INFLATION AND UNEMPLOYMENT
- It is defined as a persistent rise or a tendency towards the persistent rise in the general level of prices. It is the rise in prices of all the commodities, which are part of the price index and should not be confused with a rise in the price of a commodity or a group of commodities such as food products.
- Inflation is defined as a persistent rise or, a tendency towards the persistent rise in the general level of prices. Inflation is a macroeconomic phenomenon and is not concerned with the rise in the price of a particular commodity, or, a small group of commodities.
Types of Inflation
- On the basis of the severity of inflation or, the rate of acceleration in prices we can divide inflation into three different types, namely, moderate, galloping and hyperinflation.
- When the general price level increases slowly but steadily, it is known as moderate inflation. Moderate inflation remains within a single-digit level of less than 9 per cent.
Creeping Inflation is also known as mild-inflation. It is not dangerous especially in an economy where national income is also rising. There are some economists who regard a mild increase in the price level as a necessary condition for economic growth.
- The steady and fairly high rate of increases in the general price level is known as Galloping inflation. The rate of inflation runs into two digits (20 per cent, 40 per cent etc.) and sometimes even as high as three digits (i.e., 200 per cent).
- Hyperinflation is characterized by astronomical increases in the annual rate of inflation.
Cause of Inflation
- The causes of inflation may be grouped under two headings:
- Depending upon the initial process, we can identify two types of inflation: Demand-pull inflation or, demand-side inflation; and Cost-push inflation or, cost-side inflation.
Inflation: The Demand-Side
- Factors, which influence an increase in aggregate demand with no change in the level of aggregate supply can be said to cause demand-side inflation.
- These factors can be an increase in government spending, a decrease in the savings rate and a lower rate of taxation, which leave a greater amount of money or, increased disposable income with the public, and increase in the money supply.
- Inflation Caused by Increase in Government Spending
- Inflation due to Increase in Money Supply
Inflation: The Supply-Side
- Inflation arising out of movements in the aggregate supply curve with the aggregate demand curve remaining unchanged is known as supply-side inflation. Cost-push inflation, profit-push inflation and supply-shock inflation are three variants of this idea.
- Cost-push inflation arises when either the labour unions (or the firms) exercise their market power to increase the wage rate (or the price of their products),. With an increase in the wage rate, producers find that the labour cost per unit of output has risen, and they respond by increasing the prices of goods to cover the higher cost of production.
- A series of increase, in wage rates, leads to a series of increase in price. This kind of inflation is known as wage-push inflation.
- A series of increase in the wage rate leads to a series of increase in the prices. This kind of inflation is known as profit-push inflation.
- Inflation can arise out of either an unexpected or unforeseen sharp fall in the supply of commodities or a rise in the prices of commodities. Reasons for a situation lie out of the control of either the firms or the workers. It is known as supply-shock inflation.
I) Food Shortages
- Majority of the population in the developing economies live in rural areas and depend on agriculture for their livelihood. With development, say, the building of some new industry, some people get employment outside of agriculture and they settle down in urban areas. But, due to the various structural features such as the highly unequal distribution of land-ownership and tenancy, technological backwardness and low rates of investment in agriculture, inadequate growth of the domestic supply of food in correspondence with an increase in demand arising from increasing urbanization and population prices increase. Further, the extreme dependence of agriculture on weather produces an acute shortage of food from time to time due to droughts, floods, etc. In years of food shortages, the prices of food grains increase very fast. Food is the key wage-good, an increase in its price tends to raise other prices as well. Therefore, some economists consider food prices to be the major factor, which leads to inflation in the developing economies.
II) Scarcity of Foreign Exchange
- The industrial development of the developing economies requires a heavy import bill on account of import of capital goods, essential raw materials, and in several cases even food grains and other consumer goods. While the developing economies have a very high import requirement, their exports to the developed economies are very small for reasons like poor quality of goods. As a result, the foreign exchange that comes into the country through exports is a much smaller amount than the requirements of the economy. Due to this, the developing economies most of the times face foreign exchange shortages. Moreover, the shortages in the domestic supply of many basic inputs cannot easily be mitigated through imports. As a result, the prices of such goods increase, and the increase spreads to other prices. The result is all-round inflation. Other structural factors, like a socially unproductive private investment in land and precious metals like gold, take away a sizable chunk of resources. These resources could have been otherwise invested in new industries, new machines, new roads, better irrigation facilities for agriculture and other productive investment, which could have led to faster development of these countries. According to the structural approach to inflation, the above factors and similar other structural features of the developing economies can explain the price rise situations better
- Deflation is a situation where prices fall continuously or have a tendency to fall. This can arise when the aggregate demand is lower than the aggregate supply. Thus, deflation is characterized by a decreased fall in output, an increase in unemployment and general slowing down of the economic activities.
- Hyperinflation: It is characterized by an astronomical increase in the annual rate of inflation. This generally happens when
people lose faith in money as a medium of exchange.
- Stagflation: It is a situation when the rising inflation is accompanied by a falling or stagnating output. This generally happens in the conditions of some structural rigidities (like shortage of infrastructural facilities like transportation, power, etc.) in an economy.
The Phillips curve
- The Phillips curve shows a trade-off between inflation and unemployment. It says that an economy can achieve a lower rate of inflation only at the cost of a higher rate of unemployment and vice-versa. But the validity of this tradeoff has been questioned with the experiences of stagflation. The validity of a trade-off between the two is because the Phillips curve ignores the role of capital in sparking off inflation and unemployment. Under capitalism, the capitalists’ aim to maximize profits leads them to adopt new technologies, which are more often than not more capital-intensive in nature. This tends to lower the need for labour and hence increase the rate of unemployment. At the same time, these capitalists follow an aggressive mark-up pricing policy with a view to increasing their profit margins. This leads to an inflationary spiral.