ECO 1202 LECTURE: MONEY, INFLATION and UNEMPLOYMENT

Money

Economists use the term “money” in a more specific sense, to refer to the set of assets that
people use regularly to buy goods and services from other people. According to Crowther,
“Money is anything that is generally acceptable as a means of exchange”. The most commonly
accepted view is that “all media of exchange and payment, whose acceptance the law requires
in discharge of debts”, may be called money.

In modern economies, money is the national currency. In the absence of money, societies use a
“barter” system in which goods are exchanged for goods.

Functions of Money

 Money serves as a medium of exchange, that is, an item that buyers give to sellers in
exchange for goods and services.

 Money serves as a unit of account, that is, the units in which prices are measured.

 Money is a store of value, that is, an object that people can use to carry wealth from the
present into the future.

 Money is used as a standard for deferred payments – future payments and obligations
are contracted in monetary terms

Closely associated with the concept of money is that of liquidity: the ease with which an asset
can be converted into the economy’s medium of exchange.
 By definition, money is the most liquid asset.
 Stocks and bonds are easy to buy and sell. They are highly liquid assets.
 Houses, valuable paintings, and antiques take more time and effort to sell. They are less
liquid.
Notice that the first two items on this list highlight a trade‐off. Money is the most liquid asset,
but currency does not earn interest. Bonds are less liquid, but pay interest.

Types of Money

Historically, gold and other ornaments such as silver, bronze or gold coins, even cowrie shells
served as money. This type of money, that takes the form of a commodity with intrinsic value, is
called commodity money. Our Naira notes have value, but that value is not based on the
intrinsic value of the paper and ink themselves. Money without intrinsic value is called fiat
money, since it is used as money because of government decree.

Money in the Economy

The money stock is the total quantity of money circulating in the economy. Suppose we want
to measure the money stock for the Nigerian economy. What assets would we include in our
measure?
1. Certainly currency, the paper bills and coins in the hands of the public.
2. Probably cheques as well. Demand deposits is the official name given to bank deposits that
customers can access on demand by writing a cheque.
3. Maybe savings deposits. Bank’s won’t let customers write cheques on savings deposits, but
they still can withdraw the funds anytime.
4. Maybe also money market mutual funds, some of which offer limited cheque‐writing
privileges.
5. Maybe also time deposits (also called CD’s or certificates of deposit). Here, the funds can’t
be withdrawn without penalty for a fixed amount of time, but that amount of time tends to be
short – three to six months – so these assets, too, are fairly liquid. Evidently, the choice of what
to include is not entirely clear‐cut. For this reason, there are several official measures of the
money stock. Two of the most widely used are:
‐ M1. Includes only those assets that are clearly used as a medium of exchange: currency,
demand deposits, traveler’s cheques, and “other chequable deposits” which is the official term
for interest‐earning checking deposits.
‐ M2. Includes everything in M1, plus other highly liquid assets: savings deposits, money market
mutual funds, and small time deposits.

Demand for Money

The demand for money explains the desire of people for a definite amount of money. Money
is needed to manage transactions, and the value of transactions decides the money people
want to keep. The larger the quantum of transactions, the bigger is the amount of money
demanded. . Therefore, demand for money is a question of how much of your wealth you wish
to hold in the form of money at any point in time.

Your wealth is a stock, and you must decide how to allocate that stock of wealth between
different kinds of assets -- for example a house, income-earning securities, a bank account, and
cash.

Why would you hold any of your wealth as money -- as cash or fixed deposits? Those assets
earn little or no interest. Wouldn't it be more sensible to hold all your wealth in the form of
assets that yield income? Note that:

1. There is a cost associated with holding money balances (you give up interest
payments),
 2. There is no intrinsic value in the money balances you hold except in their use as a
medium of exchange. Generally, you acquire money in order to get rid of it -- to buy
things.

Why hold any money balances at all? Why not always hold bonds and only get hold of money
the moment you need it to pay for transactions?

It is costly, in terms of time and resources, to keep moving in and out of bonds or other assets
and money. Since this is the case, I will desire to hold a certain level of money balances on
average, to meet my needs to pay for transactions. This is called the transactions demand for
money.

If the interest payments I receive on bonds and other assets is high, then it is worth my while
to move in and out of stocks and bonds and money, so that I can earn this interest payment
instead of holding money balances. If the interest rate is not that high, then it is not worth it to
move in and out of money and bonds in order to receive this interest payment.

Another way to look at it is that the interest rate describes the cost of holding money balances.
This is because the interest rate tells you the amount of interest income you have to forego by
holding money balances instead of lending out that money and holding an asset like a bond.

We emphasize the way that r affects transactions demand because it's important to our money
market story. But two other things will also affect transactions demand. If income changes,
transactions demand should change with it. As your income rises so do your expenditures, and
hence the amount of wealth you might want to hold as money at any instant in time. Similarly
it's reasonable to assume that at a national level, demand for money will grow as national
income grows, and decline if national income declines. Additionally, as the overall price level of
goods and services changes, transactions demand will change with it: if you hold money to buy
stuff, and it becomes less expensive to buy stuff, you'll hold less money.

Determinants

The determinants of demand for money are:

i. Price
ii. Real income
iii. Interest rate
iv. Wealth
v. Risk
vi. Liquidity of money alternatives (transactions costs, marketability)...
a. The Money Demand Function
The effects of the price level, real income, and interest rates on money demand can be
expressed as: Md== P x L(Y, i)

Md == the aggregate demand for money, in nominal terms;

P == the price level;
Y == real income or output;
i == the nominal interest rate earned by alternative, nonmonetary assets;
L == a function relating money demand to real income and the nominal interest rate.

The money demand function holds that nominal money demand, Md, is proportional to the
price level, P. Hence, if the price level, P, doubles (and real income and interest rates don't
change), nominal money demand, Md, also will double, reflecting the fact that twice as much
money is needed to conduct the same real transactions .

So the transactions demand for money depends on many things:

a) interest rate: as we have noted above, the interest rate is in effect the price of holding
money balances. It is the income I forego when I hold money balances. If the interest rate goes
up, then the returns on moving in and out of money into other assets and back will increase, so
people will hold a lower level of money balances. If the interest rate falls, then the returns on
moving out of money balances and into assets are not so great. In this case, it is not worth it to
move out of money into other assets and then back when you need to make payments on
transactions, so you will hold a higher level of money balances.

b) aggregate income: if the volume of income and output produced in the goods markets
increases, then clearly there will be a larger volume of transactions and exchanges taking place.
People will need to hold a larger volume of money to meet all these transactions and make
payments.

c) price level: if prices rise, then people will need to hold a higher level of money balances to
meet their payments transactions. If prices fall, people will need a lower volume of money
balances to support a given level of transactions.

d) Expectations

The speculative demand for money is based on expectations about bond prices. All other things
unchanged, if people expect bond prices to fall, they will increase their demand for money. If
they expect bond prices to rise, they will reduce their demand for money.

The expectation that bond prices are about to change actually causes bond prices to change. If
people expect bond prices to fall, for example, they will sell their bonds, exchanging them for
money. That will shift the supply curve for bonds to the right, thus lowering their price. The
importance of expectations in moving markets can lead to a self-fulfilling prophecy.

Expectations about future price levels also affect the demand for money. The expectation of a
higher price level means that people expect the money they are holding to fall in value. Given
that expectation, they are likely to hold less of it in anticipation of a jump in prices.

Expectations about future price levels play a particularly important role during periods of
hyperinflation. If prices rise very rapidly and people expect them to continue rising, people are
likely to try to reduce the amount of money they hold, knowing that it will fall in value as it sits
in their wallets or their bank accounts. Toward the end of the great German hyperinflation of
the early 1920s, prices were doubling as often as three times a day. Under those circumstances,
people tried not to hold money even for a few minutes—within the space of eight hours money
would lose half its value!

e) Transfer Costs

For a given level of expenditures, reducing the quantity of money demanded requires more
frequent transfers between nonmoney and money deposits. As the cost of such transfers rises,
some consumers will choose to make fewer of them. They will therefore increase the quantity
of money they demand. In general, the demand for money will increase as it becomes more
expensive to transfer between money and nonmoney accounts. The demand for money will fall
if transfer costs decline. In recent years, transfer costs have fallen, leading to a decrease in
money demand.

Preferences

Preferences also play a role in determining the demand for money. Some people place a high
value on having a considerable amount of money on hand. For others, this may not be
important.

Household attitudes toward risk are another aspect of preferences that affect money demand.
As we have seen, bonds pay higher interest rates than money deposits, but holding bonds
entails a risk that bond prices might fall. There is also a chance that the issuer of a bond will
default, that is, will not pay the amount specified on the bond to bondholders; indeed, bond
issuers may end up paying nothing at all. A money deposit, such as a savings deposit, might
earn a lower yield, but it is a safe yield. People’s attitudes about the trade-off between risk and
yields affect the degree to which they hold their wealth as money. Heightened concerns about
risk in the last half of 2008 led many households to increase their demand for money.

Motives for holding money

Basically, individuals wish to hold money for three reasons

Transactionary motive

Cash balance is required to meet the day to day transactions of business. Firms hold cash for
making necessary payments for goods and services they acquire. The cash inflows and outflows
of day-to-day operations of a firm are not perfectly synchronized, and hence liquid asset
balances are necessary to serve a buffer between these flows, to meet the fluctuations in
cashflows.

As a general principle of cash management, working capital inflows should be more than
working capital outflows at any point of time. The non-working capital cash inflows like capital
receipts should be utilized for non-working capital outflows like purchase of fixed assets. The
working capital inflows should always be in surplus over working capital outflows.

Precautionary motive
Firms hold cash to meet uncertainties, emergencies, running out of cash and fluctuations in
cash balances. The holding of cash on these reasons are on precaution. The future cashflows
and the ability to borrow additional funds at short notice are often uncertain. Sometimes,
uncertainty can result in prolongation or disruption of operating cycle. This requires to carry
additional cash balances as a precautionary motive.

Speculative motive

Sometimes, individuals and or firms hold high cash balances over the precautionary level of
cash balance to take advantage of speculative investment opportunities, to exploit discounts
for prompt payments, to improve credit rating etc. Cash surplus companies can acquire the
cash starved companies at least cost of acquisition. The company with excessive cash surplus
can take steps to improve production and sales ultimately the profitability of the company
improves.

Some firms who can efficiently manage cash surplus, can seek to deploy surplus cash in short-
term marketable investments and money market instruments to get better returns. But it is to
be kept in view that idle cash will attract opportunity cost. Purchase of readily marketable
securities will enable to earn return on investment, as well as, to maintain the liquidity of the
company.
Inflation

Inflation is a rising general level of prices (not all prices rise at the same rate, and some may
fall). It is the rate of increase in prices over a given period of time. Inflation is typically a broad
measure, such as the overall increase in prices or the increase in the cost of living in a country.
The main index used to measure inflation is the Consumer Price Index (CPI). To measure
inflation, subtract last year’s price index from this year’s price index and divide by last year’s
index; then multiply by 100 to express it as a percentage.

Types

Imported Inflation
A depreciation in the exchange rate will make imports more expensive. Therefore, the prices
will increase solely due to this exchange rate effect. A depreciation will also make exports more
competitive so will increase demand.

Temporary Factors
The inflation rate can also increase due to temporary factors such as increasing indirect taxes. If
you increase VAT rate from 17.5% to 20%, all goods which are VAT applicable will be 2.5% more
expensive. However, this price rise will only last a year. It is not a permanent effect.

Core Inflation

One measure of inflation is known as ‘core inflation‘ This is the inflation rate that excludes
temporary ‘volatile’ factors, such as energy and food prices. The graph below shows inflation in
the EU. The headline inflation rate (HICP) is more volatile rising to 4% in 2008 and then falling to
-0.5% in 2009. However, the core inflation (HCIP – energy, food, alcohol and tobacco) is more
constant.

Types of inflation by rate of increase

Creeping inflation (1-4%)

When the rate of inflation slowly increases over time. For example, the inflation rate rises from
2% to 3%, to 4% a year. Creeping inflation may not be immediately noticeable, but if the
creeping rate of inflation continues, it can become an increasing problem.
Walking inflation (2-10%)

When inflation is in single digits – less than 10%. At this rate – inflation is not a major problem,
but when it rises over 4%, Central Banks will be increasingly concerned. Walking inflation may
simply be referred to as moderate inflation.

Running inflation (10-20%)

When inflation starts to rise at a significant rate. It is usually defined as a rate between 10% and
20% a year. At this rate, inflation is imposing significant costs on the economy and could easily
start to creep higher.

Galloping inflation (20%-1000%)

This is an inflation rate of between 20% up to 1000%. At this rapid rate of price increases,
inflation is a serious problem and will be challenging to bring under control. Some definitions of
galloping inflation may be between 20% and 100%. There is no universally agreed definition,
but hyperinflation usually implies over 1,000% a year.

Hyperinflation (> 1000%)

This is reserved for extreme forms of inflation – usually over 1,000% though there is no specific
definition. Hyperinflation usually involves prices changing so fast, that it becomes a daily
occurrence, and under hyperinflation, the value of money will rapidly decline.

Related concepts

 Shrinkflation – when the price stays the same, but firms reduce the size of the good –
effectively a price increase.
 Disinflation – a fall in the inflation rate. It means prices are increasing at a slower rate.
 Deflation – a fall in prices – a negative inflation rate.

Causes of Inflation

Demand-Pull Inflation
Typically, changes in the price level are caused by changes in total spending. As total spending
increases, so does consumers’ demand for products. When the economy reaches its capacity
yet demand for products is still increasing, producers have no choice but to start raising their
prices. A collective rise in the price level is a cause of inflation. This type of inflation is called
demand-pull inflation i.e., inflation caused by excess demand in the economy. In other words,
spending increases faster than production. It is often described as “too much spending chasing
too few goods.”
This concept is associated with full employment when altering the supply is not possible. Take a
look at the graph below:

In the graph above, SS is the aggregate supply curve and DD is the aggregate demand curve.
Further,

 Op is the equilibrium price

 Oq is the equilibrium output

Exogenous causes shift the demand curve to the right to D1D1. Therefore, at the current price
(Op), the demand increases by qq2. However, the supply is Oq.

Hence, the excess demand for qq2 puts pressure on the price, increasing it to Op1. Therefore, there
is a new equilibrium at this price, where demand equals supply. As you can see, the excess
demand is eliminated as follows:

 The price rises which leads to a fall in demand and a rise in supply.

Cost-push inflation or supply-side inflation occurs on the supply side of goods and services.
This type of inflation is seen when producers’ per-unit production costs rise. As goods become
more expensive to produce, suppliers raise their prices in efforts to retain revenue. Raising
prices freeze profits and decreases the supply of goods and services in the economy. A major
source of cost-push inflation is supply shocks. Supply shocks are abrupt increases in the costs of
production, such as raw materials and power inputs.
.
Supply can also cause inflationary pressure. If the aggregate demand remains unchanged but the
aggregate supply falls due to exogenous causes, then the price level increases. Take a look at the
graph below:

In the graph above, the equilibrium price is Op and the equilibrium output is Oq. If the aggregate
supply falls, then the supply curve SS shifts left to reach S1S1.

Now, at the price Op, the demand is Oq but the supply is Oq2 which is lesser than Oq. Therefore,
the prices are pushed high till a new equilibrium is reached at Op1.

At this point, there is no excess demand. Hence, you can see that inflation is a self-limiting
phenomenon.

However, the Government can take some repressive measures like price control, rationing, etc. to
prevent the excess demand from increasing the prices.
Complexities: It is difficult to distinguish between demand-pull and cost-push inflation,
although cost-push will die out in a recession if spending does not also rise.

Inflationary Expectations
In hyperinflation, the price level increases at a rapid rate. In fact, you can expect prices to increase
every hour. Usually, this leads to the demonetization of an economy as people are afraid to keep
their assets in monetary terms.

Who gets hurt with Inflation?

Unanticipated inflation hurts fixed-income recipients such as savers and creditors. Fixed income
is income that remains the same over a long period of time. As inflation rates increase, the
value or the purchasing power of the currency (Naira) drops. The most common example of
people on a fixed income are the elderly. They receive pensions or other incomes that are fixed
over a sustained period of time. Landlords with fixed rents are also hurt by inflation because
their income may not be adjusted for a fixed period of time.

Unanticipated inflation hurts savers because accounts that don’t offer interest payments
equivalent or higher than inflation rates end up eating away a saver’s purchasing power. If Mr
Smith puts his money in a savings account that yields a1 2 percent interest rate each year and
the rate of inflation for this year is at 13 percent, He ends up losing 1 percent of his purchasing
power because of inflation. The old saying “Money can’t buy today what it bought yesterday” is
true because of inflation.

Finally, unanticipated inflation hurts creditors and lenders. Suppose Union Bank lends Mr.
Valentine N1000,000 to be repaid in two years. If during those two years the rate of inflation
doubles, the N1000,000 that Mr. Valencia repays will have only half the purchasing power of
the amount he originally borrowed. As prices rise, the value of the currency (Naira) falls.

Who Benefits from Inflation?

Two groups actually benefit from inflation. The first group consists of people on a flexible
income who receive a costof- living adjustment (COLA) from their employers. The other group
consists of debtors. In our earlier example, Mr. Valentine benefited from taking out a
N1000,000 loan because inflation minimizes the purchasing power of the money owed. With
inflation, it is easier for debtors to pay back the money they owe.

Consequences of Inflation

Redistributive effects of inflation:

A. The price index is used to deflate nominal income into real income. Inflation may
reduce the real income of individuals in the economy, but won’t necessarily reduce
real income for the economy as a whole (someone receives the higher prices that
people are paying).
 B. Unanticipated inflation has stronger impacts; those expecting inflation may be able
to adjust their work or spending activities to avoid or lessen the effects.
C. Fixed-income groups will be hurt because their real income suffers. Their nominal
income does not rise with prices.
D. Savers will be hurt by unanticipated inflation, because interest rate returns may not
cover the cost of inflation. Their savings will lose purchasing power.
E. Debtors (borrowers) can be helped and lenders hurt by unanticipated inflation.
Interest payments may be less than the inflation rate, so borrowers receive “dear”
money and are paying back “cheap” dollars that have less purchasing power for the
lender.
F. If inflation is anticipated, the effects of inflation may be less severe, since wage and
pension contracts may have inflation clauses built in, and interest rates will be high
enough to cover the cost of inflation to savers and lenders.
1. “Inflation premium” is amount that interest rate is raised to cover effects of
anticipated inflation.
2. “Real interest rate” is defined as nominal rate minus inflation premium.
G. Final points
1. Unexpected deflation, a decline in price level, will have the opposite effect of
unexpected inflation.
2. Many families are simultaneously helped and hurt by inflation because they are
both borrowers and earners and savers.
3. Effects of inflation are arbitrary, regardless of society’s goals.
Output Effects of Inflation
A. Cost-push inflation, where resource prices rise unexpectedly, could cause both
output and employment to decline. Real income falls.
B. Mild inflation (<3%) has uncertain effects. It may be a healthy by-product of a
prosperous economy, or it may have an undesirable impact on real income.
C. Danger of creeping inflation turning into hyperinflation, which can cause
speculation, reckless spending, and more inflation ( examples of Japan after World
War II, and Germany following World War I).
Solutions to the problem of inflation

Inflation is generally controlled by the Central Bank and/or the government. The main policy
used is monetary policy (changing interest rates). However, in theory, there are a variety of
tools to control inflation including:
Monetary policy – Higher interest rates reduce demand in the economy, leading to lower
economic growth and lower inflation. In a period of rapid economic growth, demand in the
economy could be growing faster than its capacity to meet it. This leads to inflationary
pressures as firms respond to shortages by putting up the price. We can term this demand-pull
inflation.

In response to inflation, the Central bank could increase interest rates.

1. Higher interest rates rates make borrowing more expensive and saving more attractive.
2. Homeowners will have to pay increase mortgage payments, leading to less disposable
income to spend.
3. Therefore households will have less ability and incentive to spend
4. Also firms will be detered from borrowing to fund investment, leading to lower business
investment.
5. Therefore, higher interest rates are quite effective in slowing down consumer spending
and investment, leading to a lower rate of economic growth. And as economic growth
slows down, so does inflation.

A higher interest rate should also lead to a higher exchange rate (higher interest rate attracts
hot money flows) The appreciation in the exchange rate will also reduce inflationary pressure
by:

 Making imports cheaper. (There will be lower price of imported goods, such as petrol
and raw materials)
 Reducing demand for exports and therefore lower total demand in the economy.
 Because exports are less competitive, exporting firms will have an incentive to cut costs
and improve competitiveness over time.

Countries have also made Central Bank independent in setting monetary policy. The argument
is that an independent Central Bank will be free from political pressures and avoid making
mistakes like cutting interest rates before an election to curry favour with voters.

Control of money supply – Monetarists argue there is a close link between the money supply
and inflation, therefore controlling money supply can control inflation.

Supply-side policies – policies to increase the competitiveness and efficiency of the economy,
putting downward pressure on long-term costs. Often inflation is caused by persistent
uncompetitiveness and rising costs. Supply-side policies may enable the economy to become
more competitive and help to moderate inflationary pressures. For example, more flexible
labour markets may help reduce inflationary pressure.
However, supply-side policies can take a long time, and cannot deal with inflation caused by
rising demand.

Fiscal policy – a higher rate of income tax could reduce spending, demand and inflationary
pressures. To reduce inflation, the government can increase taxes (such as income tax and VAT)
and cut spending. This improves the government’s budget situation and helps to reduce demand
in the economy.

Both these policies reduce inflation by reducing the growth of aggregate demand. If economic
growth is rapid, reducing the growth of AD can reduce inflationary pressures without causing a
recession.

Also increasing taxes to reduce inflation is likely to be politically unpopular which is why fiscal
policy is rarely used to reduce inflation.

Wage/price controls – trying to control wages and prices could, in theory, help to reduce
inflationary pressures. However, they are rarely used because they are not usually effective. If
inflation is caused by wage inflation (e.g. powerful unions bargaining for higher real wages),
then limiting wage growth can help to moderate inflation. Lower wage growth will reduce the
costs for firms and lead to less excess demand in the economy.

Reduce expectations
A key determinant of inflation over time is inflation expectations. If people expect inflation next
year, firms will put up prices and workers will demand higher wages. This expectation tends to
cause higher inflation. If the Central Bank and government can effectively reduce expectations
by making credible threats to bring inflation under control, this will make their job easier.

Price controls
With inflation, we will see firms trying to increase prices as much as they can to maintain
profitability and deal with rising costs. One way to try to avoid this ‘profit-push’ inflation is to
introduce price controls. This is where the government sets limits on price increases.

For example, in 1971 President Nixon imposed a price freeze that he reintroduced in 1973 after
winning the election. The price freezes were politically popular for a short time but basically
failed. Firms restricted supply and when price freezes ended, suppressed inflation returned
with a vengeance. However, it is worth noting that price controls during wartime were
successful in reducing inflation. One study by Paul Evans found in WWII price controls were
successful in keeping prices 30% lower than otherwise. (though this was with rationing and 7%
lower output).
Exchange rate policy

A country may seek to keep inflation low by joining a fixed exchange rate mechanism. The
argument is that if the value of a currency is fixed (or semi-fixed) then this creates a discipline
to keep inflation low. If inflation rises, the currency would become uncompetitive and start to
fall..

Change currency

In a period of hyperinflation, conventional policies may be unsuitable. Expectations of future

inflation may be hard to change. When people have lost confidence in a currency, it may be
necessary to introduce a new currency or use another like the dollar (e.g. Zimbabwe
hyperinflation).
Unemployment

Unemployment is a condition in which skilled and abled individuals do not get gainful jobs at
a decent wage. There is unemployment in both rural and urban areas. Seasonal unemployment
occurs in the rural population and educated unemployment occurs in the urban areas. Who is
unemployed?
If you are sick and cannot work, retired and not working voluntarily, attending school and not
working voluntarily or are engaged in your own housework and not working voluntarily then
you are not counted as unemployed . You may be busy but not unemployed for the
government’s statistics.

Definition of unemployed: To be counted as unemployed you have to be actively seeking

employment or waiting to begin or return to a job
Part time people are counted as employed along with full time people.
Unemployment rate
= Total Unemployed People
Total Labor Force

Employment/Population ratio
= Total Employed People
Total Population legally eligible for work
Will move with the business cycle

Definition of “Full Employment”

1. Full employment does not mean zero unemployment.
2. The full-employment unemployment rate is equal to the total of frictional and
structural unemployment.
3. The full-employment rate of unemployment is also referred to as the natural
rate of unemployment.
5. The natural rate of unemployment is not fixed but depends on the demographic
makeup of the labor force and the laws and customs of the nations.

Is all unemployment bad?

- No, some are quitting for better jobs and searching for better jobs to improve their
earnings and productivity
- Some unemployment is being created through technological changes and technological
advancement is not bad as it also creates new jobs

Who is likely to be more unemployed?

- Younger workers – they move much more between jobs and during this move period they
are unemployed. They also suffer unemployment periods when they have to go back
 and forth from school to work. Unemployment rate of teenagers approx. 4 times the
rate of older workers.
- If there is discrimination and racial bias, visible minorities could suffer high unemployment
rates.
- Immigrants could suffer high unemployment rates due to language barriers, skills
mismatch etc. Canadian govt. is coming up with some policies on addressing some of
that problem through training.

The natural rate of unemployment is the rate of unemployment that the economy experiences
even during normal times, that is, even when the economy is not in a recession.

Types of Unemployment

Frictional unemployment occurs when there are jobs for the unemployed (who possess the
right skills) and want jobs that are available in a locality. But it takes time to match workers to
jobs; they may not accept the first offer that comes along. Frictional unemployment consists of
those searching for jobs or waiting to take jobs soon; it is regarded as somewhat desirable,
because it indicates that there is mobility as people change or seek jobs. It is sometimes
referred to as search and matching unemployment - a symptom of transition.

Structural Unemployment - it is similar to frictional unemployment in that unemployment and

vacancies co-exist, however it differs in one important aspect, there is a mismatch between the
types of jobs on offer and skills that the unemployed possess or the location of the jobs, or
cultural values or laws.. The mismatch can occur because of changes in both the supply and
demand side of the product market. Structural unemployment tends to continue for a long
period of time usually because the unemployed find it difficult to acquire new skills or move to
an area that does require their skills. Here, the jobs are there, but there are restrictions barring
some interested job seekers from getting the job. Example: a married woman in Kano and a job
in Port Harcourt or Ghana; Quota System, etc.

Cyclical unemployment refers to the additional unemployment that occurs during recessions.
Alternatively, we can think about the natural rate of unemployment as the economy’s long‐run
rate of unemployment and cyclical unemployment as the shorter‐run fluctuations around the
natural rate.

Cyclical unemployment is caused by the recession phase of the business cycle, which is
one of the four phases of the business cycle are identified over a several-year
period:
 A peak is when business activity reaches a temporary maximum with full
employment and near-capacity output. A recession is a decline in total
output, income, employment, and trade lasting six months or more. A trough
is the bottom of the recession period.
 A recovery is when output and employment are expanding toward the
full-employment level.
  It is sometimes called deficient demand or Keynesian unemployment.
Demand-deficient unemployment suggests that unemployment is a direct
result of a decline in the national level of demand which is transmitted to all
regions. Empirical evidence suggests that regional unemployment rates are
highly correlated and that unemployment increases in all regions in slumps
and declines in boom periods (although not always at the same rate).
Keynesian economists therefore argue that the best way to combat
unemployment is to raise the level of aggregate demand.

Seasonal Unemployment – unemployment due to cyclical changes in employment throughout

the year. For example, agricultural work is high during planting and harvest time and low during
other parts of the year. Also, construction work is less during the snowy months in the Midwest
states of the U.S.

Seasonal unemployment is similar to demand-deficient unemployment in that it is induced by

fluctuations in the demand for labor. However, the fluctuations can be regularly anticipated and
follow a systematic pattern over the course of a year.
To attract workers to such seasonal industries, firm will have to pay workers higher wages to
compensate them for being periodically unemployed. ⇒ The existence of compensating wage
differentials makes it difficult to evaluate whether this type of unemployment is voluntary or
involuntary in nature.
Consequences of Unemployment

(Economic cost of unemployment)

GDP gap and Okun’s Law: the GDP gap is the difference between potential and
actual GDP. Economist Arthur Okun quantified the relationship between
unemployment and GDP as follows: For every 1 percent of unemployment
above the natural rate, a negative GDP gap of 2 percent occurs. This is known as
“Okun’s law.”
(Noneconomic costs) include loss of self-respect, social vices and social and political
unrest.

Effects of Unemployment
1. Loss of Expertise

Nigeria produces millions of graduates every year and although there are many issues about
Nigerian graduates not possessing skills, I believe leaving them unemployed causes the loss of
expertise in several areas of human endeavor.
Some disciplines actually equip graduates to be ready to start work in such disciplines and grow
with experience to develop their potentials which many of them have.

The government loses all these potentials that would have contributed to the development of
the economy in one way or another.

2. Loss of Money

There are government officials who take the salaries of several people on pay rolls and such
people are roaming the streets unemployed. Money that is meant to pay ten Nigerians will be
wasted in the pocket of one person while millions of graduates are struggling to survive.

If the government will investigate and make sure the maximum number of people are
employed in every office, this will take care of this corrupt practice and reduce wastage of the
country’s wealth.

3. Terrorism and Insurgency

When there is so much unemployment and life is difficult, young people are open to be used for
any form of activities that disrupt peace. I mentioned previously that illiteracy is what is
responsible for the spread of terrorism but even the educated youths will bend when economic
pressure hits them to a level.

Unemployed youths are potential terrorists and insurgents and the government should do
something about it before it becomes too late.

4. Social Insecurity

Apart from terrorism and insurgency, Nigerian cities have become dangerous because of the
activities of thieves, pick pockets, ritual killers, and armed robbers.

Some of the youths involved in these acts are unemployed graduates who are trying to make
ends meet. Someone may say but that is not an excuse well it’s not but not everyone is moral
enough to remain honest under the kind of economic pressure this country is facing.
5. Low Standard of Living

When unemployment becomes a s rampant as it is in Nigeria, people’s standard of life begin to

go down. Some can no longer afford to pay rent or sometimes even feed because of high prices
of food items and very little money.

This also puts many people out of business like house owners with tenants who can no longer
afford to pay rent. Unemployment therefore contributes to reducing the standard of life of
Nigerian citizens.

6. Reduced Tax Revenue

The government collects tax for every worker in the country as a source of revenue. When
there is a lot of unemployed people, it cause the government to lose tax that it would have
gotten if those people were employed whether in the private or public sector.

This hinders the government from getting revenue that would have been used to develop the
country and thus hampers growth.

7. Illegal Emigration

Because of the heat of unemployment, some young people have decided to leave the country
as the better of the evils associated with unemployment. This has become quite common these
days as we always hear of Nigerian emigrants committing all kinds of crimes in China, South
Africa and many other countries just to survive.

This gives the nation a bad reputation and subjects its citizens to torture and imprisonment in
these countries. The government should do something to engage our youths in order to reduce
these embarrassing situations.

8. Increased Rural Urban Migration

Unemployment is a major cause of rural-urban migration in Nigeria. Our cities such as Lagos are
already crowded as it is but there are more people coming from rural areas to “hustle” because
they believe they will make money if only they get to Lagos.
This is not true because the same problems rural dwellers face are the same problems faced in
Lagos if not worse. The worst part is that most of these people are not skilled in anything that
will get them employment in the cities so the end up joining gangs and causing all kinds of
problems that worsen.

Youths must be engaged where they are to prevent rural-urban migrations which compound
the problems instead of bringing solutions.

9. Increased Number of Dependents

When there is massive unemployment, people who should be productive and contribute to
nation building only become dependents and drain the finances of those they depend on.

With this kind of situation, the financial status of citizens cannot improve so poverty continues
to torment them not because they are not productive but because there are more dependents
than income earners who cater for them. In order to reduce the unproductive population and
improve citizens’ standard of life, employment must be provided for the unemployed.

10. Reduced Gross Domestic Product (GDP)

Gross domestic product is the measure of productivity of a country and this determines how
well they compete in the international market.

With unemployment being so rampant in the country, productivity is low and so the country
can barely thrive in the international market.

This may be responsible for the dwindling value of the Naira against other currencies without
hope in sight. The GDP of Nigeria must increase for use to have a better life and we cannot have
an increase in GDP unless we employ the unemployed.

Conclusion
It is the desire of every country t develop and become mighty in the world and Nigeria is not
left behind in this ambition. But there are major factors fighting against this dream and
unemployment is one of such factors.
We must therefore do whatever it takes to get rid of unemployment in our nation. This will not
only help us to grow but ensure peace and prosperity for all.

Phillips Curve
A curve named after its author, AWH Phillips a British Economist that describes a
historical inverse relationship between rates of unemployment and corresponding rates
of inflation within an economy.

The diagram below depicts a downward sloping curve showing an inverse relationship
between inflation and unemployment

The graph above shows an "inverse relation" between inflation and unemployment. When the
economy is weak and unemployment is high, inflation is low. When the economy is strong and
unemployment is low, inflation is high. This relationship was first studied in England by an
economist named Phillips (as mentioned above). The inflation-unemployment graph is
therefore called the "Phillips Curve."
It suggests that policy makers have a choice between prioritizing inflation or unemployment.
Phillips curve analysis suggested there was a trade-off, and policy makers could use demand
management (fiscal and monetary policy) to try and influence the rate of economic growth and
inflation. For example, if unemployment was high and inflation low, policy makers could
stimulate aggregate demand. This would help to reduce unemployment, but cause a higher rate
of inflation.

Low unemployment and low inflation are both goals of economic policymakers. Both monetary
and fiscal policy officials seek these goals with the intention of stabilizing the economy. In the
short run, there is a trade-off between the rate of inflation and unemployment.

A Short-Run Phillips Curve

In the short run, there is a trade-off between unemployment and inflation because an increase
in spending increases output and stimulates employment. As the unemployment rate falls due
to higher spending, the inflation rate rises. This trade-off between unemployment and inflation
is temporary.

A Long-Run Phillips Curve

The long run produces no trade-off between unemployment and inflation because aggregate
supply shifts to stabilize the price level. The shift in aggregate supply lowers real GDP. As
income falls, the unemployment rate goes up. In the long run, as the economy adjusts to an
increase in aggregate demand and expectations adjust to the new inflation rate, there is a
period in which real GDP falls and the price level rises.