Lecture 10 - Inflation and Unemployment | Macroeconomics- Learning and Analysis PDF Download

 Page 1


Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
Lesson: Inflation and Unemployment 
Lesson Developer: Abhishek Kumar 
College/Department: St. Stephan’s College, University of Delhi 
  
Page 2


Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
Lesson: Inflation and Unemployment 
Lesson Developer: Abhishek Kumar 
College/Department: St. Stephan’s College, University of Delhi 
  
Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
Structure 
1. Learning Outcomes 
2. Introduction 
3. Inflation 
3.1 Causes of Inflation 
3.2 Demand Pull Inflation  
3.3 Supply Shock or Cost Push Inflation 
3.4 Wage Push Inflation 
3.5 Profit push inflation 
3.6 Supply shock inflation 
4 Unemployment 
  4.1Various types of unemployment 
5 Phillip Curve 
5.1 Aggregate Supply Curve 
5.2 Phillip curve 
5.3 Explanation for Phillip curve relation.  
6. Long run Phillip curve 
Summary 
References  
Glossory 
 
  
Page 3


Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
Lesson: Inflation and Unemployment 
Lesson Developer: Abhishek Kumar 
College/Department: St. Stephan’s College, University of Delhi 
  
Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
Structure 
1. Learning Outcomes 
2. Introduction 
3. Inflation 
3.1 Causes of Inflation 
3.2 Demand Pull Inflation  
3.3 Supply Shock or Cost Push Inflation 
3.4 Wage Push Inflation 
3.5 Profit push inflation 
3.6 Supply shock inflation 
4 Unemployment 
  4.1Various types of unemployment 
5 Phillip Curve 
5.1 Aggregate Supply Curve 
5.2 Phillip curve 
5.3 Explanation for Phillip curve relation.  
6. Long run Phillip curve 
Summary 
References  
Glossory 
 
  
Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
 
1.Learning Outcomes 
• The idea of inflation would be clear 
• Different reasons for inflation will be clear 
• Unemployment definition and its type is discussed 
• Relation between inflation and unemployment is elaborated 
• The relation between price and supply will be clear( aggregate supply curve) 
• Long run relation between inflation and unemployment is discussed. 
2.  Introduction 
The word inflation rings bell in everybody’s mind, be it an economist or sociologist or related 
to ant other profession. The simple reason for it is that inflation is something which 
increases the overall prices in an economy and therefore affects every household in a 
society. Whenever there is news of increase in prices in an economy it generally covered by 
almost all the newspaper in an economy. An increase in prices for some period may bring 
political changes in an economy. The growth of an economy is adversely affected if inflation 
is high in an economy. Given the importance of inflation in an economy it becomes 
imperative to have an understanding of the same. 
By the end of the chapter one will be in the position to understand the different concepts of 
inflation and unemployment. Although they appear to be simple as one comes across them 
in day to day activities however there are certain details which one needs to understand to 
appreciate the two. The chapter will start with giving the definition of inflation and 
unemployment. Thereafter it will explain different types of inflation and unemployment. 
Cause of inflation will make the reader understand difference between cost push and 
demand pull inflation. Once familiar with the idea one can easily apply it to the day to day 
activity to see what is the nature of inflation and what the tools to counter it are. Once the 
concept of inflation and unemployment is developed the chapter moves on to explain the 
relation of inflation with unemployment. The chapter is expected to develop certain 
understanding that helps the reader to appreciate the different policies pursued by the 
planners to counter the rising inflation in an economy. Whether there is a tradeoff between 
inflation and unemployment or not will be elaborated at the end of the chapter. Once the 
concept of tradeoff is clear it will be easy for one to understand the various efforts the 
government undertakes and its results. 
3. Inflation 
Inflation is defined as the overall or average increase in price of a basket of commodities 
from a reference period. It should be clear that inflation is not an increase in price of one 
good. It is instead the increase in price of a basket of commodity. Thus inflation implies that 
an increase in general price level in the economy rather than an increase in price of one 
commodity. Similarly deflation refers to a general decline in overall prices in an economy. A 
controlled increase in prices is good for an economy.  
Page 4


Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
Lesson: Inflation and Unemployment 
Lesson Developer: Abhishek Kumar 
College/Department: St. Stephan’s College, University of Delhi 
  
Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
Structure 
1. Learning Outcomes 
2. Introduction 
3. Inflation 
3.1 Causes of Inflation 
3.2 Demand Pull Inflation  
3.3 Supply Shock or Cost Push Inflation 
3.4 Wage Push Inflation 
3.5 Profit push inflation 
3.6 Supply shock inflation 
4 Unemployment 
  4.1Various types of unemployment 
5 Phillip Curve 
5.1 Aggregate Supply Curve 
5.2 Phillip curve 
5.3 Explanation for Phillip curve relation.  
6. Long run Phillip curve 
Summary 
References  
Glossory 
 
  
Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
 
1.Learning Outcomes 
• The idea of inflation would be clear 
• Different reasons for inflation will be clear 
• Unemployment definition and its type is discussed 
• Relation between inflation and unemployment is elaborated 
• The relation between price and supply will be clear( aggregate supply curve) 
• Long run relation between inflation and unemployment is discussed. 
2.  Introduction 
The word inflation rings bell in everybody’s mind, be it an economist or sociologist or related 
to ant other profession. The simple reason for it is that inflation is something which 
increases the overall prices in an economy and therefore affects every household in a 
society. Whenever there is news of increase in prices in an economy it generally covered by 
almost all the newspaper in an economy. An increase in prices for some period may bring 
political changes in an economy. The growth of an economy is adversely affected if inflation 
is high in an economy. Given the importance of inflation in an economy it becomes 
imperative to have an understanding of the same. 
By the end of the chapter one will be in the position to understand the different concepts of 
inflation and unemployment. Although they appear to be simple as one comes across them 
in day to day activities however there are certain details which one needs to understand to 
appreciate the two. The chapter will start with giving the definition of inflation and 
unemployment. Thereafter it will explain different types of inflation and unemployment. 
Cause of inflation will make the reader understand difference between cost push and 
demand pull inflation. Once familiar with the idea one can easily apply it to the day to day 
activity to see what is the nature of inflation and what the tools to counter it are. Once the 
concept of inflation and unemployment is developed the chapter moves on to explain the 
relation of inflation with unemployment. The chapter is expected to develop certain 
understanding that helps the reader to appreciate the different policies pursued by the 
planners to counter the rising inflation in an economy. Whether there is a tradeoff between 
inflation and unemployment or not will be elaborated at the end of the chapter. Once the 
concept of tradeoff is clear it will be easy for one to understand the various efforts the 
government undertakes and its results. 
3. Inflation 
Inflation is defined as the overall or average increase in price of a basket of commodities 
from a reference period. It should be clear that inflation is not an increase in price of one 
good. It is instead the increase in price of a basket of commodity. Thus inflation implies that 
an increase in general price level in the economy rather than an increase in price of one 
commodity. Similarly deflation refers to a general decline in overall prices in an economy. A 
controlled increase in prices is good for an economy.  
Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
It is also useful to distinguish between one time increase in prices and sustained increase in 
prices. One time increase in price implies that the price rises in a particular period and 
thereafter it stops rising. On the other hand sustained increase in prices means that 
increase in prices is maintained over a longer period of time rather than just one period. 
 
3.1 Causes of Inflation 
Once the meaning of inflation is clear, it is time to move towards a deeper understanding of 
inflation. There are various explanations for inflation in an economy.  
3.2 Demand Pull Inflation  
Demand pull inflation is caused by the increase in aggregate demand in the economy. 
Aggregate demand in the economy consists of household consumption expenditure on final 
goods, Firms investment expenditure, Government expenditure and Net Exports. 
Aggregate Expenditure = C +I +G +(X –M)  
Any factor other than prices which increases aggregate expenditure in the economy would 
result in demand pull inflation. Thus inflation which is caused due to increase in aggregate 
demand is known as demand pull inflation. Demand pull inflation can be caused by any 
factor that results in the rightward shift of the aggregate demand in the economy. 
Expansionary fiscal or expansionary monetary policy adopted by the government can 
result in demand pull inflation. Expansionary fiscal or monetary policy results in rightward 
shift of the demand curve. Expansionary fiscal policy is a situation where the government 
expenditure tends to grow at a faster pace than growth in the taxes or revenue of the 
government. This excess growth of expenditure in comparison to revenue results in 
government budget moving towards deficit. If the government was previously running 
surplus, expansionary fiscal policy would reduce that surplus. If the government was 
running a balance budget expansionary fiscal policy would result into deficit. If the 
government budget were already in deficits then those deficits would be on a rise with 
expansionary fiscal policy. 
Thus Expansionary fiscal policy would result in the right word shift of the aggregate demand 
curve and thus higher prices. 
Expansionary monetary policy or cheap money policy is the policy where the money supply 
in the economy is increased. The increase in money supply will reduces the rate of interest 
in the economy. The fall in the rate of interest spurs consumption demand as borrowing 
money becomes easier. As rate of interest falls buying consumer goods on credit becomes 
cheap as well as home loan rates take a dip which results in the rise in demand for new 
homes in an economy. Moreover the fall in the rate of interest induces firms to invest more 
as their profitability goes up with the fall in the cost of borrowing capital. Aggregate 
expenditure which is the sum of C +I +G +(X –M) in the economy goes up as consumption 
expenditure of the households and investment expenditure of the firms goes up. This shifts 
the aggregate demand curve upward or rightward resulting in the increase in prices in the 
economy. 
Page 5


Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
Lesson: Inflation and Unemployment 
Lesson Developer: Abhishek Kumar 
College/Department: St. Stephan’s College, University of Delhi 
  
Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
Structure 
1. Learning Outcomes 
2. Introduction 
3. Inflation 
3.1 Causes of Inflation 
3.2 Demand Pull Inflation  
3.3 Supply Shock or Cost Push Inflation 
3.4 Wage Push Inflation 
3.5 Profit push inflation 
3.6 Supply shock inflation 
4 Unemployment 
  4.1Various types of unemployment 
5 Phillip Curve 
5.1 Aggregate Supply Curve 
5.2 Phillip curve 
5.3 Explanation for Phillip curve relation.  
6. Long run Phillip curve 
Summary 
References  
Glossory 
 
  
Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
 
1.Learning Outcomes 
• The idea of inflation would be clear 
• Different reasons for inflation will be clear 
• Unemployment definition and its type is discussed 
• Relation between inflation and unemployment is elaborated 
• The relation between price and supply will be clear( aggregate supply curve) 
• Long run relation between inflation and unemployment is discussed. 
2.  Introduction 
The word inflation rings bell in everybody’s mind, be it an economist or sociologist or related 
to ant other profession. The simple reason for it is that inflation is something which 
increases the overall prices in an economy and therefore affects every household in a 
society. Whenever there is news of increase in prices in an economy it generally covered by 
almost all the newspaper in an economy. An increase in prices for some period may bring 
political changes in an economy. The growth of an economy is adversely affected if inflation 
is high in an economy. Given the importance of inflation in an economy it becomes 
imperative to have an understanding of the same. 
By the end of the chapter one will be in the position to understand the different concepts of 
inflation and unemployment. Although they appear to be simple as one comes across them 
in day to day activities however there are certain details which one needs to understand to 
appreciate the two. The chapter will start with giving the definition of inflation and 
unemployment. Thereafter it will explain different types of inflation and unemployment. 
Cause of inflation will make the reader understand difference between cost push and 
demand pull inflation. Once familiar with the idea one can easily apply it to the day to day 
activity to see what is the nature of inflation and what the tools to counter it are. Once the 
concept of inflation and unemployment is developed the chapter moves on to explain the 
relation of inflation with unemployment. The chapter is expected to develop certain 
understanding that helps the reader to appreciate the different policies pursued by the 
planners to counter the rising inflation in an economy. Whether there is a tradeoff between 
inflation and unemployment or not will be elaborated at the end of the chapter. Once the 
concept of tradeoff is clear it will be easy for one to understand the various efforts the 
government undertakes and its results. 
3. Inflation 
Inflation is defined as the overall or average increase in price of a basket of commodities 
from a reference period. It should be clear that inflation is not an increase in price of one 
good. It is instead the increase in price of a basket of commodity. Thus inflation implies that 
an increase in general price level in the economy rather than an increase in price of one 
commodity. Similarly deflation refers to a general decline in overall prices in an economy. A 
controlled increase in prices is good for an economy.  
Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
It is also useful to distinguish between one time increase in prices and sustained increase in 
prices. One time increase in price implies that the price rises in a particular period and 
thereafter it stops rising. On the other hand sustained increase in prices means that 
increase in prices is maintained over a longer period of time rather than just one period. 
 
3.1 Causes of Inflation 
Once the meaning of inflation is clear, it is time to move towards a deeper understanding of 
inflation. There are various explanations for inflation in an economy.  
3.2 Demand Pull Inflation  
Demand pull inflation is caused by the increase in aggregate demand in the economy. 
Aggregate demand in the economy consists of household consumption expenditure on final 
goods, Firms investment expenditure, Government expenditure and Net Exports. 
Aggregate Expenditure = C +I +G +(X –M)  
Any factor other than prices which increases aggregate expenditure in the economy would 
result in demand pull inflation. Thus inflation which is caused due to increase in aggregate 
demand is known as demand pull inflation. Demand pull inflation can be caused by any 
factor that results in the rightward shift of the aggregate demand in the economy. 
Expansionary fiscal or expansionary monetary policy adopted by the government can 
result in demand pull inflation. Expansionary fiscal or monetary policy results in rightward 
shift of the demand curve. Expansionary fiscal policy is a situation where the government 
expenditure tends to grow at a faster pace than growth in the taxes or revenue of the 
government. This excess growth of expenditure in comparison to revenue results in 
government budget moving towards deficit. If the government was previously running 
surplus, expansionary fiscal policy would reduce that surplus. If the government was 
running a balance budget expansionary fiscal policy would result into deficit. If the 
government budget were already in deficits then those deficits would be on a rise with 
expansionary fiscal policy. 
Thus Expansionary fiscal policy would result in the right word shift of the aggregate demand 
curve and thus higher prices. 
Expansionary monetary policy or cheap money policy is the policy where the money supply 
in the economy is increased. The increase in money supply will reduces the rate of interest 
in the economy. The fall in the rate of interest spurs consumption demand as borrowing 
money becomes easier. As rate of interest falls buying consumer goods on credit becomes 
cheap as well as home loan rates take a dip which results in the rise in demand for new 
homes in an economy. Moreover the fall in the rate of interest induces firms to invest more 
as their profitability goes up with the fall in the cost of borrowing capital. Aggregate 
expenditure which is the sum of C +I +G +(X –M) in the economy goes up as consumption 
expenditure of the households and investment expenditure of the firms goes up. This shifts 
the aggregate demand curve upward or rightward resulting in the increase in prices in the 
economy. 
Inflation and Unemployment 
Institute of Lifelong Learning, University of Delhi 
 
 
In the above diagram the vertical line represents long run aggregate supply curve whereas 
SRAS is the short run aggregate supply curve.AD and AD
1
 curve represents the aggregate 
demand curve. The intersection of aggregate demand and aggregate supply curve 
determines the economy’s output as well as prices.  
Initially the economy is at equilibrium where the short run aggregate supply curve 
intersects the aggregate demand curve AD. The equilibrium output is Y and equilibrium 
price is P. 
Expansionary fiscal or expansionary monetary policy would shift the aggregate demand 
curve towards the right. The rightward shift of aggregate demand curve affects both the 
output as well as price in the economy.The increase in price that results from rightward shift 
of aggregate demand is called as demand pull inflation. 
Supply Shock or Cost Push Inflation. 
 
 
Supply shock or cost push inflation is the result of fall or upward shift of short run aggregate 
supply curve.