1. Unemployment & Inflation ECO 120 Macroeconomics Week 10 Lecturer
Dr. Rod Duncan

2. Topics
Definition of unemployment.
Types of unemployment.
Costs of unemployment.
Definition of inflation.
Types of inflation.
Impacts of inflation.
Relationship between unemployment and inflation- the Phillips Curve.

3. Unemployment A person becomes unemployed if he or she is a: Job loser
Job leaver
New entrant or re-entrant into the labour force
He or she is no longer unemployed if:
Hired or recalled
Withdraws from the labour force

4. Labour Force Participation Rate
Population
Working age population
Labour Force Participation Rate
Labour Force
Employed /
Unemployed
Unemployment Rate

5. Labour Force Participation Rate (LFPR)
Proportion of country’s population that takes part in its economic activities directly (either actually taking part or willing to) ( / )
Labour Force
Working Age Population X
100

6. Labour Force Participation, 1978-2005

7. Labour Force Participation by Sex at Ages 35-44
Males
Females

8. Unemployment Rate (UR)
Proportion of country’s labour force that is unemployed. ( / )
Number Unemployed
Labour Force X
100

9. Unemployment,

10. Aged looking for
full-time work
Total Unemployment
Aged 20 & over seeking
full-time work

11. Types of Unemployment
Cyclical unemployment
Frictional (or search) unemployment
Structural (technological) unemployment

12. Cyclical Unemployment
Associated with the ups and downs of the business cycle
Reflects shifts in AD or AS curves.
High during recessions and low during booms.
Fiscal and monetary policies can reduce cyclical unemployment - policies are relevant.

13. Unemployment over the Business Cycle (1965- 1995)
Change in GDP

14. Frictional Unemployment
Associated with the period of time in which people are searching for jobs, being interviewed and waiting to commence duties.
It is inevitable and always exist
Fiscal and monetary policies can not reduce frictional unemployment – macroeconomic policies are irrelevant.
Policies that make it easier to find new jobs will affect frictional unemployment.

15. Structural Unemployment
Associated with wider structural or technological changes in the economy that may make some jobs redundant.
It is inevitable and always exist
Lasts longer than frictional unemployment
Fiscal and monetary policies can not reduce structural unemployment – macroeconomic policies are irrelevant.
Policies that encourage workers to retrain skills or to move to a new area with more jobs will decrease structural unemployment.

16. Full Employment
Full employment means when all productive resources in the economy are in full use - implies no cyclical unemployment - still frictional and structural unemployment exist - they can be low - but can never be zero.
The full-employment rate of unemployment is called the natural rate of unemployment
equals the sum of frictional and structural unemployment
cyclical unemployment = zero
Domestic output consistent with the natural rate of unemployment is potential output or full employment level of GDP

17. Other Employment Issues
Part-time employment - very high in Australia in recent years.
Discouraged workers or the “hidden unemployed”
Those who become discouraged and drop out of the labour force temporarily - would return if a suitable job prospect arose
Discourage workers, participation rate and the unemployment rate

18. Cost of Unemployment Economic cost
output foregone, measured in terms of the loss of potential GDP - Okun’s law quantifies the relationship between the unemployment rate and the GDP gap - for every 1% of unemployment (over the natural rate) 3.5% of GDP loss in Australia.
Underemployment
High budget costs
Social Costs
Increase in crime rate, abuse etc.
Physical & mental illness
Unlikely to develop work ethics

19. Classical Employment Theory
Economy always operates under full employment - it is automatic and self sustaining - if there is any unemployment that is only temporary
Price-wage flexibility
the assumption that all prices, including wages and interest rates, are flexible and will, rapidly adjust to remove disequilibria

20. AD-AS in the Classical Theory
Vertical aggregate supply curve
exclusively determines level of real domestic output
Stable down-sloping aggregate demand
exclusively determines price level

21. Classical View of Unemployment
ASLR = AS P1
Price Level P2
AD1
AD2 Q1
Real Domestic Output

22. Keynesian View of AD - AS
Full employment is not automatic - unemployment exists for longer periods - the Great Depression of the 1930s - sticky wages and prices.
Horizontal aggregate supply curve during recession - ‘recessionary’ or ‘Keynesian’ range
Change in AD impacts on unemployment - not on price level.
Unstable aggregate demand - especially investment demand management and stabilisation policies by the government are essential

23. Keynesian View of Unemployment
ASLR AS P1
Price Level
AD1
AD2 Q2 Q1
Real Domestic Output

24. Current year index - Previous year
Inflation
We measure the general price level through a price index such as the Consumer Price Index (CPI)
Inflation is a continuous rise in the general price level
Inflation
rate
Current year index - Previous year
index
Previous year index x
100 =

25. Inflation in Australia (1970-2003)

26. Types of Inflation
Demand-Pull Inflation
Cost-Push Inflation

27. Demand-Pull Inflation
Occurs when an increase in AD pulls up the price level
Excess demand for output - increase in AD - AD shifts rightward - AS does not change in the short run - movement along the AS curve - price level increases - GDP increases
May be caused by expansionary fiscal and monetary policies - can be cured by contractionary policies.

28. Demand-Pull Inflation - Short run
ASLR
AS1
Price Level
An increase in
aggregate
demand....
Increases the price
level and output
in the short run P2 b P1 a
AD2
AD1
Real GDP o Q1

29. Cost-Push Inflation
Occurs when an increase in the cost of production at each price level shifts the AS curve leftward resulting in increased prices
Short-run: Increased prices and decreased real output (and more unemployment)
Wage push : increase in wage rate - power of trade unions
Supply shocks - increase in prices of major raw materials - oil etc.
Profit push : increase in profit requirement of large monopoly businesses.

30. Cost-Push Inflation Price Level Real GDP o ASLR AS2 AS1 Cost-push
inflation occurs
when aggregate
supply shifts left....
Causing a higher
price level b
Price Level P2 P1 a
AD1
Real GDP o Q1

31. Cost-Push Inflation and Demand Management
Government intervention (AD): If government intervenes to increase AD an inflationary spiral will result
No Government intervention (AD): If government does not intervene to increase AD severe recession will result, however nominal wages will eventually decline and will restore AS to original position

32. Cost-Push Inflation Price Level Real GDP o ASLR AS2 AS1 An attempt to
increase AD
will only further
increase the
price level P3 c b
Price Level P2 P1 a
AD1
Real GDP o Q1 Q2

33. Stagflation
Simultaneous experience of high and increasing unemployment and inflation - cost-push inflation.
Caused by :
Aggregate supply shocks such as severe increases in fuel costs, and devaluations
Productivity decline
Inflationary expectations and wages - expectations about the likely future path and rate of increase of the general price level

34. Types of Inflation in Australia
: Cost push - caused by international oil price rise.
1979 : cost-push - caused by international oil price rise.
: cost push - caused by rapidly rising wages.
In early 1993, RBA changed its policy to inflation targeting - 2% - 3% a year - initially caused a recession & rise in unemployment

35. Impacts of Inflation
Anticipated (expected) and unanticipated (unexpected) inflation.
Anticipated inflation is not a big problem - economy adjusts automatically.
Unanticipated inflation redistributes income between :
employers and employees
lenders and borrowers

36. Phillips Curve
Suggests an inverse relationship (or a trade-off) between inflation and the unemployment rate
Named after A W Phillips who originally discovered the relationship between unemployment and nominal wages, using British data in 1950s.
In general, inflation is associated with economic expansion and unemployment with economic recession.
During expansion : the greater the rate of growth of AD - inflation is high - unemployment is low.
During recession : the slower the rate of growth of AD - inflation is low - unemployment is high.

37. The Phillips Curve Annual rate of inflation (percent)7 6 5 4 3 2 1
Annual rate of inflation
(percent)
Unemployment rate (percent)

38. Implications of Phillips Curve
Trade-off suggests : a rise in inflation should lead to a decline in unemployment, and vice versa.
In general, both can not be brought down to the minimum level.
The society must make a choice between low inflation and low unemployment.

39. Phillips Curve in Australia
1977
1983
1970
1993
2003

40. Shifting Phillips Curve
The smooth relationship may not be valid in the long-run - Conflicts with the trade-offs embodied in the Phillips Curve
Vertical Phillips Curve - at full employment level, only price level changes
Simultaneous high and increasing unemployment and inflation - may lead to shifts in the curve