chapter 16 prices & employment

8/6/2019 Chapter 16 Prices & Employment

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EconomicsEconomicsChapter 16Chapter 16

PRICES & EMPLOYMENTPRICES & EMPLOYMENT


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Government ObjectivesGovernment Objectives

THE BIG PICTURETHE BIG PICTURE -- KEY QUESTIONSKEY QUESTIONS

WHAT ARE THE ECONOMIC TARGETS WHAT ARE THE ECONOMIC TARGETSOF THE GOVERNMENT?OF THE GOVERNMENT?

HOW CAN WE AVOID A CRIPPLING HOW CAN WE AVOID A CRIPPLING

RECESSION?RECESSION? WHY ARE SO MANY PEOPLE ON THE WHY ARE SO MANY PEOPLE ON THE

DOLE?DOLE?

WHAT MAKES THE ECONOMY OF

WHAT MAKES THE ECONOMY OFRIPLEY AND THE UK BIGGER?RIPLEY AND THE UK BIGGER?

WHY DO WE WANT TO AVOID HIGH WHY DO WE WANT TO AVOID HIGHINFLATION?INFLATION?


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Government Objectives and TargetsGovernment Objectives and Targets

FFour main targets:our main targets:

-- Low unemploymentLow unemployment lots of people in worklots of people in work -- Low and steady inflationLow and steady inflation prices and wages fairly stableprices and wages fairly stable -- Steady and sustainable economic growth (%change in GDP)Steady and sustainable economic growth (%change in GDP)

the economy to grow a little bit each yearthe economy to grow a little bit each year --A positive balance of paymentsA positive balance of payments to export more than weto export more than we

importimport

Two otherTwo other possibilitiespossibilities::

--To reduce inequality in the countryTo reduce inequality in the country to redistribute incometo redistribute incomeand wealth in order to help the poorand wealth in order to help the poor

--To protect the environmentTo protect the environment to avoid pollution andto avoid pollution andcongestioncongestion


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What is inflation?What is inflation?

InIn economicseconomics,, inflationinflation is a rise in the generalis a rise in the general level oflevel of

pricesprices of goods and services in anof goods and services in an economyeconomyover a periodover a periodof time.of time.

When the general price level rises, each unit of currencyWhen the general price level rises, each unit of currencybuys fewer goods and services. Consequently, inflationbuys fewer goods and services. Consequently, inflation

also reflects an erosion in thealso reflects an erosion in the purchasing powerpurchasing power of moneyof money a loss of real value in the internal medium of exchangea loss of real value in the internal medium of exchangeand unit of account in the economy.and unit of account in the economy. For the type ofFor the type ofinflation that makes the currency to almost worthlessinflation that makes the currency to almost worthless --

hyperinflationhyperinflation

A chief measure of price inflation is theA chief measure of price inflation is the inflation rateinflation rate, the, theannualized percentage change in a generalannualized percentage change in a general price indexprice index(normally the(normally the Consumer Price IndexConsumer Price Index) over time.) over time.


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DeflationDeflation a sustained fall in the general level of pricesa sustained fall in the general level of prices

in an economy is also a concernin an economy is also a concern

Happens when demand for goods decreaseHappens when demand for goods decrease

Firms unable to sell thus lower prices & reduce profitsFirms unable to sell thus lower prices & reduce profits

Lower production and unemployment increasesLower production and unemployment increases

Household income will fall thus demand drop furtherHousehold income will fall thus demand drop further

Debts increaseDebts increase

Economy will go into recession as demand, output, theEconomy will go into recession as demand, output, the

demand for labor and incomes continue to falldemand for labor and incomes continue to fall


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How to measure inflation?How to measure inflation?

T

he rate of price inflation is measure by calculatingT

he rate of price inflation is measure by calculatingthe avg percentage in the prices of all goods/the avg percentage in the prices of all goods/

services from one point in time to anotherservices from one point in time to another

Difficult to obtain up to date information on all theDifficult to obtain up to date information on all the

millions of different goods in an economymillions of different goods in an economy Now used basket of goods & services purchased byNow used basket of goods & services purchased by

a typical familya typical family

The above price info will be used to compile a CPIThe above price info will be used to compile a CPI

A CPIA CPI main measure of price inflationmain measure of price inflation

A CPI include any sales & excise taxes. Exclude priceA CPI include any sales & excise taxes. Exclude price

of assets, life insurance and prices for food, oil andof assets, life insurance and prices for food, oil and

electricityelectricity


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Calculating a Price IndexCalculating a Price Index The average price of the basket of products in theThe average price of the basket of products in the

1st year of calculation or BASE YEAR is given as 1001st year of calculation or BASE YEAR is given as 100

Then if on avg. the prices in the same basket rise byThen if on avg. the prices in the same basket rise by

25% over the next year, the P Index at end of 2nd25% over the next year, the P Index at end of 2nd

year will be 125.year will be 125.

If 3rd year prices increase by another 10%, the CPI atIf 3rd year prices increase by another 10%, the CPI at

end of 3rd year will be 137.5 ( 125 +(125X10%))end of 3rd year will be 137.5 ( 125 +(125X10%))

This tell us that CP have risen on average of 37.5 %This tell us that CP have risen on average of 37.5 %

over a 2 year periodover a 2 year period


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Asimple calculationAsimple calculation

Types of goods &Types of goods &

servicesservices

Proportion ofProportion of

weeklyweeklyhouseholdhousehold

income spentincome spenton eachon each

categorycategory

Average price ($)Average price ($)

of goods andof goods andservicesservices

purchased inpurchased ineach categoryeach category

Weighted Avg price ($)Weighted Avg price ($)

Travel & LeisureTravel & Leisure 15%15% $20.00$20.00 0.15x20.00=$30.15x20.00=$3

Household goodsHousehold goods 25%25% $40.00$40.00 0.25x40.00=$10.000.25x40.00=$10.00

Clothing &Clothing &FootwearFootwear

40%40% $30.00$30.00 0.40x$30.00=$12.000.40x$30.00=$12.00

TransportTransport 20%20% $25.00$25.00 0.20x$25.00=$5.000.20x$25.00=$5.00

Total =Total =100%100%

Price of basket = $30.00Price of basket = $30.00

BASE YEAR


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Types of goods &Types of goods &

servicesservices

Proportion ofProportion of

weeklyweeklyhouseholdhousehold

income spentincome spenton eachon each

categorycategory

Average price ($)Average price ($)

of goods andof goods andservicesservices

purchased in eachpurchased in eachcategorycategory

Weighted Avg price ($)Weighted Avg price ($)

Travel & LeisureTravel & Leisure 25%25% $22.00$22.00 0.25x22.00=$5.500.25x22.00=$5.50

Household goodsHousehold goods 25%25% $46.00$46.00 0.25x46.00=$11.500.25x46.00=$11.50

Clothing &Clothing &FootwearFootwear

35%35% $38.00$38.00 0.35x$38.00=$13.300.35x$38.00=$13.30

TransportTransport 15%15% $20.00$20.00 0.15x$20.00=$3.000.15x$20.00=$3.00

Total = 100%Total = 100% Price of basket = $33.30Price of basket = $33.30

Year 1


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Overall weighted average @ end of Year 1 is nowOverall weighted average @ end of Year 1 is now$33,30.$33,30.

So CPI in year 1 =So CPI in year 1 = Weighted Avg price Year 1Weighted Avg price Year 1

Weighted Avg Price base yearWeighted Avg Price base year

= $33.30/$30,00 X 100 = 111= $33.30/$30,00 X 100 = 111

Represent a inflation of 11% increase in Year 1Represent a inflation of 11% increase in Year 1If in Year 2, weighted price for the basket in $36.00, theIf in Year 2, weighted price for the basket in $36.00, the

CPI at end of year 2 will be:CPI at end of year 2 will be:

= $36.00/$30.99 X100 = 120= $36.00/$30.99 X100 = 120

SO inflation increase by 20% from base yearSO inflation increase by 20% from base year

DO EXERCISE 2 Page 303DO EXERCISE 2 Page 303


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Uses of CPI DataUses of CPI Data

As an economic indicatorAs an economic indicator

used to measure price inflation and a measureused to measure price inflation and a measureof changes in cost of living.of changes in cost of living.

-- Used macroeconomic policies to control priceUsed macroeconomic policies to control priceinflation.inflation.

-- Used by workers to seek increases in wagesUsed by workers to seek increases in wages

As a price deflaterAs a price deflater Rising prices will reduceRising prices will reducepurchasing power. Used to deflate otherpurchasing power. Used to deflate othereconomic series to calculate real valueseconomic series to calculate real values


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IndexationIndexation tying certain payments to the rate oftying certain payments to the rate of

increase in CPI. Example Pensions/ Savings/ incomeincrease in CPI. Example Pensions/ Savings/ income

taxtax

PROBLEMS WITH PRICE INDICESPROBLEMS WITH PRICE INDICES

Changes in taste and fashionChanges in taste and fashion Intro of new goodsIntro of new goods

The changing composition of the population andThe changing composition of the population and

households.households.


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Inflation refers to a rise in prices that causes theInflation refers to a rise in prices that causes the

purchasing powerpurchasing power of a nation to fall. Inflation is aof a nation to fall. Inflation is anormalnormal economic developmenteconomic development as long as the annualas long as the annualpercentage remains low; once the percentage rises overpercentage remains low; once the percentage rises overa prea pre--determined level, it is considered an inflationdetermined level, it is considered an inflation

crisis.crisis. There are many causes for inflation, depending on aThere are many causes for inflation, depending on a

number of factors. For example, inflation can happennumber of factors. For example, inflation can happenwhen governments print an excess of money to dealwhen governments print an excess of money to deal

with a crisis. As a result, prices end up rising at anwith a crisis. As a result, prices end up rising at anextremely high speed to keep up with the currencyextremely high speed to keep up with the currencysurplus. This is called the demandsurplus. This is called the demand--pull, in which pricespull, in which pricesare forced upwards because of a high demand.are forced upwards because of a high demand.

Causes of Inflation


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Another common cause of inflation is a rise inAnother common cause of inflation is a rise in

production costs, which leads to an increase inproduction costs, which leads to an increase inthe price of the final product. For example, ifthe price of the final product. For example, ifraw materials increase in price, this leads to theraw materials increase in price, this leads to the

cost of production increasing, which in turncost of production increasing, which in turn

leads to the company increasing prices toleads to the company increasing prices tomaintain steady profits. Rising labor costs canmaintain steady profits. Rising labor costs can

also lead to inflation. As workers demand wagealso lead to inflation. As workers demand wage

increases, companies usually chose to pass onincreases, companies usually chose to pass onthose costs to their customers.those costs to their customers.


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Inflation can also be caused by international lendingInflation can also be caused by international lendingand national debts. As nations borrow money, theyand national debts. As nations borrow money, theyhave to deal with interests, which in the end causehave to deal with interests, which in the end causeprices to rise as a way of keeping up with their debts. Aprices to rise as a way of keeping up with their debts. Adeep drop of the exchange rate can also result indeep drop of the exchange rate can also result ininflation, as governments will have to deal withinflation, as governments will have to deal withdifferences in the import/export level.differences in the import/export level.

Finally, inflation can be caused by federal taxes put onFinally, inflation can be caused by federal taxes put onconsumer products such asconsumer products such as cigarettescigarettes or fuel. As theor fuel. As thetaxes rise,taxes rise, supplierssuppliers often pass on the burden to theoften pass on the burden to theconsumer; the catch, however, is that once prices haveconsumer; the catch, however, is that once prices haveincreased, they rarely go back, even if the taxes are laterincreased, they rarely go back, even if the taxes are later

reduced. Wars are often cause for inflation, asreduced. Wars are often cause for inflation, asgovernments must both recoup the money spent andgovernments must both recoup the money spent andrepay the funds borrowed from therepay the funds borrowed from the central bankcentral bank. War. Waroften affects everything from international trading tooften affects everything from international trading tolabolabouur costs to product demand, so in the end it alwaysr costs to product demand, so in the end it always

produces a rise in prices.produces a rise in prices.


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What causes inflation?What causes inflation?There are 2 main reasons why prices could increase in ourThere are 2 main reasons why prices could increase in our

economyeconomy

1. COST PUSH1. COST PUSH

An increase in costs may lead to an increase in prices.An increase in costs may lead to an increase in prices. Examples:Examples:

Raw material prices ( possibly from abroad) increase...Raw material prices ( possibly from abroad) increase......Costs to business increase......Costs to business increase......Business still wants to make a profit......Business still wants to make a profit......Business puts its prices up......Business puts its prices up......Consumers can buy less with their money......Consumers can buy less with their money......Workers demand and receive pay increases......Workers demand and receive pay increases......Businesses costs increase again......Businesses costs increase again......Businesses put prices up again...Businesses put prices up again


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2. DEMAND PULL2. DEMAND PULL

If there is too much demand for goods and services in theIf there is too much demand for goods and services in theeconomy then prices may be forced upwards.economy then prices may be forced upwards.

Individuals and businesses experience a feelIndividuals and businesses experience a feel good factor ( maybegood factor ( maybethey have just had a tax cut)they have just had a tax cut)

They wish to buy more goods and servicesThey wish to buy more goods and services

Only so many goods and services are available at presentOnly so many goods and services are available at present

Suppliers experience so much demand for their limited numberSuppliers experience so much demand for their limited numberof goods that they decide to put up pricesof goods that they decide to put up prices

ACTIONACTION

a. In the cost push example, why are workers demanding highera. In the cost push example, why are workers demanding higherwages?wages?b. How does a ticket tout use demand pull to increase their ticketb. How does a ticket tout use demand pull to increase their ticketprices?prices?


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EffectsEffects OF InflationOF Inflation

The effects of inflation can be brutal for the elderlyThe effects of inflation can be brutal for the elderlywho are looking to retire on a fixed income. The dollarswho are looking to retire on a fixed income. The dollarsthat they expect to retire with will be worth less and lessthat they expect to retire with will be worth less and lessas time goes on and inflation goes higher.as time goes on and inflation goes higher.

When the balance between supply and demand spiralsWhen the balance between supply and demand spiralsout of control, buyers will change their spending habitsout of control, buyers will change their spending habitsas they meet their purchasing thresholds and producersas they meet their purchasing thresholds and producerswill suffer and be forced to cut output. This can bewill suffer and be forced to cut output. This can be

readily tied to higherreadily tied to higher unemployment ratesunemployment rates. When. Whenextremes arise in the supply/demand structure,extremes arise in the supply/demand structure,imbalances are created.imbalances are created.


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TheThe mortgage crisis of 2007mortgage crisis of 2007 is a great example of this.is a great example of this.Home prices were increasing at a very rapid rate fromHome prices were increasing at a very rapid rate from

2002 to 2005 and got to the point where the prices2002 to 2005 and got to the point where the pricesbecame too high, forcing buyers to step aside. This lackbecame too high, forcing buyers to step aside. This lackof demand forced sellers to drop prices back to a pointof demand forced sellers to drop prices back to a pointwhere there is demand.where there is demand. BBut the extreme acceleration ofut the extreme acceleration ofinflation in home prices is directly correlated to theinflation in home prices is directly correlated to the

pullback we are seeing.pullback we are seeing. A similar example can be seen in the internet euphoriaA similar example can be seen in the internet euphoria

in the stock market back in 1998 to 2000. This rapidin the stock market back in 1998 to 2000. This rapidacceleration in stock prices eventually becameacceleration in stock prices eventually becameunsustainable and led to a disastrous fall.unsustainable and led to a disastrous fall.

The point that is being made is that if inflation is notThe point that is being made is that if inflation is notcontained and rises at an unsustainable rate; thecontained and rises at an unsustainable rate; thestronger the impact on the other side. There is a saying;stronger the impact on the other side. There is a saying;"the bigger they are, the harder they fall"."the bigger they are, the harder they fall".


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Is inflation Bad? Why are people alwaysIs inflation Bad? Why are people alwayscomplaining about rising pricescomplaining about rising prices

Do exercise 4 Page 308


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Costs of InflationCosts of Inflation

Purchasing power of income reducePurchasing power of income reduce

Real income fallsReal income falls

People will face hardships if they are unable toPeople will face hardships if they are unable toincrease their money incomeincrease their money income


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Cost of Inflation to the EconomyCost of Inflation to the Economy

May causes unemployment. HowMay causes unemployment. How

Country with a higher rate of inflation thanCountry with a higher rate of inflation than

another will have more difficulty to export theiranother will have more difficulty to export theirgoodsgoods

So what can a government do????So what can a government do????


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Objective of the governmentObjective of the government: to maintain a high: to maintain a high

and stable level of employment in theirand stable level of employment in theireconomieseconomies

EmploymentEmployment: Provides people with incomes &: Provides people with incomes &

wealthwealthUnemploymentUnemployment: Wastes productive resources: Wastes productive resources

Crucial: for government & economists to keep anCrucial: for government & economists to keep aneye on the employment trendeye on the employment trend


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The government has several ways to controlThe government has several ways to control

inflation.inflation.

It can do this by means of fiscal policy, that manages theIt can do this by means of fiscal policy, that manages theaggregate demand by using government spending.aggregate demand by using government spending.

To reduce inflation government should reduceTo reduce inflation government should reduceexpenditure and raise taxes.expenditure and raise taxes. ((works only againstworks only against

demand caused inflationdemand caused inflation).).CControlling interest rates (money policy) and mediumontrolling interest rates (money policy) and medium--

term financial strategyterm financial strategy

A very effective wayA very effective way (short term)(short term) to reduce the cost pushto reduce the cost push

inflation is by direct interventioninflation is by direct intervention ((government takesgovernment takesmeasures to restrict the increase in wages (incomes) andmeasures to restrict the increase in wages (incomes) andprices.prices.


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InflationInflation

Global Food Prices Rises

Rising prices to the consumers

Hyperinflation 1

Hyperinflation 2


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Employment TrendEmployment Trend


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Employment TrendsEmployment Trends

Main government objectives: Maintain a high andMain government objectives: Maintain a high and

stable level of employment in their economiesstable level of employment in their economies

Employment provides people with incomes &Employment provides people with incomes &

wealthwealth


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Key Employment TrendsKey Employment Trends

Government & Economists will be interested to followGovernment & Economists will be interested to follow--up on theup on the

following employment trends:following employment trends:

Labour ForceLabour Force total # of people of working age in work ortotal # of people of working age in work oractively seeking workactively seeking work

Labour force participation rateLabour force participation rate Labour force as aLabour force as a

proportion of the total working age populationproportion of the total working age population Employment by industrial sectorEmployment by industrial sector -- # of people employed in# of people employed in

agriculture & manufacturing industriesagriculture & manufacturing industries

Employment statusEmployment status -- # of people working FT/ PT or# of people working FT/ PT orTemporaryTemporary

UnemploymentUnemployment the # of people registered as beingthe # of people registered as beingwithout workwithout work

Unemployment rateUnemployment rate The unemployed as a proportion ofThe unemployed as a proportion ofthe total labour forcethe total labour force


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The Global Employment RateThe Global Employment Rate

2009


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UnemploymentUnemployment


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End of WW IGreat Depression

FDR New Deal

End of WW II

Housing

market crunch

Dot.com

crunch

Overproduction

crisis


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Current World

Unemployment

Rate


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EXERCISEEXERCISE

DO exercise 5 Page 314DO exercise 5 Page 314


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What causes UnemploymentWhat causes Unemployment

Rapid changes in technologyRapid changes in technology

RecessionsRecessions

InflationInflation

DisabilityDisability Undulating business cyclesUndulating business cycles

Changes in tastes as well asChanges in tastes as well asalterations in the climaticalterations in the climatic

conditions. This may in turnconditions. This may in turnlead to decline in demand forlead to decline in demand for

certain services as well ascertain services as well asproducts.products.

Attitude towards employersAttitude towards employers

Willingness to workWillingness to work

Perception of employeesPerception of employees

Employee valuesEmployee values Discriminating factors in theDiscriminating factors in the

place of work (may includeplace of work (may includediscrimination on the basis ofdiscrimination on the basis of

age, class, ethnicity, color andage, class, ethnicity, color andrace).race).

Ability to look forAbility to look foremploymentemployment

In the set up of a modern market economy, there are many factors,

which contribute to unemployment. Causes of unemployment are

varied and it may be due to the following factors:


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ExerciseExercise

Do Exercise 6 What causes Unemployment?Do Exercise 6 What causes Unemployment?

Page 315Page 315


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UnemploymentUnemployment

There will always be unemploymentThere will always be unemployment

Frictional UnemploymentFrictional Unemployment Occurs whenOccurs whenworkers change jobs or looking for a new one inworkers change jobs or looking for a new one in

a short period of timea short period of time Seasonal UnemploymentSeasonal Unemployment Occurs as consumerOccurs as consumer

demand for some goods or services is seasonal.demand for some goods or services is seasonal.

Ex:

tourismEx:

tourismThese 2 types of unemployment are not a bigThese 2 types of unemployment are not a big

issue.issue.


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Falling DemandFalling Demand Occurs when there is a fallingOccurs when there is a falling

demand for goods & services.demand for goods & services. CyclicalCyclicalunemploymentunemployment occurs when there is littleoccurs when there is littledemand for goods during a recessiondemand for goods during a recession

Do exercise 7 Page 316Do exercise 7 Page 316

Multiplier EffectMultiplier Effectwhere a smallwhere a small in spending can in spending can

cause large in income, output & employmentcause large in income, output & employment


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Structural ChangeStructural Change occurs if demand falls isoccurs if demand falls is

permanent in favour of new goods or cheaper sourcepermanent in favour of new goods or cheaper sourceof supply Ex: From agricultural to manufacturing orof supply Ex: From agricultural to manufacturing or

labour intensive to high tech intensive productionlabour intensive to high tech intensive production

Technological AdvanceTechnological Advance Occurs when new machinesOccurs when new machines

are capable to replace labourare capable to replace labour


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Factors interfere in the labour marketFactors interfere in the labour market

1.1. Powerful trade unions demand high wagesPowerful trade unions demand high wages

2.2. Benefits paid to the unemployed can reduce theBenefits paid to the unemployed can reduce the

incentive to workincentive to work

3.3. Other employment costs are too highOther employment costs are too high

4.4. Lack of information prevents people from findingLack of information prevents people from findingjobsjobs

5.5. Minimum wage laws increased wages andMinimum wage laws increased wages and

increased unemploymentincreased unemployment

6.6. Immobility of labour prevents workers from findingImmobility of labour prevents workers from finding

new jobsnew jobs


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EXERCISEEXERCISE

Do Exercise 8 Page 319Do Exercise 8 Page 319

A sorry tale to tellA sorry tale to tell


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Costs of UnemploymentCosts of Unemployment

UnemploymentUnemployment described as a drain on a nationdescribed as a drain on a nationand a waste of resources.and a waste of resources.

Personal CostsPersonal Costs Economic & Emotional costs.Economic & Emotional costs.

Cost to working peopleCost to working people UnemploymentUnemploymentbenefits are paid from taxes. Thus those who arebenefits are paid from taxes. Thus those who are

working are actually supporting the unemployed.working are actually supporting the unemployed.

Cost to the economyCost to the economy Total outfall willTotal outfall will and aand awaste of resources. Opportunity cost ofwaste of resources. Opportunity cost ofunemployed needs to be identified..???unemployed needs to be identified..???

chapter 16 prices & employment

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