okun's law, inflation and imp of umem

7/29/2019 Okun's Law, Inflation and Imp of Umem

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OKUNS LAW:

The remarkable co-movement of output and unemployment, along with the

numerical relationship was first identified by Arthur Okun and is known as Okuns

Law.

Okuns Law states that For every 2 percent that GDP falls relative to potentialGDP, the unemployment rate rises about 1 percentage point.

Okuns law provides the vital link between the output market and labour market.

INFLATION:

Coulborn defined Inflation as, Inflation is a situation of too much money

chasing too few goods.

It is also defined as Inflation is a steady and upward movement in the level of

prices, decreasing purchasing power, over a given period of time, usually one

year.

Types of Inflation:

1. Demand-Pull Inflation and2. Cost-Push Inflation

1. Demand-Pull Inflation

Demand-pull inflation is inflation initiated by an increase in aggregate

demand.

Demand Pull Inflation occurs when Aggregate demand (C+I+G+(X-M))increases at a rate faster than the capacity of the economy to produce goods and

services ie: AD>AS. This increase competition for goods and services drives up

their prices.

Where AD=Aggregate Demand

AS=Aggregate SupplyDemand-pull inflation can arise from:

High supply of money

Excessive fiscal deficits

Demand-pull inflation occurs due to heavy government expenditure either

for financing war or financing developments projects.


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The figure shows rising demand from AD1 to AD2, the increase in price level isaccompanied by increase in aggregate output. At point, full employment is

reached and therefore beyond that point or above AD3, rise takes place only in the

price level and not in production. This is known as true inflation.

Sources of Demand-Pull Inflation are:

Full employment causes labour shortages, employers thus bid up wages to

attract labour. The increased income transpires into increased consumption

causing Aggregate Demand to rise.

High levels of foreign investment increases employment, income,

consumptions and ultimately Aggregate Demand. Growth in foreign economies can lead to higher incomes for our exporters,

thus allowing increases in Aggregate Demand

Inflationary expectations If members of an economy expect prices to rise,

it brings forward expenditure decisions leading to demand pull inflation eg:

Pre GST in Australia

Increasing consumption due to changes in consumption patterns (fewer

saving at any level of income).

Monetary consideration too much credit in the economy. A relaxed

monetary policy leads to a reduction in interest rates leading to an increase

in Aggregate Demand and thus prices.


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2. Cost-Push Inflation

Cost-push, or supply-side, inflation is inflation caused by an increase in

costs.

Cost Push Inflation occurs when prices are pushed up by rising costs to

producers who compete with each other for increasingly scarce resources. Theincreased costs are passed onto consumers.

Cost-push inflation is resulting from rising costs during periods of high

unemployment.

Cost-push inflation is a new phenomenon of modern industrial economies.

This figure indicates the full employment equilibrium at the point E where the

demand curve D1 and supply curve S1 intersect. At this point, the output is OQ1

and price is OP1. When the aggregate supply function shifts to S2, output declines

to OQ2 and the price level increases to OP2. Similarly, when the supply function

further rises to S3, output declines to OQ3 and the price level rises to OP3. The

process will continue still further upward shifts in the supply function.

Sources of Cost-Push Inflation are Any input may become a major cost to business eg: wage increases lead to

higher production costs

Labour shortages in some sectors necessitate wage increases in that sector,

however it has a domino effect leading to wage rises in other sectors.

NB: Wage rises in excess of productivity increase leads to inflationary

pressure.


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The extend to which a producer can pass on price rises depends on the level

of competition in the industry.

The more competitive the industry, the more the producer has to absorb

costs rather than pass them onto consumers.

Inflation imported from abroad, eg: the rise in the cost of intermediate

goods and resources imported from other countries flows through in the

form of higher prices domestically eg: oil prices.

Government budgetary problems an increase in the cost of public utilities

eg: electricity, water etc, leads to higher costs to business and households.

3. IMPACT OF UNEMPLOYMENT

Unemployment

The state of being unemployed.

Unemployed

People who are not employed but are actively looking forward for work or

waiting, to return to work.

Impact

a) Impact on individual

b) Social Impacts

c) Socio-Political Impact and

d) Impacts on economy

a) Impact on individual

Unemployed individuals are unable to earn money to meet financial

obligations.

Failure to pay mortgage payments or to pay rent may lead to

homelessness through foreclosure or eviction.

Unemployment increases susceptibility to malnutrition, illness,

mental stress, and loss of self-esteem, leading to depression.


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b) Social Impacts

An economy with high unemployment is not using all of the

resources, specifically labor, available to it.

Since it is operating below its production possibility frontier , it

could have higher output if all the workforce were usefully

employed.

However, there is a trade-off between economic efficiency and

unemployment: if the frictionally unemployed accepted the first job

they were offered, they would be likely to be operating at below

their skill level, reducing the economys efficiency.

c) Socio- Political Impacts

High levels of unemployment can be causes of civil unrest, in some

cases leading to revolution, and particularly totalitarianism.

The fall of the Weimer Republic in 1933 an Adolf Hitlers rise in

power, which culminated in World War II and the deaths of tens of

millions and the destruction of much of the physical capital of

Europe, is attributed to the poor economic conditions in Germany at

the time, notably a high unemployment rate of above 20%

d) Impacts on economy

When the unemployment rate goes up, the economy is in effect

throwing away the goods and services that the unemployed workers

could have produced.

During recessions, it is as if vast quantities of automobiles, housing,

clothing, and other commodities wee simply dumped into the ocean.

The largest economic loss occurred during the great depression, but

the oil and inflation crises of the 1970s and 1980s also generated

more than a trillion dollars of lost output.

The last decade has been one of unprecedented stability in the

United States, with very small business-cycle looses.

okun's law, inflation and imp of umem

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