GROUP 3 – CAPINDING – CATONER – GARAY – GIRON – MARTINEZ – PERIABRAS – SALAPARE – SOMBILLA

CAUSES OF UNEMPLOYMENT

1. A large number of technological advancements:

It is very needless to say that today we live in an age of technology. Previously companies required a lot
of labour in order to perform tasks for them. However, nowadays, computers and various other
machines can perform even the most complex of tasks in just minutes. In addition to that, some years ago,
even sending one message or reply took so much of time. Nowadays with the help of the internet, things
are done in a matter of minutes and it is for this reason that so many people are no longer required to do
tasks which required manual labour and intellectual ability. This is one of the reasons for
unemployment.

2. Jobs have become increasingly specialized:

Big companies provide their employees with a large number of benefits and facilities. It is for this reason
that when looking for employees, they have a large number of specifications. Unless a person fulfils all
the requirements, he or she will not even be considered for the position at hand. Since job
descriptions have become so very specific and particular, people are finding it very tough to even get an
interview. At such a point in time, there is little which can be done, because companies will not be willing
to take on board those who are not exactly perfect for the job.

3. Companies prefer hiring a few people on board:

Previously top companies hired a large number of people so as to ensure that all the jobs get done in a
proper manner, within the stipulated deadline. However, nowadays, companies prefer to hire as few
people as possible on board. This is so that they do not have to spend too much money on salaries and
secondly so that their trade secrets do not go out. They are only willing to hire those people who they trust
and are entirely sure of. Many bosses believe that hiring 5 competent people on board is better than
having 20 average people. Offices only hire rockstar employees who are all-rounders and are capable of
excellent work at all times.

4. People voluntarily choose to remain unemployed:

There are many individuals out there who are very specific when it comes to choosing jobs, simply
because they do not work in a company which they would not like to mention on their CV, in the future.
On the other end of the spectrum, there are those individuals who are willing to take up any job as long as
they are getting a salary and job. The first kind of people prefer to wait for the right job to come along
and that is why they end up being unemployed. They too want to be employed but they are unwilling to
take up simply any and every job which happens to come their way.

5. A higher literacy rate among men and women:

Till a few years ago, the literacy rate of the world over was not very high at all. However nowadays more
and more people from even the rural regions are coming forward in order to receive an education. In
addition to this even women are being encouraged to come forward and study so that their future is bright
and promising. It is very sad indeed that because so many people are educated, the number of jobs are
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falling short and that is why there is so much of unemployment, especially in big cities. Once people are
well educated, chances are that they will be unwilling to accept a job which is not worthy of their
intellect.

6. The issue of the immobility of the workforce:

In certain places, job opportunities are more than others. Some places are just not developed enough to
provide jobs to a large number of people. The immobility of the work or labour force is one major reason
for unemployment as well. For various reasons, certain able people are simply unwilling to migrate from
one location to the next. Rather than taking the plunge, they prefer to remain close to home and families
as well. Doing this is something which is not very wise simply because if you realize that your current
location does not hold much potential for you and your career, you must be willing to relocate.

EFFECTS OR CONSEQUENCES OF UNEMPLOYMENT

1. Affects the economy of a region very negatively:

It is rather interesting to note that the global economic crisis is not merely a cause but also an effect of
unemployment. Once people are unemployed the government of a country becomes responsible for
providing the people with amenities and facilities which they cannot afford. So when so many people in a
country are unemployed it automatically results in recession.

2. Reduces the spending power of both the employed as well as unemployed:

Once people are unemployed they are naturally unwilling to have any purchasing power. However,
besides the unemployed, even those who are employed are unwilling to spend a lot of money, simply
because they fear that if things get worse and the company closes down they too might end up losing their
jobs.

3. Makes the individual feel very depressed:

In addition to affecting the country and society it also negatively affects the individual who begins to
second guess all his decisions as well as his personal worth at such a time.

4. It is a cause of distress to the entire family:

When someone in the family is unemployed, it is usually not just that one person but the entire family
which is affected and has to suffer. In addition to money being scarce in the family, the family also has to
cater to the emotional needs of the person who is unemployed.

5. Increase in crime in the country:

Of all the negative effects of unemployment, one of the worst effects is that it leads to an increase in
crime in the country. When breadwinners in a family are unable to provide for their loved ones, they
have no option but to resort to crime as well as foul means in order to feed their family members. At such
a time when people are unable to keep body and soul together, their conscience seizes to function and
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they do what seems correct to them at the moment as well as under the given circumstances. It is often
said that desperate times call for desperate measures and that is the motto which such people choose to
live by.

CAUSES OF INFLATION

1. The Money Supply Inflation is primarily caused by an increase in the money supply that
outpaces economic growth. When the Federal Reserve decides to put more money into
circulation at a rate higher than the economy’s growth rate, the value of money can fall because of
the changing public perception of the value of the underlying currency. As a result, this
devaluation will force prices to rise due to the fact that each unit of currency is now worth less.
The less currency there is in the money supply, the more valuable that currency will be. When a
government decides to print new currency, they essentially water down the value of the money
already in circulation. A more macroeconomic way of looking at the negative effects of an
increased money supply is that there will be more dollars chasing the same amount of goods in an
economy, which will inevitably lead to increased demand and therefore higher prices.

2. The National Debt. As a country’s debt increases, the government has two options: they can
either raise taxes or print more money to pay off the debt. A rise in taxes will cause businesses to
react by raising their prices to offset the increased corporate tax rate.
3. Demand-Pull Effect. The demand-pull effect states that as wages increase within an economic
system (often the case in a growing economy with low unemployment), people will have more
money to spend on consumer goods. This increase in liquidity and demand for consumer goods
results in an increase in demand for products. As a result of the increased demand, companies will
raise prices to the level the consumer will bear in order to balance supply and demand.

4. Cost-Push Effect. Essentially, this theory states that when companies are faced with increased
input costs like raw goods and materials or wages, they will preserve their profitability by passing
this increased cost of production onto the consumer in the form of higher prices.

5. Exchange Rates Inflation can be made worse by our increasing exposure to foreign
marketplaces. In America, we function on a basis of the value of the dollar. When the exchange
rate suffers such that the U.S. currency has become less valuable relative to foreign currency, this
makes foreign commodities and goods more expensive to American consumers while
simultaneously making U.S. goods, services, and exports cheaper to consumers overseas. This
exchange rate differential between our economy and that of our trade partners can stimulate the
sales and profitability of American corporations by increasing their profitability and
competitiveness in overseas markets. But it also has the simultaneous effect of making imported
goods (which make up the majority of consumer products in America), more expensive to
consumers in the United States.

RISKS OF PERSISTENTLY HIGH INFLATION

1. Income redistribution: One risk of higher inflation is that it has a regressive effect on lower-
income families and older people in society. This happens when prices for food and domestic
utilities such as water and heating rises at a rapid rate

2. Falling real incomes: With millions of people facing a cut in their wages or at best a pay freeze,
rising inflation leads to a fall in real incomes.
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3. Negative real interest rates: If interest rates on savings accounts are lower than the rate of
inflation, then people who rely on interest from their savings will be poorer. Real interest rates for
millions of savers in the UK and many other countries have been negative for at least four years

4. Cost of borrowing: High inflation may also lead to higher borrowing costs for businesses and
people needing loans and mortgages as financial markets protect themselves against rising prices
and increase the cost of borrowing on short and longer-term debt. There is also pressure on the
government to increase the value of the state pension and unemployment benefits and other
welfare payments as the cost of living climbs higher.

5. Risks of wage inflation: High inflation can lead to an increase in pay claims as people look to
protect their real incomes. This can lead to a rise in unit labour costs and lower profits for
businesses

6. Business competitiveness: If one country has a much higher rate of inflation than others for a
considerable period of time, this will make its exports less price competitive in world markets.
Eventually this may show through in reduced export orders, lower profits and fewer jobs, and
also in a worsening of a country’s trade balance. A fall in exports can trigger negative multiplier
and accelerator effects on national income and employment.

7. Business uncertainty: High and volatile inflation is not good for business confidence partly
because they cannot be sure of what their costs and prices are likely to be. This uncertainty might
lead to a lower level of capital investment spending. Overall, a high and volatile rate of inflation
is widely considered to be damaging for an economy that trades in international markets.

THE SHORT RUN TRADE OFF BETWEEN INFLATION AND UNEMPLOYMENT

Introduction

Since both inflation and unemployment are undesirable, the sum of inflation and unemployment has been
termed the misery index. Inflation and unemployment are independent in the long run, because
unemployment is determined by features of the labour market while inflation is determined by money
growth. However, in the short run inflation and unemployment are related, because an increase in
aggregate demand temporarily increases inflation and output while it lowers unemployment.

The Phillips curve:

In 1958, a British economist named A.W. Phillips found a negative relationship between inflation
and unemployment. That is, years of high inflation are associated with low unemployment. This
negative relationship has been found for other countries, including the United States, and has been termed
the Phillips curve. The Phillips curve appears to offer policymakers a menu of inflation and
unemployment choices. To have lower unemployment, one need only choose a higher rate of
inflation.

The model of aggregate supply and aggregate demand can explain the relationship described by the
Phillips curve. The Phillips curve shows the combinations of inflation and unemployment that arise in the
short run as shifts in the aggregate-demand curve move along a short-run aggregate-supply curve. For
example, an increase in aggregate demand moves the economy along a short-run aggregate-supply curve
to a higher price level, a higher level of output and a lower level of unemployment. Since prices in the
GROUP 3 – CAPINDING – CATONER – GARAY – GIRON – MARTINEZ – PERIABRAS – SALAPARE – SOMBILLA

previous period are now fixed, a higher price level in the current period implies a higher rate of inflation,
which is now associated with a lower rate of unemployment. This can be seen in Exhibit 1. An increase in
aggregate demand, which moves the economy from point A to point B in panel (a), is associated with a
movement along the short-run Phillips curve from point A to point B.

Shifts in the Phillips curve:

The role of expectations In 1968, US economists Friedman and Phelps argued that the Phillips curve is
not a menu policymakers can exploit. This is because, in the long run, money is neutral and has no real
effects. Money growth just causes proportional changes in prices and incomes, and should have no impact
on unemployment. Therefore, the long-run Phillips curve should be vertical at the natural rate of
unemployment - the rate of unemployment to which the economy naturally gravitates.

A vertical long-run Phillips curve corresponds to a vertical long-run aggregate-supply curve. As Exhibit 1
illustrates, in the long run an increase in the money supply shifts aggregate demand to the right and moves
the economy from point A to point C in panel (a). The corresponding Phillips curve is found in panel (b)
where an increase in money growth increases inflation but, because money is neutral in the long run,
prices and incomes move together and inflation fails to affect unemployment. Thus, the economy moves
from point A to point C in panel (b) and traces out the long-run Phillips curve.

Friedman and Phelps used the phrase 'natural rate of unemployment', not because it is either desirable or
constant, but because it is beyond the influence of monetary policy. The natural rate of unemployment is
also referred to as the NAIRU - the non-accelerating inflation rate of unemployment. Changes in labour-
market policies, such as changes in minimum-wage laws and unemployment insurance that lower the
natural rate of unemployment, shift the long-run Phillips curve to the left and the long-run aggregate-
supply curve to the right.

Even though Friedman and Phelps argued that the long-run Phillips curve is vertical, they also argued
that, in the short run, inflation can have a substantial impact on unemployment. Their reasoning is similar
to that surrounding the short-run aggregate-supply curve in that they assume that, in the short run, price
expectations are fixed. Just as with short-run aggregate supply, if price expectations are fixed in the short-
run, an increase in inflation could temporarily increase output and lower unemployment below the natural
rate. In Exhibit 2, this is a movement from point A to point B. However, in the long-run, people adjust to
the higher rate of inflation by raising their expectations of inflation and the short-run Phillips curve shifts
GROUP 3 – CAPINDING – CATONER – GARAY – GIRON – MARTINEZ – PERIABRAS – SALAPARE – SOMBILLA

upward. The economy moves from point B to point C with higher inflation but no change in
unemployment. Thus, policymakers face a short-run trade-off between inflation and unemployment, but if
they attempt to exploit it, the relationship disappears and they arrive back on the vertical long-run Phillips
curve.

The analysis of Friedman and Phelps can be summarised by the following equation:
unemployment rate = natural rate of unemployment - a (actual inflation - expected inflation)

This says that, for any given expected inflation rate, if actual inflation exceeds expected inflation,
unemployment will fall below the natural rate by an amount that depends on the parameter a. However, in
the long run, people learn to expect the inflation that actually exists, and the unemployment rate will
equal the natural rate.

Friedman and Phelps proposed the natural rate hypothesis, which states that unemployment eventually
returns to its natural rate, regardless of inflation. While controversial, it proved to be true when tested in
the US economy. During the 1960s in the US, expansionary monetary and fiscal policies steadily
increased the rate of inflation and unemployment fell. However, in the early 1970s, people raised their
expectations of inflation and the unemployment rate returned to the natural rate - about five or six
percent.

Shifts in the Phillips curve: The role of supply shocks The short-run Phillips curve can also shift due to a
supply shock. A supply shock is an event that directly alters firms' costs and prices, shifting the economy's
aggregate-supply curve and Phillips curve. A supply shock occurred in 1974 when OPEC raised oil prices.
This act raised the cost of production and shifted the US short-run aggregate-supply curve to the left,
causing prices to rise and output to fall, or stagflation. Rising oil prices also impacted on the Australian
economy. Inflation rose substantially in 1973-74, causing an increase in expected inflation. The rise in
actual inflation was fuelled by both rising oil prices and wages. By 1983, the inflation rate was over 11%
and unemployment was nearly 10%, as oil prices and wages continued to rise.

Since inflation has increased and unemployment has increased, this corresponds to a rightward (upward)
shift in the short-run Phillips curve. Policymakers now face a less favourable trade-off between inflation
and unemployment. That is, policymakers must accept a higher inflation rate for each unemployment rate,
or a higher unemployment rate for each inflation rate. Also, policymakers now have a difficult choice
because, if they reduce aggregate demand to fight inflation, they will further increase unemployment. If
GROUP 3 – CAPINDING – CATONER – GARAY – GIRON – MARTINEZ – PERIABRAS – SALAPARE – SOMBILLA

they increase aggregate demand to reduce unemployment, they further increase inflation.

The cost of reducing inflation

To reduce inflation, the RBA could use a policy of disinflation - a reduction in the rate of inflation. A
reduction in the money supply reduces aggregate demand, reduces production and increases
unemployment. This is shown in Exhibit 3 as a movement from point A to point B. Over time, expected
inflation falls and the short-run Phillips curve shifts downward and the economy moves from point B to
point C.

AGGREGATE DEMAND AND AGGREGATE SUPPLY

Aggregate demand (AD)

Aggregate demand is a schedule or curve that shows the amount of a nation’s output (real GDP) that
buyers collectively desire to purchase at each possible price level. These buyers include the nation’s
households, businesses, and government along with consumers located abroad (households, businesses,
and governments in other nations). The relationship between the price level (as measured by the GDP
price index) and the amount of real GDP demanded is inverse or negative. When the price level rises, the
quantity of real GDP demanded decreases; when the price level falls, the quantity of real GDP demanded
increases.

Aggregate demand consists of

C - the amount households plan to spend on goods

I - planned spending on capital investment
G - government spending
X – exports minus M - imports from abroad

The standard equation is:

AD = C + I + G + (X – M)

Aggregate demand and the circular flow (explanation of the equation)

Aggregate demand can be illustrated by reference to the circular flow of income.

Aggregate demand is generated as income is transferred to spending as a result of the circular flow of
income. Income is spent on consumer goods and services (C) plus spending on capital goods by firms (I).
Spending is also generated by government when it allocates resources to public goods, merit goods and
income transfers, such as pension benefits. Finally, there is 'net overseas spending', which is overseas
spending on an economy's exports of goods and services, less what the economy spends on importing
goods and services.

Example of aggregate demand AD can be found by adding-up the value of all the individual components
at various average price levels. D and the price level:
Apart from imports, the components of AD are inversely related to prices. Each component responds
differently to changes in prices, in other words they have different elasticities with respect to the price
level. For example, we can assume that overseas demand is elastic with respect to price, because overseas
consumers can choose from many global suppliers. This makes them highly sensitive to changes in the
prices of imported products.

The aggregate demand curve

The AD curve shows the relationship between AD and the price level. It is assumed that the AD curve
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will slope down from left to right. This is because all the components of AD, except imports, are inversely
related to the price level. For convenience, the AD curve is normally drawn as a straight line, though it
can be argued that it is more likely to be non-linear, many suggesting it has a rectangular hyperbola shape.
It is also claimed that the downward slope of the AD curve reflects 'normal' macro-economic conditions,
and that in a deep recession, the AD curve could become vertical.

Aggregate supply
Aggregate supply (AS) is defined as the total amount of goods and services (real output) produced and
supplied by an economy’s firms over a period of time. It includes the supply of a number of types of
goods and services including private consumer goods, capital goods, public and merit goods and goods
for overseas markets.

COMPONENTS OF AS

Consumer goods
Private consumer goods and services, such as motor vehicles, computers, clothes and entertainment, are
supplied by the private sector, and consumed by households. For a developed economy, this is the single
largest component of aggregate supply.

Capital goods
Capital goods, such as machinery, equipment, and plant, are supplied to other firms. These investment
goods are significant in that their use adds to capacity, and increases the economy’s ability to supply
private consumer goods in the future.

Public and merit goods

Goods and services produced by private firms for use by central or local government, such as education
and healthcare, are also a significant component of aggregate supply. Many private firms such as those in
construction, IT and pharmaceuticals, rely on contracts to supply to the public sector.

Traded goods
Goods and services for export, such as chemicals, entertainment, and financial services are also a key
component of aggregate supply.

THE AGGREGATE SUPPLY CURVE

The simple law of supply suggests that firms will, in general, plan to produce more output at higher price
levels.

The basic AS curve

At higher price levels across the economy firms expect that they can sell their final products at higher
prices, and there will be a positive relationship between the price level and aggregate supply. Any increase
in input prices (costs) which may follow is assumed to lag behind increases in the general price level.
Because of this firms expect that they will benefit - at least in the short run - from a rise in the price level.

Short run variations in unemployment (cyclical unemployment) are caused by the business cycle as
the economy expands and contracts. Over the long run, in the United States, the unemployment rate
typically hovers around 5% (give or take one percentage point or so), when the economy is healthy. In
many of the national economies across Europe, the unemployment rate in recent decades has only
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dropped to about 10% or a bit lower, even in good economic years. We call this baseline level of
unemployment that occurs year-in and year-out the natural rate of unemployment and we determine it by
how well the structures of market and government institutions in the economy lead to a matching of
workers and employers in the labor market. Potential GDP can imply different unemployment rates in
different economies, depending on the natural rate of unemployment for that economy.
The AD/AS diagram shows cyclical unemployment by how close the economy is to the potential or
full GDP employment level. Returning to , relatively low cyclical unemployment for an economy occurs
when the level of output is close to potential GDP, as in the equilibrium point E1. Conversely, high
cyclical unemployment arises when the output is substantially to the left of potential GDP on the AD/AS
diagram, as at the equilibrium point E0. Although we do not show the factors that determine the natural
rate of unemployment separately in the AD/AS model, they are implicitly part of what determines
potential GDP or full employment GDP in a given economy.

Inflationary Pressures in the AD/AS Diagram

Inflation fluctuates in the short run. Higher inflation rates have typically occurred either during or just
after economic booms: for example, the biggest spurts of inflation in the U.S. economy during the
twentieth century followed the wartime booms of World War I and World War II. Conversely, rates of
inflation generally decline during recessions. As an extreme example, inflation actually became negative
—a situation called “deflation”—during the Great Depression. Even during the relatively short 1991-1992
recession, the inflation rate declined from 5.4% in 1990 to 3.0% in 1992. During the relatively short 2001
recession, the rate of inflation declined from 3.4% in 2000 to 1.6% in 2002. During the deep recession of
2007–2009, the inflation rate declined from 3.8% in 2008 to –0.4% in 2009. Some countries have
experienced bouts of high inflation that lasted for years. In the U.S. economy since the mid–1980s,
inflation does not seem to have had any long-term trend to be substantially higher. Instead, it has stayed in
the 1–5% range annually.

The AD/AS framework implies two ways that inflationary pressures may arise. One possible trigger is if
aggregate demand continues to shift to the right when the economy is already at or near potential GDP
and full employment, thus pushing the macroeconomic equilibrium into the AS curve’s steep portion.