Costs of unemploment and inflation, Managerial Economics


In  an  economy  both  unemployment  and  inflation  have  adverse effects  and policy makers  formulate policy instruments to contain both  the problems. The costs of unemployment at the macro level could be  loss of potential output and wastage of valuable resources (manpower). At the household level it is a loss of income and consequent deterioration  in standard of living of the household. It is difficult to measure the human cost of unemployment with precision  as social stigma  and  psychological trauma  of  the  problem  are  also involved.  On  the whole, policy makers and political leaders see  to  the  fact that the  cost of unemployment  is  minimal. Ideally  the  economy should not have  a  rate of unemployment higher than the natural rate of unemployment.  

Inflation  is  defined  as a situation of  persistent price rise.  While  the rate  of inflation  varies over  time  and  across  countries  there  is  much  debate  on permissible rate of inflation. While inflation rate has been moderately high  in certain countries, there are  instances of hyperinflation in  some countries where rate of inflation has been more than  1,000 per cent per year (for example, Latin American countries in 1980s  and former socialist  economies in 1990s). 

Inflation is widely considered as a social evil. Policy makers are always on the look  out for  price trend  so  that  high  inflation  can  be  checked  through appropriate policy measures. General public also are widely vigilant about price movements  so  that  pressure can  be  exerted  on  the  government  if  there  is acceleration  in inflation rate.

During inflation money loses its purchasing power and nominal costs of goods and services increase. Moreover, there is a reduction in  real  income of fixed  income groups (salaried class,  for example), as  their income does not change at the same pace as price rise. When there is a price rise borrowers gain in fixed interest rate environment as the value money they return is  lower  than anticipated at  the time of borrowing. On the other hand,  lenders stand to lose  as  the value  of money  they  receive  after a  lapse  of  time  gets eroded. During periods of high inflation,  there is fair chance that government revenue is much less than government expenditure resulting in huge fiscal deficits.  In order to finance the deficit the government has three options: borrow from public, run down  on  foreign exchange reserve,  and  print  money. Usually  a  government running huge deficit is already under heavy debt and paying a high amount of interest.  Hence,  further  borrowing  becomes  difficult.  Moreover,  such governments also have  low  foreign exchange reserve  and  therefore, printing money becomes an easy option which fuels  the rate of inflation fiuther. You can recall the Indian  condition  in 1990-91 when  it was loaded with  heavy  debt, foreign exchange reserve was  abysmally low and  there  was  double-digit inflation. In general, high inflation put  the economy out of gear aid it becomes difficult  to maintain economic stability. When  inflation  is  anticipated correctly  then  individuals take precaution  and adjust  their future  paymentslreceipts  keeping the rate  of  inflation  in  mind. However, unexpected inflation provokes income re-distribution between income groups. Usually the wage earning class who have a fixed nominal wage are the looser as real wage gets deteriorated due to price rise while profit earning class gain handsomely. 

Posted Date: 10/26/2012 6:15:03 AM | Location : United States

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