr 2) – CPI 1 (yr 1) _____________________ x 100 CPI 1 (yr 1)

What is the equation for the measurement of Inflation?

CPI 2 (yr 2) – CPI 1 (yr 1) _____________________ x 100 CPI 1 (yr 1)

Define Demand Pull Inflation

A situation where the level of prices are rising because of excess demand I the economy at the full employment level • Too much money chasing too few goods • High levels of demand caused by high levels of aggregate expenditure

Define Cost Push Inflation

The situation where price rises are caused by cost pressures, independent of the level of Aggregate Expenditure • When rising production costs are passed on to consumers who the have to pay higher prices for final goods and services

Where does demand Pull Inflation Originate?

• Consumers: wage rises, interest rate cuts, tax cuts, wealth increases • Firms: interest rate cuts, business optimism • Government: budget deficit (financed through borrowing from PBA) • Overseas: rising demand for our exports or rising export prices

Where does Cost Push Inflation Originate

• Rises in price of the factors of production (wages) o When wages increase more than productivity • Price of Imports Rise o Could be as a result of depreciation of domestic currency (ie our dollar; how much of another currency it can buy) • Key Raw materials rise (ie oil) • When government charges and taxes rise

What are some examples of Demand Pull Inflation?

• Building Boom 2004-2006 high demand created shortage of skilled building tradespeople • Mining Boom in WA forced pay rates of mining occupations

Define Headline Inflation

• Includes the effects of seasonal factors, interest rate changes and the influences of other policy changes • It can be misleading • Includes price movements that don’t necessarily reflect the core or underlying rate of inflation

Define Underlying Inflation

• Also referred to as the ‘core rate’ • Excludes the effect of seasonal factors, interest rate changes and the influence of other policy changes • A more accurate way to measure he ‘true’ rate of inflation • The rate with the volatile elements removed

What are some issues with using CPI as a form of measurement of Inflation?

• the CPI does not reflect the price movements outside of metro areas • does not reflect changing consumer preferences (such as substituting chicken for beef if beef prices went up) o therefore not regarded as true cost of living index • Does not account for changes in quality of goods over time o Likely to overstate price changes • Despite this the CPI is an important macroeconomic indicator and is the key element in making decisions on pensions and contracts and in the formulation of government economic policy

What are the effects on output of Inflation?

Output Effects Inflation affects the level of output. Income and employment in the economy Costs of Inflation Inflation reduces the purchasing Power of consumers Impacts Economic Efficiency and level of production in the economy Promotes Uncertainty: Both savings and investment are discouraged Inflation leads to capital for labour substitution Causes a lack of confidence in money High inflation (compared to trading partners) worsens the CAD Hyperinflation can lead to economic collapse Benefits of Low Inflation Low inflation helps maintain lower interest rates Low Inflation improves Australia’s International Competitiveness Ongoing Inflation tends to cause a currency to depreciate (lose value) (you need to be able to explain each not just list – refer to notes)

Who are the winners out of inflation?

Those people who are able to anticipate inflation Households who are able to purchase real assets Sectors of the economy with market power Debtors (borrowers) Government (in terms of receiving PAYG tax at higher rate) (you need to be able to explain each not just list – refer to notes)

Who are the losers out of inflation

Living standards of low income earners and recipients or transfer income (pensions) will fall during periods of inflation PAYG taxpayers Savers Creditors (lenders) (you need to be able to explain each not just list – refer to notes)

Define Unemployment

• when people are willing and able to work cannot find a job (employment). The • proportion of the labour force who are willing and able to work, but have not been employed in paid work for at least one hour in the survey week. • Those people aged fifteen years old or over, who are currently not working but are actively seeking some form of employment

Define Potential Labour Force

The Potential labour force is all of those people aged 15 or over not only employed or unemployed but all those excluded from the labour force

Define Participation Rate

the proportion of working age population (>15) who are either in work, or actively seeking work.

What is the formula for calculating the participation Rate?

PR = Labour Force x 100 _______________ Population >15

The participation rate can have an important moderating influence on the unemployment rate: What does this mean?

• In a boom UE falls, however as more people start looking for work the PR rises and the UE rate does not fall as much (which reduces inflationary pressures) • In a recession, EU rises, but people give up looking for work and therefore the PR falls – so the UE rate does not rise as much as it otherwise would

Define and Explain underemployment

People who would prefer to work longer than the one hour a week that the ABS uses to define paid employment • Official statistics underestimate the degree of underemployment • May occur because someone may have a university degree and be employed in an area that does not use their skills adequately • Someone may be employed part time but may want full time work

Define The Natural Rate of Unemployment

The minimum level of unemployment which can be achieved, given the current characteristics of the labour market. It occurs when cyclical unemployment is zero; it is the sum of frictional and structural rates. • Occurs when there is full employment in the economy • Only includes frictional, structural and hard-core unemployment; there is no cyclical unemployment • Socially acceptable measure • Currently at 4.5% (some say between 4-5%) in Australia (at time of printing) • Even in a booming economy in 2008 – 457,300 people were still officially listed as unemployed

What are some reasons given for the fact that Unemployment is not at 0%

• The main explanation is persistent structural unemployment (when their marketable skills do not meet the needs of firms seeking to take on skilled staff) • Impediments prevent the market from working efficiently o Information lags and compliance costs (caused by labour market rigidities) make it difficult for all potential workers to find a job • Minimum Wage tends to create an oversupply of labour • it is above market equilibrium, bad for those unemployed (good for those employed) • creates a barrier because the labour market can not clear – demand and supply are not in equilibrium • Many regulations affect both demand and supply ides of the labour market • Cost of complying to regulations may be greater than the benefits delivered • Labour Union Power in some sectors of the economy may impede employment • Above equilibrium rates of pay and inflexibility in working hours and conditions

How is unemployment measured?

Every month the ABS surveys 35,000 Australian households to determine the labour force status of people living in Australian households. • A limitation of the ABS survey is that the sample size is small ( 2/3 of 1%) therefore the reported UE rate can vary as a result of random error UE Rate: Unemployed ________________ x 100 Labour Force

What is the equation for calculating the unemployment rate?

UE Rate: Unemployed ________________ x 100 Labour Force

Define the Labour Force

• Also called the workforce • Made up of people aged 15 and over who are either employed, or actively looking for employment (unemployed) • You are not considered part of the labour force if you/have o Attending educational institution on a full time basis o Retired before the age of 65 o Permanently incapacitated and unable to work o Hospitalized o In prison

What measurement issues should be borne in mind when examining employment statistics?

A number of measurement issues should be borne in mind when examining employment statistics • The degree of underemployment o People who would like to be doing more hours, or a different type of work though still complete 1 hour of work per week • The degree of hidden unemployment o Many discouraged workers who choose not to participate in the workforce because all their efforts to find a job in the past have been frustrated • A proportion of students in post compulsory education may choose to pursue further study because they can not find a job

What are the three main types of unemployment

Economists usually further classify these into three categories each having different causes • Frictional • Cyclical • Structural

Define Frictional Unemployment

uncertain matching of demand and supply across the labour market) Occurs when people are between jobs;

What are the reasons for Frictional Unemployment occurring?

It takes time and effort for workers to find suitable jobs, and for employers to find suitable employees • Supply of jobs on offer differ in their location, working conditions, educational requirements and required experience • Workers offer different job aspirations, skills and willingness to travel • Labour market is dynamic – due to changes in tastes and technology, patterns of demand an government policy

What is the incidence of Frictional Unemployment in Australia?

• Depending on the phase of the business cycle, it is likely that between 1-1.5% of the workforce is unemployed due to friction • In troughs, people may not seek work because they think jobs will be difficult to find • In a boom there could be a lot of job search if people believe they can leave one job to find another fairly easily • Likely to be short in duration • Is a benefit rather than cost to economy: leads to better outcomes for both firms and employees

Define Structural Unemployment

occurs when there is a mismatch of available and required skills in geographical or occupational sector of the economy.

What are the reasons for Structural Unemployment occurring?

• Occupational structure of the economy may change over the long run for a number of reasons o New technologies (product and process invocation) • Firms may only survive if they introduce new products, improve their quality, seek lower costs of production • Changes bring about changes in demand for productive factors • Want to employ workers with more skills, or substitute capital for labour to reduce costs o Changes in consumer demand • More people wear hats, surfboards vs boogie boards, lighters vs matches, VCR etc • Labour market adjusts in response to changes in goods and service markets

What is the incidence of Structural Unemployment in Australia?

• The dominant type of unemployment in Australia • Historical examples: assembly worker who has been replaced by robot; the blacksmith who has been replaced when automobiles became more popular; the ban teller replaced by ATM • Has affected all sectors of the economy o In 1961 12.4% of workforce employed in primary occupations by 76 – 7.5% today it’s less than 6% o manufacturing also on the decline as capital intensive processes associated with the knowledge and service economy replace labour intensive forms of production o In developed countries 70% of GDP comes from services sector benefited most from ICT • Should be temporary, although workers are unemployed for longer periods than the other types • The demand generation effects of new technology have outweighed its labour displacing effects • Workers can retrain and rejoin the workforce • The resulting unemployment may be long term – particularly for people aged over 45 and those who have little training or education • Structural Unemployment may be the key factor of the upward shift in the unemployment rate from the 1970s.

What is the incidence of Cyclical Unemployment in Australia?

• Cyclical UE is expected to follow the up and downs of the business cycle • In periods of recession, when there is a slowdown in economic activity, UE will rise • In periods of high spending, there is strong demand for labour and cyclical UE will fall • In booms (such as 2007) cyclical can be considered (almost) zero • Cyclical downturns affect some sectors more than others o Demand for durables (hh equipment) and motor vehicles and nonessential such as holidays tends to fall in periods of reduced economic activity – therefore jobs in this sector are at risk o Teachers, nurses, public servants and accountants are not as much affected

What are the reasons for Cyclical Unemployment occurring?

• The demand for labour is derived from the demand for goods and services • It rises when there is insufficient demand to fully employ the country’s resources o When there is lower spending on durables, reductions in business investment and lower business and consumer confidence – therefore business profitability is low, many firms shed labour in order to reduce costs and remain viable

Define Cyclical Unemployment

cyclical or demand deficient unemployment occurs when the level of aggregate demand is not high enough to ensure production occurs at a level that ensures full employment.

What are the ‘output’ effects of Unemployment on the economy

• Unemployed Labour represents unused resources, so the output of the economy must be less than its potential if resources were fully utilised • There is a gap between potential and actual output – called the GDP Gap • Unemployment results in lower levels of aggregate consumption, investment and business confidence. • Unemployment causes a direct cost in welfare payments • Unemployment has an Opportunity Cost o Overtime, unemployment reduces the rate of economic growth (you need to be able to explain each not just list – refer to notes)

What are the ‘distribution’ effects of Unemployment on the economy

• High levels of Unemployment increases the level of income inequality • Unemployment affects some groups more than others • Unemployment benefits do not provide for a comfortable lifestyle • Effects of UE may be long-lasting • Personal, family and social problems associated with unemployment (you need to be able to explain each not just list – refer to notes)

Full Employment in Australia is considered between 4.5-5% – why is this considered ‘Full Employment?’

• In Australia Full employment is considered between 4-5% • Full employment means the lowest level of unemployment that can be sustained given the structure of the economy. • Full employment is a situation in which all of those people who are both willing and able to find work are able to do so. In reality, we must allow for a small level of unemployment to exist, as to achieve an unemployment rate that is too low would result in negative consequences such as inflation. • As a result, the goal for full employment is to maintain an unemployment rate that is as close as possible to the NAIRU. The NAIRU is the Non-Accelerating Inflationary Rate of Unemployment. In simple terms, it is the lowest rate of unemployment that the Australian economy can sustain without leading to inflation. This is also referred to as the "natural" rate of unemployment.

What does NAIRU stand for

Non-Accelerating Inflationary Rate of Unemployment.

What are the IMPLICATIONS Of FULL EMPLOYMENT on the economy

INFLATION • The further that the unemployment rate falls below the natural rate, the greater the pressure on inflation. This is a result of modern production methods. SKILLS SHORTAGE • There is a need for the government to assess policies to increase immigration of skilled workers in this situation THE RISK OF WAGE INFLATION: Wage Rises • When unemployment is falling, there is pressure on firms to bid up wages both to attract and retain staff. • Since there are less people looking for work that would take lower wages, the wages begin to rise as firms compete for the most skilled employees. Full employment can result in a re-allocation of the labour resource HIGHER DEMAND FOR IMPORTS NEW BUSINESSES STRUGGLE TO SUCCEED OTHER EFFECTS • As more and more people are employed there is more pressure to use natural resources, overtime these may begin to run out • Further damage to the environment • Pollution from car exhaust • Shift to increased public transport leading to overcrowding on trains, trams and buses • Reduction in consumer welfare (you need to be able to explain each not just list – refer to notes)

What does the Phillips Curve show?

The Inverse relationship between unemployment and inflation.

What is the logic behind the Phillips curve? i.e why is there a tradeoff between unemployment and inflation?

The chain of basic ideas behind this belief follows: as more people work the national output increases, causing wages to increase, causing consumers to have more money and to spend more, resulting in consumers demanding more goods and services, finally causing the prices of goods and services to increase. In other words, Phillips showed that unemployment and inflation shared an inverse relationship: inflation rose as unemployment fell, and inflation fell as unemployment rose. Since two major goals for economic policy makers are to keep both inflation and unemployment low, Phillip’s discovery was an important conceptual breakthrough, but also posed a troublesome challenge: how to keep both unemployment and inflation low, when lowering one results in raising the other?

What is Stagflation

A situation where both inflation and unemployment are high at the same time This occurred in Australia in the 1970s (due mainly to the

Draw the Phillips Curve

What is the current Rate of Inflation in Australia?

I am leaving you to find this one out!

What is the RBA goal for Inflation?

Between 2-3%

Why does the ABS choose to weight certain goods and services in the ‘basket of goods’ used to calculate the CPI

• The ABS attaches a weight to each commodity and group of commodities in the CPI regimen in order to reflect it importance in the pattern of expenditure by the average household

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