Macro Economics Final Report

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Unemployment And Inflation
The Expectations-Augmented Phillips Curve
“INFLATION & UNEMPLOYMENT”

COURSE:- PRINCIPLE OF MACRO ECONOMICS
COURSE CODE:- ECO 102
FACULTY:- SYED ZIA ABBAS RIZVI
SECTION:- C
SUBMITTED BY:
1. ABDULLAH ALTAF BHESANIA
2. RAMAL SHAKOOR KHAN
3. MADIHA ILYAS BAWANY
4. KAMRAN QUREISHI
5. AASIYA YUNUS GHANI
Macro Economics Report Page 2

Acknowledgements
Firstly, we pay thanks to “ALMIGHTY ALLAH” who helped us to

achieve our target. No report is the result of an individual effort only.
This report would not have been possible without the help of first and
foremost our course instructor Syed Zia Abbas Rizvi, thank you for
acquainting us with the world of Macro Economics.
As one a scholar said, “My parents brought me from the skies to the
earth, but my teacher put me back on the skies” and so did Mr Zia
Abbas Rizvi.

Executive Summary
Pakistan has undergone a significant economic growth during last few years,
but the core problems of the economy are still unsolved. Inflation and
unemployment remain still the major hurdles to the growth of Pakistan’s
economy. Our aim is to find the determinants of inflation and unemployment,
causes and corrective measures of it.
The last five years are reported as highly inflationary due to expansionary
monetary policy and high oil prices. Domestic production should be
encouraged instead of imports; investment should be done in capital goods
instead of luxuries. Agriculture sector should be given subsidies, foreign
investment should be attracted. Developed nations should be requested for
financial assistance. And lastly a strong monitoring system should be
established on different levels in order to have a sound evaluation of the
process at every stage.

INTRODUCTION:
Our study will be focused on various aspects of inflation and unemployment

in Pakistan over a period of time.
OBJECTIVE OF THE PROJECT:
1. Present the scenario of inflation and unemployment in Pakistan.

2. Highlight the measures used by the SBP (State Bank of Pakistan) to
control inflation and unemployment.
UNEMPLOYMENT:
Unemployment, as defined by the International Labor Organization, occurs
when people are without jobs and they have actively looked for work within
the past four weeks. The unemployment rate is a measure of the prevalence
of unemployment and it is calculated as a percentage by dividing the
number of unemployed individuals by all individuals currently in the labor
force.
There remains considerable theoretical debate regarding the causes,
consequences and solutions for unemployment. Classical, neoclassical and
the Austrian School of economics focus on market mechanisms and rely on
the invisible hand of the market to resolve unemployment.
HISTORY:
In traditional societies, salary jobs did not exist yet, because money was not
invented yet. These cultures lived off the land directly, and the land
belonged to the tribe or to no one. Everyone knew how to build shelter and
make food. When these cultures invented currency and moved to the cities,
they began to depend on money to buy food from a middle man, instead of
growing, gathering, or hunting the food directly from nature. Dependence on
jobs to make money to buy food and shelter was the beginning of
unemployment.

Recognition of unemployment occurred slowly as economies across the

world industrialized and bureaucratized. The recognition of the concept of
"unemployment" is best exemplified through the well documented historical
records in England.
TYPES & THEORIES:
Economists distinguish between various overlapping types of and theories

of unemployment, including cyclical or Keynesian unemployment, frictional
unemployment, structural unemployment and classical
unemployment. Some additional types of unemployment that are
occasionally mentioned are seasonal unemployment, hardcore
unemployment, and hidden unemployment.
Though there have been several definitions
of voluntary and involuntary unemployment in the economics literature, a
simple distinction is often applied. Voluntary unemployment is attributed to
the individual's decisions, whereas involuntary unemployment exists
because of the socio-economic environment (including the market structure,
government intervention, and the level of aggregate demand) in which
individuals operate. In these terms, much or most of frictional
unemployment is voluntary, since it reflects individual search behavior.
Voluntary unemployment includes workers who reject low wage jobs whereas
involuntary unemployment includes workers fired due to an economic crisis,
industrial decline, company bankruptcy, or organizational restructuring.
On the other hand, cyclical unemployment, structural unemployment, and
classical unemployment are largely involuntary in nature. However, the
existence of structural unemployment may reflect choices made by the
unemployed in the past, while classical (natural) unemployment may result
from the legislative and economic choices made by labour unions or political
parties. So, in practice, the distinction between voluntary and involuntary
unemployment is hard to draw. The clearest cases of involuntary
unemployment are those where there are fewer job vacancies than
unemployed workers even when wages are allowed to adjust, so that even if
all vacancies were to be filled, some unemployed workers would still remain.
This happens with cyclical unemployment, as macroeconomic forces cause
microeconomic unemployment which can boomerang back and exacerbate
these macroeconomic forces.

CLASSICAL UNEMPLOYMENT:
Classical or real-wage unemployment occurs when real wages for a job are
set above the market-clearing level, causing the number of job-seekers to
exceed the number of vacancies.
Most economists have argued that unemployment increases the more the
government intervenes into the economy to try to improve the conditions of
those with jobs. For example, minimum wage laws raise the cost of laborers
with few skills to above the market equilibrium, resulting in people who wish
to work at the going rate but cannot as wage enforced is greater than their
value as workers becoming unemployed. Laws restricting layoffs made
businesses less likely to hire in the first place, as hiring becomes more risky,
leaving many young people unemployed and unable to find work.
However, this argument is criticized for ignoring numerous external factors
and overly simplifying the relationship between wage rates and
unemployment- in other words, that other factors may also affect
unemployment. It is noted that there can be unemployment when job market
is in equilibrium.
CYCLIC OR KEYNESSIAN UNEMPLOYMENT:

Cyclical or Keynesian unemployment, also known as deficient-demand
unemployment, occurs when there is not enough aggregate demand in the
economy to provide jobs for everyone who wants to work. Demand for most
goods and services falls, less production is needed and consequently fewer
workers are needed, wages are sticky and do not fall to meet the equilibrium
level, and mass unemployment results. Its name is derived from the frequent
shifts in the business cycle although unemployment can also be persistent as
occurred during the Great Depression of the 1930s. With cyclical

unemployment, the number of unemployed workers exceeds the number of

job vacancies, so that even if full employment was attained and all open jobs
were filled, some workers would still remain unemployed. Some associate
cyclical unemployment with frictional unemployment because the factors
that cause the friction are partially due to cyclical variables.
Classical economists reject the conception of cyclical unemployment and
alternatively suggest that the invisible hand of free markets will respond
quickly to unemployment and underutilization of resources by a fall in wages
followed by a rise in employment. Similarly, Hayek and others from
the Austrian school of economics argue that if governments intervene
through monetary policy to lower interest rates this will exacerbate
unemployment by preventing the market from responding effectively.
Keynesian economists on the other hand see the lack of demand for jobs as
potentially resolvable by government intervention. One suggested
interventions involves deficit spending to boost employment and demand.
Another intervention involves an expansionary monetary policy that
increases the demand of money which should reduce interest rates which
should lead to an increase in non-governmental spending.
MARXIST THEORY OF UNEMPLOYMENT:

It is in the very nature of the capitalist mode of production to overwork some
workers while keeping the rest as a reserve army of unemployed paupers.

– Marx, Theory of Surplus Value.

According to Karl Marx, unemployment is inherent within the
unstable capitalist system and periodic crises of mass unemployment are to
be expected. The function of the proletariat within the capitalist system is to
provide a "reserve army of labour" that creates downward pressure on
wages. This is accomplished by dividing the proletariat into surplus labour
(employees) and under-employment (unemployed). This reserve army of
labour fight among themselves for scarce jobs at lower and lower wages. At
first glance, unemployment seems inefficient since unemployed workers do
not increase profits. However, unemployment is profitable within the global
capitalist system because unemployment lowers wages which are costs from
the perspective of the owners. From this perspective low wages benefit the
system by reducing economic rents. Yet, it does not benefit workers.
Capitalism unfairly manipulates the market for labour by perpetuating
unemployment which lowers laborers' demands for fair wages. Workers are
pitted against one another at the service of increasing profits for owners.
According to Marx, the only way to permanently eliminate unemployment
would be to abolish capitalism and the system of forced competition for
wages and then shift to a socialist or communist economic system. For
contemporary Marxists, the existence of persistent unemployment is proof of
the inability of capitalism to ensure full employment.
INVOLUNTARY UNEMPLOYMENT:
In The General Theory, Keynes argued that neo-classical economic theory did
not apply during recessions because of excessive savings and weak private
investment in an economy. In consequence, people could be thrown out of
work involuntarily and not be able to find acceptable new employment.
This conflict between the neoclassical and Keynesian theories has had strong
influence on government policy. The tendency for government is to curtail
and eliminate unemployment through increases in benefits and government
jobs, and to encourage the job-seeker to both consider new careers and
relocation to another city.
Involuntary unemployment does not exist in agrarian societies nor is it
formally recognized to exist in underdeveloped but urban societies, such as
the mega-cities of Africa and of India/Pakistan. In such societies, a suddenly
unemployed person must meet their survival needs either by getting a new
job at any price, becoming an entrepreneur, or joining the underground
economy of the hustler.

FULL EMPLOYMENT:
Short-Run Phillips Curve before and after Expansionary Policy, with Long-Run
Phillips Curve (NAIRU)
In demand-based theory, it is possible to abolish cyclical unemployment by
increasing the aggregate demand for products and workers. However,
eventually the economy hits an "inflation barrier" imposed by the four other
kinds of unemployment to the extent that they exist.
Some demand theory economists see the inflation barrier as corresponding
to the natural rate of unemployment. The "natural" rate of unemployment is
defined as the rate of unemployment that exists when the labour market is
in equilibrium and there is pressure for neither rising inflation rates nor
falling inflation rates. An alternative technical term for this rate is
the NAIRU or the Non-Accelerating Inflation Rate of Unemployment.
No matter what its name, demand theory holds that this means that if the
unemployment rate gets "too low," inflation will get worse and worse
(accelerate) in the absence of wage and price controls (incomes policies).
One of the major problems with the NAIRU theory is that no one knows
exactly what the NAIRU is (while it clearly changes over time). The margin of
error can be quite high relative to the actual unemployment rate, making it
hard to use the NAIRU in policy-making.
Another, normative, definition of full employment might be called
the ideal unemployment rate. It would exclude all types of unemployment
that represent forms of inefficiency. This type of "full employment"
unemployment would correspond to only frictional unemployment (excluding
that part encouraging the McJobs management strategy) and would thus be
very low. However, it would be impossible to attain this full-employment
target using only demand-side Keynesian stimulus without getting below
the NAIRU and suffering from accelerating inflation (absent incomes
policies). Training programs aimed at fighting structural unemployment
would help here.
To the extent that hidden unemployment exists, it implies that official
unemployment statistics provide a poor guide to what unemployment rate
coincides with "full employment".

STRUCTUAL UNEMPLOYMENT:
"Driver looking for work" Unemployed German laborer in 1949
Structural unemployment occurs when a labour market is unable to provide

jobs for everyone who wants one because there is a mismatch between the
skills of the unemployed workers and the skills needed for the available jobs.
Structural unemployment is hard to separate empirically from frictional
unemployment, except to say that it lasts longer. As with frictional
unemployment, simple demand-side stimulus will not work to easily abolish
this type of unemployment.
Structural unemployment may also be encouraged to rise by persistent
cyclical unemployment: if an economy suffers from long-lasting low
aggregate demand, it means that many of the unemployed become
disheartened, while their skills (including job-searching skills) become "rusty"
and obsolete. Problems with debt may lead to homelessness and a fall into
the vicious circle of poverty. This means that they may not fit the job
vacancies that are created when the economy recovers. Some economists
see this scenario as occurring under British Prime Minister Margaret
Thatcher during the 1970s and 1980s. The implication is that
sustained high demand may lower structural unemployment. This theory of

persistence in structural unemployment has been referred to as an example

of path dependence or "hysteresis".
Much technological unemployment (e.g. due to the replacement of
workers by machines) might be counted as structural unemployment.
Alternatively, technological unemployment might refer to the way in which
steady increases in labour productivity mean that fewer workers are needed
to produce the same level of output every year. The fact that aggregate
demand can be raised to deal with this problem suggests that this problem is
instead one of cyclical unemployment. As indicated by Okun's Law, the
demand side must grow sufficiently quickly to absorb not only the growing
labour force but also the workers made redundant by increased labour
productivity. Otherwise, we see a jobless recovery such as those seen in
the United States in both the early 1990s and the early 21st century.
Seasonal unemployment may be seen as a kind of structural unemployment,
since it is a type of unemployment that is linked to certain kinds of jobs
(construction work, migratory farm work). The most-cited official
unemployment measures erase this kind of unemployment from the
statistics using "seasonal adjustment" techniques.
FRICTIONAL UNEMPLOYMENT:
Beveridge curve of 2004 job vacancyand unemployment rate from the

United States Bureau of Labour Statistics
Frictional unemployment is the time period between jobs when a worker

is searching for, or transitioning from one job to another. It is sometimes
called search unemployment and can be voluntary based on the
circumstances of the unemployed individual. Frictional unemployment is
always present in an economy, so the level of involuntary unemployment is

properly the unemployment rate minus the rate of frictional unemployment,

which means that increases or decreases in unemployment are normally
under-represented in the simple statistics.[55]
Frictional unemployment exists because both jobs and workers
are heterogeneous, and a mismatch can result between the characteristics
of supply and demand. Such a mismatch can be related to skills, payment,
work-time, location, seasonal industries, attitude, taste, and a multitude of
other factors. New entrants (such as graduating students) and re-entrants
(such as former homemakers) can also suffer a spell of frictional
unemployment. Workers as well as employers accept a certain level of
imperfection, risk or compromise, but usually not right away; they will invest
some time and effort to find a better match. This is in fact beneficial to the
economy since it results in a better allocation of resources. However, if the
search takes too long and mismatches are too frequent, the economy
suffers, since some work will not get done. Therefore, governments will seek
ways to reduce unnecessary frictional unemployment through multiple
means including providing education, advice, training, and assistance such
as daycare centers.
The frictions in the labour market are sometimes illustrated graphically with
a Beveridge curve, a downward-sloping, convex curve that shows a
correlation between the unemployment rate on one axis and the vacancy
rate on the other. Changes in the supply of or demand for labour caused
movements along this curve. An increase (decrease) in labour market
frictions will shift the curve outwards (inwards).

HIDDEN UNEMPLOYMENT:
Hidden, or covered, unemployment is the unemployment of potential

workers that is not reflected in official unemployment statistics, due to the
way the statistics are collected. In many countries only those who have no
work but are actively looking for work (and/or qualifying for social security
benefits) are counted as unemployed. Those who have given up looking for
work (and sometimes those who are on Government "retraining" programs)
are not officially counted among the unemployed, even though they are not
employed. The same applies to those who have taken early retirement to
avoid being laid off, but would prefer to be working. The statistic also does
not count the "underemployed" - those with part time or seasonal jobs who
would rather have full time jobs. In addition, those who are of working age
but are currently in full-time education are usually not considered
unemployed in government statistics. Because of hidden unemployment,
official statistics often underestimate unemployment rates.
MEASUREMENT:
Though many people care about the number of unemployed individuals,

economists typically focus on the unemployment rate. This corrects for the
normal increase in the number of people employed due to increases in
population and increases in the labour force relative to the population. The
unemployment rate is expressed as a percentage, and is calculated as
follows:
UNEMPLOYMENT RATE = UNEMPLOYED WORKERS

TOTAL LABOUR FORCE
As defined by the International Labour Organization, "unemployed workers"
are those who are currently not working but are willing and able to work for
pay, currently available to work, and have actively searched for work.
[58]
Individuals who are actively seeking job placement must make the effort
to: be in contact with an employer, have job interviews, contact job
placement agencies, send out resumes, submit applications, respond to
advertisements, or some other means of active job searching within the prior
four weeks. Simply looking at advertisements and not responding will not
count as actively seeking job placement. Since not all unemployment may be
"open" and counted by government agencies, official statistics on
unemployment may not be accurate.

EQULIBRIUM UEMPLOYMENT
The equilibrium unemployment level is the difference between those who are
employed at a given wage rate and those who can work. In other words,
there is equilibrium with respect to the demand and supply of labour,
however, unemployment still exists because a proportion of the labour force
are not willing to work at that time and that wage rate.
DISEQUILIBRIUM UNEMPLOYMENT
It happens when the aggregate demand for labour is less than the aggregate
supply of labour at the current real wage rate.
WORLD STATISTICS OF UNEMPLOYMENT

Rank Country Unemployment rate (%) (top 78 countires)
14 Afghanistan 40 Herzegovina 29
1 Nauru 90 26 Mayotte
25.4
2 Liberia 85 15 Swaziland 40
27 Dominica 23
3 Zimbabwe 80 16 Marshall Islands
36 28 South Africa
4 Burkina Faso77 22.9
17 Yemen 35
5 Turkmenistan 29 Micronesia,
60 18 Macedonia, The Federated States of
Former Yugoslav 22
6 Cocos (Keeling) Republic of 33.5
Islands 60 30 Gabon21
19 Mali 30
7 Djibouti 59 31 Cape Verde 21
20 Mauritania 30
8 Zambia 50 32 Mozambique 21
21 Libya 30
9 Senegal 48 33 Comoros 20
22 Equatorial
10 Nepal 46 Guinea 30 34 East Timor 20
11 Lesotho 45 23 Cameroon 30 35 Saint Lucia 20
12 Gaza Strip 24 American Samoa 36 Sudan 18.7
41.3 29.8
37 Iraq 18.2
13 Kenya 40 25 Bosnia and

38 Kyrgyzstan 18 51 Spain 13.9 65 Guam 11.4
39 New Caledonia 52 Croatia 66 Colombia

17.1 13.7 11.3
40 West Bank 53 Georgia 67 Ghana11

16.3 13.6
68 Antigua and
41 Netherlands 54 Cook Islands Barbuda 11
Antilles 15.5 13.1
69 Jamaica 11
42 Dominican 55 Tonga 13
Republic 15.5 70 Guyana 11
56 Jordan12.6
43 Wallis and 71 Barbados
Futuna 15.2 57 Iran 12.5 10.7
44 Saint Vincent 58 Grenada 72 Turkey

and the Grenadines 12.5 10.7
15 59 Albania 73 Saint Pierre and
45 Bahrain 15 12.5 Miquelon 10.3
46 Oman 15 60 Algeria 74 Turks and Caicos

12.5 Islands 10
47 Montenegro
14.7 61 Niue 12 75 Morocco 10
48 Maldives 62 Puerto Rico 12 76 Poland 9.8

14.4 63 Saudi Arabia 77 Suriname 9.5
49 Tunisia 11.8
78 Burma 9.5
14.1 64 French Polynesia
50 Saint Helena 14 11.7

This entry contains the percent of the labor force that is without jobs.
Substantial underemployment might be noted.
Source: CIA World Factbook
EFFECTS OF UNEMPLOYMENT
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. Across the United States
the growing ranks of people made homeless in the foreclosure crisis are
generating tent cities. Unemployment increases susceptibility to
malnutrition, illness, mental stress, and loss of self-esteem, leading to
depression. According to a study published in Social Indicator Research,
even those who tend to be optimistic find it difficult to look on the bright
side of things when unemployed. Using interviews and data from German
participants aged 16 to 94 – including individuals coping with the stresses
of real life and not just a volunteering student population – the
researchers determined that even optimists struggled with being
unemployed.
Dr. M. Brenner conducted a study in 1979 on the "Influence of the Social

Environment on Psychology." Brenner found that for every 10% increase
in the number of unemployed there is an increase of 1.2% in total
mortality, a 1.7% increase in cardiovascular disease, 1.3% more cirrhosis
cases, 1.7% more suicides, 4.0% more arrests, and 0.8% more assaults
reported to the police.[86] A more recent study by Christopher Ruhm[87]
on the effect of recessions on health found that several measures of
health actually improve during recessions. As for the impact of an
economic downturn on crime, during the Great Depression the crime rate
did not decrease. Because unemployment insurance in the U.S. typically
does not replace 50% of the income one received on the job (and one
cannot receive it forever), the unemployed often end up tapping welfare
programs such as Food Stamps or accumulating debt.
Not everyone suffers equally from unemployment. In a prospective study

of 9570 individuals over four years, highly conscientiousness people
suffered more than twice as much if they became unemployed.[88] The
authors suggested this may be due to conscientious people making
different attributions about why they became unemployed, or through
experiencing stronger reactions following failure.
Some hold that many of the low-income jobs are not really a better option
than unemployment with a welfare state (with its unemployment
insurance benefits). But since it is difficult or impossible to get
unemployment insurance benefits without having worked in the past,
these jobs and unemployment are more complementary than they are
substitutes. (These jobs are often held short-term, either by students or
by those trying to gain experience; turnover in most low-paying jobs is
high.)
Another cost for the unemployed is that the combination of

unemployment, lack of financial resources, and social responsibilities may
push unemployed workers to take jobs that do not fit their skills or allow
them to use their talents. Unemployment can cause underemployment,
and fear of job loss can spur psychological anxiety.
SOCIAL:-
An economy with high unemployment is not using all of the resources,
specifically labour, 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 economy's efficiency.[89]
During a long period of unemployment, workers can lose their skills,

causing a loss of human capital. Being unemployed can also reduce the
life expectancy of workers by about 7 years [90]
High unemployment can encourage xenophobia and protectionism as

workers fear that foreigners are stealing their jobs.[91] Efforts to preserve
existing jobs of domestic and native workers include legal barriers against
"outsiders" who want jobs, obstacles to immigration, and/or tariffs and
similar trade barriers against foreign competitors.
High unemployment can also cause social problems such as crime; if

people don't have as much disposable income as before, then it is very
likely that crime levels within the economy will increase.

SOCIO-POLITICAL:-
High levels of unemployment can be causes of civil unrest, in some cases
leading to revolution, and particularly totalitarianism. The fall of the
Weimar Republic in 1933 and Adolf Hitler's rise to 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[92] of above 20%; see Great Depression in Central
Europe for details.
Note that the hyperinflation in the Weimar republic is not directly blamed
for the Nazi rise – the Inflation in the Weimar Republic occurred primarily
in the period 1921–23, which was contemporary with Hitler's Beer Hall
Putsch of 1923, and is blamed for damaging the credibility of democratic
institutions, but the Nazi party only assumed government in 1933, 10
years after the hyperinflation but in the midst of high unemployment.
BENEFITS OF UNEMPLOYMENT:
Unemployment is argued to be "beneficial" to the people who are not

unemployed in the sense that it averts inflation, which itself has damaging
effects, by providing (in Marxian terms) a reserve army of labour, that keeps
wages in check. However the direct connection between full local
employment and local inflation has been disputed by some due to the recent
increase in international trade that supplies low-priced goods even while
local employment rates rise to full employment.[93]
In the Shapiro-Stiglitz model of efficiency wages, workers are paid at a level

that dissuades shirking. This prevents wages from dropping to market
clearing levels. Full employment cannot be achieved because workers would
shirk if they were not threatened with the possibility of unemployment.
Because of this, the curve for the no-shirking condition (labeled NSC) goes to
infinity at full employment.
The inflation-fighting benefits to the entire economy arising from a presumed

optimum level of unemployment has been studied extensively.[94] The
Shapiro-Stiglitz model suggests that wages are not bid down sufficiently to
ever reach 0% unemployment.[95] This occurs because employers know that
when wages decrease, workers will shirk and expend less effort. Employers
avoid shirking by preventing wages from decreasing so low that workers give

up and become unproductive. These higher wages perpetuate
unemployment while the threat of unemployment reduces shirking.
Before current levels of world trade were developed, unemployment was

demonstrated to reduce inflation, following the Phillips curve, or to
decelerate inflation, following the NAIRU/natural rate of unemployment
theory, since it is relatively easy to seek a new job without losing one's
current one. And when more jobs are available for fewer workers (lower
unemployment), it may allow workers to find the jobs that better fit their
tastes, talents, and needs.
As in the Marxist theory of unemployment, special interests may also benefit:

some employers may expect that employees with no fear of losing their jobs
will not work as hard, or will demand increased wages and benefit. According
to this theory, unemployment may promote general labour productivity and
profitability by increasing employers' rationale for their monopsony-like
power (and profits).[50]
Optimal unemployment has also been defended as an environmental tool to

brake the constantly accelerated growth of the GDP to maintain levels
sustainable in the context of resource constraints and environmental
impacts.[96] However the tool of denying jobs to willing workers seems a
blunt instrument for conserving resources and the environment—it reduces
the consumption of the unemployed across the board, and only in the short
term. Full employment of the unemployed workforce, all focused toward the
goal of developing more environmentally efficient methods for production
and consumption might provide a more significant and lasting cumulative
environmental benefit and reduced resource consumption.[97] If so the
future economy and workforce would benefit from the resultant structural
increases in the sustainable level of GDP growth.
Some critics of the "culture of work" such as anarchist Bob Black see
employment as overemphasized culturally in modern countries. Such critics
often propose quitting jobs when possible, working less, reassessing the cost
of living to this end, creation of jobs which are "fun" as opposed to "work,"
and creating cultural norms where work is seen as unhealthy. These people
advocate an "anti-work" ethic for life.
CONTROLLING OR REDUCING UNEMPLOYMENT:
Societies try a number of different measures to get as many people as

possible into work, and various societies have experienced close to full
employment for extended periods, particularly during the Post-World War II
economic expansion. The United Kingdom in the 1950s and 60s averaged
1.6% unemployment,[99] while in Australia the 1945 White Paper on Full
Employment in Australia established a government policy of full
employment, which policy lasted until the 1970s when the government ran
out of money.
However, mainstream economic discussions of full employment since the

1970s suggest that attempts to reduce the level of unemployment below the
natural rate of unemployment will fail, resulting only in less output and more
inflation.
DEMAND SIDE SOLUTIONS:
Many countries aid the unemployed through social welfare programs. These
unemployment benefits include unemployment insurance, unemployment
compensation, welfare and subsidies to aid in retraining. The main goal of
these programs is to alleviate short-term hardships and, more importantly, to
allow workers more time to search for a job.
A direct demand-side solution to unemployment is government-funded

employment of the able-bodied poor. This was notably implemented in
Britain from the 17th century until 1948 in the institution of the workhouse,
which provided jobs for the unemployed with harsh conditions and poor
wages to dissuade their use. A modern alternative is a job guarantee, where
the government guarantees work at a living wage. Temporary measures can
include public works programs such as the Works Progress Administration.
Government-funded employment is not widely advocated as a solution to
unemployment, except in times of crisis; this is attributed to the public
sector jobs' existence depending directly on the tax receipts from private
sector employment.
In the U.S. the unemployment insurance allowance one receives is based

solely on previous income (not time worked, family size, etc.) and usually
compensates for one-third of one's previous income. To qualify, one must
reside in their respective state for at least a year and, of course, work. The
system was established by the Social Security Act of 1935. Although 90% of
citizens are covered by unemployment insurance, less than 40% apply for
and receive benefits. However, the number applying for and receiving
benefits increases during recessions. In cases of highly seasonal industries

the system provides income to workers during the off seasons, thus
encouraging them to stay attached to the industry.
According to classical economic theory, markets reach equilibrium where

supply equals demand; everyone who wants to sell at the market price can.
Those who do not want to sell at this price do not; in the labour market this is
classical unemployment. Increases in the demand for labour will move the
economy along the demand curve, increasing wages and employment. The
demand for labour in an economy is derived from the demand for goods and
services. As such, if the demand for goods and services in the economy
increases, the demand for labour will increase, increasing employment and
wages. Monetary policy and fiscal policy can both be used to increase short-
term growth in the economy, increasing the demand for labour and
decreasing unemployment.
SUPPLY SIDE SOLUTIONS:
However, the labour market is not 100% efficient: it does not clear, though it
may be more efficient than bureaucracy. Some argue that minimum wages
and union activity keep wages from falling, which means too many people
want to sell their labour at the going price but cannot. This assumes perfect
competition exists in the labour market, specifically that no single entity is
large enough to affect wage levels. Advocates of supply-side policies believe
those policies can solve this by making the labour market more flexible.
These include removing the minimum wage and reducing the power of
unions. Supply-siders argue the reforms increase long-term growth. This
increased supply of goods and services requires more workers, increasing
employment. It is argued that supply-side policies, which include cutting
taxes on businesses and reducing regulation, create jobs and reduce
unemployment. Other supply-side policies include education to make
workers more attractive to employers.
However, recent meta-analyzes involving many studies refute that there is

any statistically significant, negative impact of minimum wages on
unemployment.[102] Further, a number of scholars argue that the predicted
negative impact is based on incoherent or simplistic logic that ignores
mitigating environmental factors, such as non-minimum wage labour
markets including farm, service and self employed workers.[41][42][43][44]
[45] They argue that the benefits of minimum wage laws outweigh the
supposed but unproven costs.

UNEMPLOYMENT IN PAKISTAN: STATISTICS
Unemployment rate: 15% (2010 est.)
14% (2009 est.)
note: substantial underemployment exists
Year Unemployment rate Rank Percent ChangeDate of Information
2003 7.80 % 119 2002

est.
2004 7.70 % 122 -1.28 %

2003 est.
2005 8.30 % 75 7.79 %

2004 est.
2006 6.60 % 65 -20.48 %

2005 est.
2007 6.50 % 72 -1.52 %

2006 est.
2008 5.60 % 71 -13.85 %

2007 est.
2009 7.40 % 92 32.14 % 2008

est.
2010 14.00 % 143 89.19 %

2009 est.
This entry contains the percent of the labor force that is without jobs.
Substantial underemployment might be noted.

The higher growth rate of population is one of the major cause of
unemployment in Pakistan. The resources of the country are limited because
population has exceeded the optimum level. It can be clearly seen the
Pakistan is suffering from over population and the being an underdeveloped
country it is very difficult to control this. It also affects the employment rate
of Pakistan. The population has been increasing. Although the growth rate is
decreasing by the actual figure of population has increased from 85.10
million in 1981 to 149.03 in 2003. This shows the rapid rate of increase in
population. In order to minimize the unemployment problem, a strict
population policy maybe introduced.
Our educational system is also responsible for increasing unemployment rate

among the youth. The attitude of our youth towards the choice of a career is
unrealistic and unproductive. Rapid mechanization and computer technology
also causing unemployment. Less than three-quarters of its school-age
population attends primary school. Nearly two-third of the total adult
population can’t read or write. Expenditure on education as a percentage of
GDP has been less than 2 % in the last decade.
The level of unemployment in Pakistan is moving up day by day. The socio

economics system of Pakistan and institutions has failed to provide
employment to the increasing labor force. The rate of expansion in industrial
sector is very slow. In fact, the employment in the private sector has
absolutely stopped because they shifted their capital to other countries
because of the global economics condition and also as we are the front line
state against war on terror. And investors are reluctant to invest here
because of the political instability in the country, unrest and violence. The
unemployment rate in Pakistan in the year 2007 and 2008 was estimated as
6.5% and 7.5% in the year 2007. In exact terms, it was 5.6% plus substantial
underemployment in 2007 and 7.5% estimated in the year 2008. These facts
are according to CIA world fact book which comprise of the percentage of
labor force which is currently unemployed. According to the Human
Development Report on South Asia, Pakistan’s labour force is growing at the
rate of 2.4%, and the unemployment rate is growing at an alarming rate of
6% per anum in the last five years.

As we know that the Pakistan’s economy used to derive great benefit from
overseas Pakistanis and expatriate labour abroad, especially the Gulf
countries. This was traditionally unskilled labour engaged in the construction
boom of the post-1973 oil price hike shock. However, the opportunities for
unskilled labour in Arab countries have been reducing due to the economic
changes taking place there.
With the decline in jobs abroad, the economy’s capacity to generate

employment opportunities has been decreasing, which can be figured out
from the low growth rates. With the high rate of population growth, rate is
further expected to increase in near future because of the current financial
crisis in the country.

REASONS FOR GROWING UNEMPLOYMENT IN PAKISTAN:
Unemployment is one of the biggest problems of Pakistan. That person is

unemployed who has ability to do work and is willing to do work but is unable
to get job opportunity. In the current situation more than 30 lakh people are
unemployed in Pakistan and unemployment ratio is more than 12%.
i. The biggest reason of unemployment in Pakistan is concerned with the

backwardness of agriculture sector. Agriculture is the biggest sector of our
economy that contributes 20.9% to GDP and 44% people get jobs from this
sector directly or indirectly. Unemployment in this sector is from two sides.
First is due to the adoption of latest machinery and capital intensive

technology. Due to this, demand for labour has been decreased. Second is
the backwardness of this sector. There is less availability of fertilisers,
pesticides, quality seeds, absence of land reforms and lack of agriculture
education. Due to all these factors agriculture sector is not expanding and
there is general and disguised unemployment.
ii. Industrial sector is the second largest sector of our economy and
contributes 19% to national income. This sector should employ a large
number of labor. But due to backwardness it is employing a small number of
people. Due to electricity breakdown already established industry is
deteriorating, resulting in the prevailing unemployment ratio.
iii. High cost and low quality are responsible for less demand for our agri and
industrial items. Because of less demand of such kinds of goods both the
domestic and international producers are losing their interest in production.
That’s why people are becoming unemployed.
iv. In Pakistan education system is defective. There is no educational

planning. This system is producing the stuff, which is useless in technical
fields of the country. There is lack of technical and vocational institutions.
Public attitude towards education is wrong, they want to get their degrees in
general and arts subjects. Nobody can set up his own business without
technical education.
v. Millions of people in Pakistan are poor. Due to poverty people are

overburdened with expenditures and their savings are very low. It is said
that for the reasonable growth of economy saving rate should be at least
25% in any country, but in Pakistan it is only 13 to 14% which is very low.
Low investment level is due to less savings, ultimately there is

unemployment.
vi. In Pakistan majority of the businessmen are less educated. They do not
know how to run their businesses properly. So they become bankrupt. This
factor generates unemployment on a massive level.
vii. In Pakistan there is lack of every kind of planning. There is a huge

difference between the demand and supply for labor. There is absence of
such kind of planning to produce doctors, engineers, technical experts
scientists etc, according to the need of different sectors of the economy.
viii. Loadshedding of electricity is disturbing economy, especially the

industrial sector. Due to less availability and high rates of basic inputs like
electricity, gas and oil etc, many industries have been closed.
ix. In Pakistan, tax system is not satisfactory. Ratio of direct taxes is more
than indirect taxes. Tax evasion is common. Due to less income from the
taxes, government cannot start developmental projects. If there is no
investment, then from where public would find jobs. On the other side if
government takes step to increase indirect taxes, it would also affect
investment and ultimately employment level.
x. Current international financial crisis is one of the biggest reason of

unemployment in Pakistan and in the whole world. This crisis originated from
the banking sector of USA, UK and some European countries and is now a
global phenomena.
xi. Pakistan’s population growth rate is 1.8% which is the highest in the
region. Our resources are limited. Different sectors of economy are unable to
provide jobs to the growing population. So there is unemployment.
xii. Fiscal and monetary policies are also responsible for unemployment. In
view of fiscal policy, Pakistan has less funds to invest in job providing
projects. Every annual budget shows deficit. Through the monetary policy if
the government increases the rate of interest, it discourages the investors
from getting loans.
xiii. Political instability, bad law and order situation, army’s interference,
bomb blasts, terrorism, inconsistent economic policies etc are the factors
which are disturbing domestic and foreign investment. Pakistan investors are
taking away their money to Dubai and other countries of the world.
xiv. Due to 9/11 incident, Gulf war and the baseless allegations of terrorism

the image of Pakistan has been affected very badly at international level. So
in the current scenario Pakistan has limited job opportunities in other
countries of the world.
xv. Craze for work only in government sector, instead of private sector and
seasonal firms, industries are also responsible for unemployment.
xvi. Since 1947, Pakistani rulers got loans from IMF, World Bank and many
other sources. Such loans were not utilised honestly. Current external debt of
Pakistan is more than 50 billion dollar. Government has to allocate a big
amount for the repayment of loans with interest. So due to less resources for
developmental projects there is unemployment.
Concluding, I would like to suggest that with proper economic planning,

consistent policies of government, better law and order situation, abolishing
energy crisis, sincerity with Pakistan and by adopting the Islamic economic
system we can not only tackle the issue of unemployment but every
economic problem of our country as well.
HOW TO CURB EFFECTS OF UNEMPLOYMENT IN PAKISTAN:
1) Govt. should make efforts to push economic growth process.
For this purpose Economic Revival Package should announce for the revival
of industries sector, to stimulate production and investment.
2) Govt. should seriously try to boost exports through broadening the tax
base and lowering tariffs.
3) Govt. should announce a package for the development of agriculture

sector .
4) Beside this a number of fiscal and monetary measures should take to

attract industrialists and particularly foreign investment.
5) More Technical and Vocational training facilities should be provided. In

this way unemployed people will get the chance to enhance their skills and
become able to earn reasonable income.
6) With a view to reduce educate unemployment; self-employment scheme

should be encouraged in true manners.

INFLATION
The rate at which the general level of prices for goods and services is rising,
and, subsequently, purchasing power is falling. Central banks attempt to
stop severe inflation, along with severe deflation, in an attempt to keep the
excessive growth of prices to a minimum.
TYPES OF INFLATION:
Demand-pull Inflation:
Demand-pull inflation is also called as wage or excess demand inflation. This

type of inflation occurs when total demand for goods and services in an
economy exceeds the available supply. this, leading to a situation called as
demand-pull inflation. War produces this type of inflation as demand for war
materials and manpower grows rapidly during that time.
Cost-push Inflation:
As the name suggests, when the cost of production of goods and services
increases, there is likely to be an increase in the prices of finished goods and
services. For instance, a rise in the wages of laborers is what raises the unit
costs of production and thus raises price. This is less common than demand-
pull inflation. This type of inflation may or may not occur in conjunction with
demand-pull inflation.
Pricing Power Inflation:

Pricing power inflation is more often called as administered price inflation.
This type of inflation occurs when the businesses decide to increase their
prices to increase their profit margins. Pricing power inflation does not occur
at the time of financial crises and economic depression, or when there is a
downturn in the economy. This type of inflation is also called as oligopolistic
inflation because oligopolies have the power of to set their own prices.
Sectoral Inflation:
This is the fourth major type of inflation. The sectoral inflation takes place
when there is an increase in the prices of the goods and services produced
by a certain sector of industries. For instance, an increase in the cost of
crude oil would directly affect all the sectors, which are directly related to
the oil industry. Thus, the ever-increasing price of fuel has become an
important issue related to the economy all over the world. This would lead to
a widespread inflation throughout the economy. If this situation occurs when
there is a recession in the economy, there would be layoffs and it would
adversely affect the work force and the economy in turn
Hyperinflation:
Hyperinflation is also known as runaway inflation or galloping inflation. This

type of inflation occurs during or soon after a war. This can usually lead to
the complete breakdown of a country’s monetary system. However, this type
of inflation is short-lived. In 1923, in Germany, inflation rate touched
approximately 322 percent per month with October being the month of
highest inflation.

MEASEUREMENT OF INFLATION:
CONSUMER PRICE INDEX (CPI)
It is a measure that examines the weighted average of prices of a basket of

consumer goods and services, such as transportation, food and medical care.
Taking price changes for each item in the predetermined basket of goods
and averaging them calculate the CPI; the goods are weighted according to
their importance. Changes in CPI are used to assess price changes
associated with the cost of living.
Calculating the CPI for a single item
Where 1 is usually the comparison year and CPI1 is usually an index of 100.
Alternately, the CPI can be performed as:
The "updated cost" (i.e the price of an item at a given year, eg: the price of
bread in 1982) is divided by the initial year (the price of bread in 1970), then
multiplied by one hundred.
PRODUCER PRICE INDEX
A Producer Price Index (PPI) measures price change from the perspective of
the seller. It measures average changes in prices received by domestic
producers for their output. The PPI shows trends within the wholesale
markets (the PPI was once called the Wholesale Price Index), manufacturing
industries and commodities markets.
GDP DEFLATOR
GDP deflator (implicit price deflator for GDP) is a measure of the level of
prices of all new, domestically produced, final goods and services in an

economy. GDP stands for gross domestic product, the total value of all final
goods and services produced within that economy during a specified period.
the GDP deflator measures the ratio of nominal (or current-price) GDP to the
real (or chain volume) measure of GDP. The formula used to calculate the
deflator is:
Dividing the nominal GDP by the GDP deflator and multiplying it by 100
would then give the figure for real GDP, hence deflating the nominal GDP
into a real measure.
Unlike some price indexes, the GDP deflator is not based on a fixed basket of
goods and services. The basket is allowed to change with people's
consumption and investment patterns. The theory behind this approach is
that the GDP deflator reflects up to date expenditure patterns. For instance,
if the price of chicken increases relative to the price of beef, it is claimed that
people will likely spend more money on beef as a substitute for chicken.
Pakistan publishes four different price indices, namely: the consumer price
index (CPI), the wholesale price index (WPI), the sensitive price index (SPI)
and the GDP deflator. The CPI is the main measure of price changes at the
retail level. It indicates the cost of purchasing a representative fixed basket
of goods and services consumed by private households. In Pakistan, the CPI
covers the retail prices of 374 items in 35 major cities and reflects roughly
the changes in the cost of living of urban areas. The WPI is designed for
those items which are mostly consumable in daily life on the primary and
secondary level; these prices are collected from wholesale markets as well
as from mills at organised wholesale market level. It covers the wholesale
price of 106 commodities prevailing in 18 major cities of Pakistan. The SPI
shows the weekly change of price of 53 selected items of daily use
consumed by those households whose monthly income in the base year
2000-01 ranged from Rs3000 to above Rs12000 per month. The SPI also
informs about the actual position of supply: whether the commodity is
available in market or not. If the commodity is not available, the reason for
that is also recorded. It is based on the prices prevailing in 17 major cities
and is computed for the basket of commodities being consumed by the
households belonging to all income groups combined as in CPI. In most

countries, the main focus for assessing inflationary trends is placed on the
CPI, because it most closely represents the cost of living. In Pakistan, the
main focus is also placed on the CPI as a measure of inflation as it is more
representative with a wider coverage of 374 items in 71 markets of 35 cities
around the country. Inflation has started veering its ugly head in many parts
of the world, including Pakistan. Food inflation has emerged as the main
contributor to inflationary pressures.
The inflation rates based on CPI, SPI and WPI for the year 2008-09 increased
by 22.35 per cent, 26.33 per cent and 21.44 per cent respectively over the
corresponding period of 2007-08. It increased by 10.27 per cent, 14.09 per
cent and 13.70 per cent respectively in 2007-08 over the corresponding
period of 2006-07. In 2006-07, the rate of inflation increased by 7.89 per
cent, 11.13 per cent and 6.92 per cent respectively over the same period of
2005-06. An analysis of data for last three years for the same period
indicates that CPI, SPI & WPI were higher as compared to last two years.
The government is cautious about inflation and thus has taken various steps
to release demand pressures on the one hand and enhance supplies of
essential commodities on the other. To ease demand pressures, the State
Bank of Pakistan (SBP) has continuously tightened the monetary policy over
the last three years and more so in the current fiscal year, while to enhance
supplies, the government has relaxed its import regime and allowed imports
of several essential items so that there is a continuous flow in the supply of
those important commodities. In addition, the government increased the
imports of items like wheat, pulse and sugar to complement the efforts of
the private sector. In order to provide relief to the common man, the
government also increased the scale of operations of the Utility Stores
Corporation (USC) which supplies essential commodities such as wheat flour,
sugar, pulses and cooking oil/ ghee at less than the market prices.
ALL THREE INDICES CPI, SPI AND WPI AT A GLANCE
Average July–April over same period of previous year
(Change of indices in %)
Index 2006-07 2007-08 2008-09

CPI 7.89 10.27 22.35
SPI 11.13 14.09 26.33
WPI 6.92 13.70 21.44
PAKISTAN ECONOMY: INFLATION PASSES GOVERNMENT

TARGETS
Consumer Price Index (CPI) rose by 11.73 percent in 2009/10, surpassing the
government’s target of 10 percent, mainly because of unprecedented
increase in the electricity tariff.It was, however, below the central bank’s
projection of 12 percent. In the last financial year, CPI had gone up by 21
percent. “CPI could have been contained to a single digit figure if the
electricity charges had not been raised during the year,” said an analyst. The
government had to raise electricity prices because of a commitment with the
International Monetary Fund (IMF).
Food inflation came down to 14.48 percent from over 30 percent in the
previous fiscal.
In June, inflation stood at 12.69 percent, according to figures released by the
Federal Board of Statistics (FBS).
Khurram Schehzad, an analyst at InvesCap, said that the drop in CPI was
mainly due to higher base affect, but reduction in oil prices also had its
impact. He said that inflation would continue to remain in double digit figures
during the current fiscal year because of higher dependence on furnace oil
for power generation. “The high cost of power generation will result in rise in
electricity tariff, which will lead to inflationary pressures.” The non-perishable
food items index rose 13.64 percent and the perishable items index 20.76
percent. House rent index climbed 9.69 percent, while fuel and lighting index
surged 16.36 percent. Transport and communication expenses were higher
by 15.82 percent. Education and health expenses went up by 8.36 percent
and 10.59 percent, respectively. Sensitive Price Index (SPI) and Wholesale
Price Index (WPI) increased by 13.32 percent and 12.63 percent,
respectively.

PAKISTAN ECONOMY: HIGHEST INFLATION IN 30 YEARS
Soaring food and oil prices drove inflation in Pakistan to its highest level in
over 30 years in May, and analysts expect it to rise further as the
government was expected to slash price subsidies in a budget to be
announced later on Wednesday.
Official data on Wednesday showed the consumer price index rose 2.69 per
cent in May to stand 19.27 per cent higher than a year earlier, after a 17.21
per cent year-on-year rise in April.
“There are two factors driving inflation, high food prices and the second is
the base effect of passing the burden of oil prices,” said Asif Qureshi, head of
research at Invisor Securities Ltd. Prices of food and beverages rose 28.48pc
in May, while house rent and fuel and lighting increased by 12.05 per cent
and 9.50 per cent, respectively.
Inflation is at its highest since 1975 when annual average prices rose 26.83
per cent. Analysts said monthly data started being released in 1991 and
therefore it was difficult to make an exact comparison of inflation figures.
Total budget subsidies on fuel oil, electricity, fertilisers and food items were
due to be reduced to 295.20 billion rupees from 407.48 billion rupees.
EFFECTS OF INFLATION:
The effect of inflation is not

distributed evenly in the economy,
and as a consequence there are
hidden costs to some and benefits to
others from this decrease in the
purchasing power of money. For example, with inflation, lenders or
depositors who are paid a fixed rate of interest on loans or deposits will lose
purchasing power from their interest earnings, while their borrowers benefit.
Individuals or institutions with cash assets will experience a decline in the
purchasing power of their holdings. Increases in payments to workers and
pensioners often lag behind inflation, especially for those with fixed
payments. Increases in the price level (inflation) erode the real value of
money (the functional currency) and other items with an underlying
monetary nature (e.g. loans and bonds). However, inflation has no effect on

the real value of non-monetary items, (e.g. goods and commodities, gold,
real estate). Debtors who have debts with a fixed nominal rate of interest will
see a reduction in the "real" interest rate as the inflation rate rises. The
“real” interest on a loan is the nominal rate minus the inflation rate
When the balance between supply and demand spirals out of control, buyers
will change their spending habits as they meet their purchasing thresholds
and producers will suffer and be forced to cut output. This can be readily tied
to higher unemployment rates. When extremes arise in the supply/demand
structure, imbalances are created.
The point that is being made is that if inflation is not contained and rises at
an unsustainable rate; there will be a stronger impact on the other side.
There is a saying; "the bigger they are, the harder they fall".
The most immediate effects of inflation are the decreased purchasing power
of the rupee and its depreciation. Depreciation is especially hard on retired
people with fixed incomes, as spending power decreases each month. Those
not on fixed incomes are more able to cope, because they can simply
increase their income. Another destabilising effect of inflation is that some
people choose to speculate heavily in an attempt to take advantage of the
higher price level. Because some of the purchases are high-risk investments,
spending is diverted from the normal channels and some structural
unemployment may take place. Finally, inflation alters the distribution of
income. Lenders are generally hurt more than borrowers during long
inflationary periods, which mean that loans made earlier are repaid later in
inflated rupees. Inflation weakens the function of money as storage of value,
because each unit of money is worth less with the passing of time. The
progressive loss of the value of money during a period of inflation makes the
borrowers to be less willing to use the money as standard differed payments
DEMAND-PULL INFLATION:
• The demand-pull theory suggests that inflation occurs when aggregate
demand exceeds aggregate supply; essentially, the number of people
wanting to purchase goods and services outweighs what is available. When
more people want to spend money on something, the price will increase to
account for the greater demand. This scenario is typically associated with a
strong economy and low unemployment, when more people put money into
the economy.

COST-PUSH INFLATION:
• Cost-push inflation occurs when goods and services become more expensive
to produce, which means prices increase to maintain a desirable profit
margin. A shortage of raw materials also can contribute to cost-push
inflation. One example of this was the 1973 oil crisis, when some Middle
Eastern and North African countries placed an embargo on oil exports to the
U.S.
MONETARIST THEORY:
The monetarist theory suggests the money supply determines inflation,
which occurs when the rate of a country's income rises faster than economic
growth. If additional money is pumped into the economy while prices of
goods and services remain the same, it will potentially result in inflation. Top
causes of an increased money supply are banks increasing lending, or
central banks, such as the Federal Reserve, printing more money and buying
government assets.
KEYNESIANS THEORY:
According to Keynesian, inflation can be caused by increase in demand
and/or increase in cost.
Demand-pull inflation is a situation where aggregate demand persistently
exceeds aggregate supply when the economy is near or at full employment.
Aggregate demand could rise because of several reasons. A cut in personal
income tax would increase disposable income and contribute to a rise in
consumer expenditure. A reduction in the interest rate might encourage an
increase in investment as well as lead to greater consumer spending on
consumer durables. A rise in foreigners' income may lead to an increase in
exports of a country. An expansion of government spending financed by
borrowing from the banking system under conditions of full employment is
another cause of inflation.
An increase in demand can be met initially by utilising unemployed resources
if these are available. Supply rises and the increase in demand will have little
or no effect on the general price level at this point. If the total demand for
goods and services continue to escalate, a full employment situation will
eventually be reached and no further increases in output are possible. This
leads to inflationary pressures in the economy.

Demand-pull inflation is caused by excess demand, which can originate from
high exports, strong investment, rise in money supply or government
financing its spending by borrowing. If firms are doing well, theey will
increase their demand for factors of production. If the factor market is
already facing full employment, input prices will rise. Firms may have to bid
up wages to tempt workers away from their existing jobs.
It is most likely that during full employment conditions, the rise in wages will
exceed any increase in productivity leading to higher costs. Firms will pass
the higher costs to consumers in the form of higher prices. Workers will
demand for higher wages and this will add fuel to aggregate demand, which
increases once again. The process continues as prices in the product market
and factor market are being pulled upwards.
Keynesian theory of cost-push inflation attributes the basic cause of inflation
to supply side factors. This means that according to Keynesian, rising
production costs will lead to inflation.
Cost-push inflation is usually regarded as being primarily a wage inflation
process because wages usually constitute the greaer part of total costs.
Powerful and militant trade unions who negotiate wage increases in excess
of productivity are more likey to succeed in their wage claims the closer the
economy is to full employment and the greater the problem of skill
shortages.
An increase in the price of coal, oil and many other basic inputs or even
semi-manufactured goods used as component parts in the production
process will manifest itself as higher consumer prices. The oil crisis in 1973-
1974 and 1970-80 resulted in many countries experiencing severe cost-push
inflation.
Inflation may occur when there is a depreciation of the home currency. A
depreciation of a country's currency results in increases in the price of
imported foodstuff, raw materials and capital equiment which then results in
a rise in production costs.
A significant increase in the level of indirect taxes(taxes on goods and
services) will raise domestic prices independently of the state of demand and
could be a causal factor in creating wage-push pressure on the economy.
When firms are faced with higher wage costs, they push up the prices of
their products to maintain their profits. Sometimes, they may even seize the
opportunity to increase their profit margins. The more price inelastic the
demand for their goods, the less likely such behaviour will lead to a fall in
demand for their products.

Cost push inflation in inevitable when there is a struggle between workers
and firms. Both try to maintain their real incomes by bidding up their wages
and profits. Workers force firms to give inflationary pay increases while firms
increase prices so as to raise their profit margins. Price rises are inevitable.
This process is known as a wage-price spiral.
In practice, it may not be easy to identify the primary cause of inflation.
Demand pull and cost push inflation can occur together. An initial demand
pull inflation may strengthen the power of trade unions which then use this
power to drive up costs. Alternatively, an initial cost push inflation may
encourage the government to expand aggregate demand to offset rises in
unemployment. Once inflation is under way, it is not always easy to identify
the underlying cause.
Keynes' demand and cost push theories pointed out that the closer the
economy is to full employment, the greater the inflationary pressure. The
greater the rate of unemployment, the less the inflationary pressure.
CONTROLLING INFLATION:
Controlling inflation forms a significant part of the economic activities of a

nation. Inflation is an economic condition characterized by a general rise in
the prices. Thus, controlling Inflation is important as unrestrained increase of
the prices may culminate in Hyperinflation, and an excessive fall in the
prices may lead to Deflation. Both the situations are not healthy and sound
for the overall growth and development of a country's economy.
Infect, keeping a strong control over Inflation has turned out to be one of the
primary objectives of the governments of different countries across the
globe. To this effect, efficacious economic policies are being formulated,
which mainly concentrate on the fundamental causes of Inflation in an
economy, and try to improvise methods to keep the inflationary conditions
under control.
For instance, if the primary reason for inflation in a nation is the excessive
demand for goods and services, then the economy policy on the government
level should find out the causes of such unnecessary rise and undertake
measures to decrease the overall level of collective demand .Sometimes, if it
is seen that Cost-Push Inflation is responsible for the rise in the demand for
goods and services, then the cost of production must be checked, to handle
the inflation-related problems.

Mentioned below are some methods, which have proved to be highly
effective in controlling inflation to large extents:
FISCAL POLICY:
Fiscal policies are effective in increasing the leakage rates from the circular
income flow, thereby rejecting all further additions into this particular flow of
income. This brings about a reduction in the Demand-Pull Inflation, in terms
of increasing unemployment and slackening the economic growths.
Following are a few types of fiscal policies commonly employed:
• Lowering the expenses on governmental level

• A fall in the borrowing amounts in the government sectors, on an
annual basis
• High direct taxes, for reducing the disposable income.
MONETARY POLICY:
Monetary policies have a great role to play in controlling Inflation. These are
policies which can actually control the rise in demand, by increasing the
rates of interest and reducing the supply of real money. An escalation in the
interest rates brings about a reduction in collective demands, in the following
three ways:
• A rise in the interest rate discourages borrowing from both companies

and households. When interest rates increase, it simultaneously
encourages the saving rate, owing to an escalation in the opportunity
cost of expenditure.
• Rise in the interest rates is a very useful tool for restricting monetary
inflation. Increase in the real rates of interest decreases the demands
for loans, thereby limiting the growth of broad money.
• There may also be a fall in the commercial investments, due to a rise
in the costs of borrowing money. This exerts a direct influence on a
handful of planned investment-related projects, which turn out to be
unprofitable. This leads to a fall in the collective demand
• An increase in the payment of mortgage interests automatically
decreases the real 'effective' disposable income of the house owners,
as well as their spending capacities. Escalation in the mortgage costs
also decreases the demand generated in the housing markets.

EXCHANGE RATE:
An escalation in the exchange rate is possible by increasing the rates of

interest or buying money through the central band interferences in the
foreign exchange markets. Mentioned below is a short-term mean by which
inflation can be controlled through exchange rates:
• Income policies or direct wage controls: Setting restrictions on the

growth rate of wages may decrease cost push inflation. Om
governmental level, an attempt to influence the growth of wage leads
to limit the rise in the pay in public sectors, as well as initiates cash
restrictions for making payments to the employees of public sectors.
As far as the private sector is concerned, the government attempts to

convince the commercial firms and its employees to implement self-controls
at the time of negotiating wages. Generally, there is a fall in the wage
inflation when there is an economic depression, leading to a rise in the
unemployment rates.
The Long term means of controlling the Inflation are as follows:
• Supply-side reform Policy: According to this policy, if more output is

produced at a low per unit cost, there are chances for economy to
attain persistent economic growth and development, without being
affected by inflation.
• Policy regarding labor market reforms: If an increase in the flexibility of
labor market permits the commercial forms to put a check on labor
costs, it can lead to a reduction in the pressures created by the Cost-
Push Inflation.
THE PHILLIPS CURVE:
The essence of the Phillips Curve is that there is a short-term trade-off

between unemployment and inflation. But the original Phillips Curve has
come under sustained attack – in particular from monetarist economists, and
when we consider the data for unemployment and inflation in Britain over
the last fifteen years, we will find that the nature of the trade-off has
certainly changed for the economy and others as well.
The Basic Phillips Curve Idea – Economic Trade-Offs

In 1958 AW Phillips from whom the Phillips Curve takes its name plotted 95
years of data of UK wage inflation against unemployment. It seemed to
suggest a short-run trade-off between unemployment and inflation. The
theory behind this was fairly straightforward. Falling unemployment might
cause rising inflation and a fall in inflation might only be possible by allowing
unemployment to rise. If the Government wanted to reduce the
unemployment rate, it could increase aggregate demand but, although this
might temporarily increase employment, it could also have inflationary
implications in labour and the product markets.
The key to understanding this trade-off is to consider the possible
inflationary effects in both labour and product markets arising from an
increase in national income, output and employment.
The labour market: As unemployment falls, some labour shortages may
occur where skilled labour is in short supply. This puts extra pressure on
wages to rise, and since wages are usually a high percentage of total costs,
prices may rise as firms pass on these costs to their customers
Other factor markets: Cost-push inflation can also come from rising demand
for commodities such as oil, copper and processed manufactured goods such
as steel, concrete and glass. When an economy is booming, so does demand
for these components and raw materials.
Product markets: Rising demand and output puts pressure on scarce
resources and can lead to suppliers raising prices to widen profit margins.
The risk of rising prices is greatest when demand is out-stripping supply-
capacity leading to excess demand (i.e. a positive output gap)
Explaining the Phillips Curve concept using AD-AS and the

output gap
Let us consider the explanation for the trade-off using AD-AS analysis and
the concept of the output gap. In the next diagram, we draw the LRAS
curve as vertical - this makes the assumption that the productive capacity of
an economy in the long run is independent of the price level.
We see an outward shift of the AD curve (for example caused by a large rise
in consumer spending) which takes the equilibrium level of national output to
Y2 beyond potential GDP Yfc. This creates a positive output gap and it is this
that is thought to cause a rise in inflationary pressure as described above.
Excess demand in product markets and factor markets causes a rise in
production costs and this leads to an inward shift in short run aggregate
supply from SRAS1 to SRAS2. The fall in supply takes the economy back

towards potential output but at a higher price level.
So this might help to explain the Phillips Curve idea. We could equally use a
diagram that uses a non-linear SRAS curve to demonstrate the argument.
The next diagram shows the original short-run Phillips Curve and the trade-
off between unemployment and inflation:
The Expectations-Augmented Phillips Curve
The original Phillips Curve idea was subjected to fierce criticism from the
Monetarist economic school among them the American economist Milton

Friedman. Friedman accepted that the short run Phillips Curve existed – but
that in the long run, the Phillips Curve was vertical. In other words, Friedman
argued that in the long run, there was no trade-off between unemployment
and inflation. He argued that each short run Phillips Curve was drawn on the
assumption of a given expected rate of inflation. So if there were an increase
in inflation caused for example by a temporary boost to aggregate demand
caused by a large monetary expansion and this had the effect of driving
inflationary expectations higher, then this would cause an upward shift in the
short run Phillips Curve. The Monetarist view is that attempts to boost AD
artificially to achieve faster growth and lower unemployment have only a
temporary effect on unemployment. Friedman argued that a government
could not permanently drive unemployment down below the NAIRU – the
result would be higher inflation which in turn would eventually bring about a
return to higher unemployment but with inflationary expectations increased
along the way. Friedman introduced the idea of adaptive expectations – if
people see and experience higher inflation in their everyday lives, they come
to expect a higher average rate of inflation in future time periods. And they
(or the trades unions who represent them) may then incorporate these
changing expectations into their pay bargaining. Wages often follow prices. A
burst of price inflation can trigger higher pay claims, rising labour costs and
further upward pressure on the market prices of many different goods and
services. This is illustrated in the next diagram – inflation expectations are
higher for SPRC2. The result may be that higher unemployment is required to
keep inflation at a certain target level.

The expectations-augmented Phillips Curve argues that attempts by the
government to reduce unemployment below the natural rate of
unemployment by boosting aggregate demand will have little sustained
success in the long run. The effect is to create higher inflation and with it an
increase in inflationary expectations. The Monetarist school believes that
inflation is best controlled through tight control of money and credit. Credible
policies to keep on top of inflation can also have the beneficial effect of
reducing inflation expectations – causing a downward shift in the short run
Phillips Curve.
The Long Run Phillips Curve
Normally drawn as vertical – but the long run curve can shift inwards over
time.

An inward shift in the long run Phillips Curve might be brought about by
supply-side improvements to the economy – and in particular a reduction in
the natural rate of unemployment. For example labour market reforms might
be successful in reducing frictional and structural unemployment – perhaps
because of improved incentives to find work or gains in the human capital of
the workforce that improves the occupational mobility of labour.

BIBILIOGRAPHY
1. www.economicshelp.org/.../inflation/different-types-of-inflation
2. www.economywatch.com/inflation/causes.html
3. www.economywatch.com/unemployment/measurement.html
4. tutor2u.net/economics/content/topics/.../unemp_policies.html
5. http://tutor2u.net/economics/revision_focus_2004/A2_The_Phillips_Curve.pdf
6. http://tutor2u.net/economics/revision-notes/a2-macro-phillips-curve.html
7. http://www.britannica.com/EBchecked/topic/456596/Phillips-curve
8. http://www.opfblog.com/8447/inflation-and-its-impact-on-the-pakistan-economy
9. http://www.infocheese.com/expectationsaugmentedphillipscurve.html

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Unemployment And Inflation

The Expectations-Augmented Phillips Curve

“INFLATION & UNEMPLOYMENT”

Macro Economics Report Page 2

Firstly, we pay thanks to “ALMIGHTY ALLAH” who helped us to

Macro Economics Report Page 3

Macro Economics Report Page 4

Our study will be focused on various aspects of inflation and unemployment

OBJECTIVE OF THE PROJECT:

1. Present the scenario of inflation and unemployment in Pakistan.

Macro Economics Report Page 5

Recognition of unemployment occurred slowly as economies across the

TYPES & THEORIES:

Economists distinguish between various overlapping types of and theories

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CYCLIC OR KEYNESSIAN UNEMPLOYMENT:

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unemployment, the number of unemployed workers exceeds the number of

MARXIST THEORY OF UNEMPLOYMENT:

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– Marx, Theory of Surplus Value.

Macro Economics Report Page 9

Macro Economics Report Page 10

"Driver looking for work" Unemployed German laborer in 1949

Structural unemployment occurs when a labour market is unable to provide

Macro Economics Report Page 11

persistence in structural unemployment has been referred to as an example

Beveridge curve of 2004 job vacancyand unemployment rate from the

Frictional unemployment is the time period between jobs when a worker

Macro Economics Report Page 12

properly the unemployment rate minus the rate of frictional unemployment,

Macro Economics Report Page 13

Hidden, or covered, unemployment is the unemployment of potential

Though many people care about the number of unemployed individuals,

UNEMPLOYMENT RATE = UNEMPLOYED WORKERS

Macro Economics Report Page 14

WORLD STATISTICS OF UNEMPLOYMENT

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38 Kyrgyzstan 18 51 Spain 13.9 65 Guam 11.4

39 New Caledonia 52 Croatia 66 Colombia

40 West Bank 53 Georgia 67 Ghana11

44 Saint Vincent 58 Grenada 72 Turkey

46 Oman 15 60 Algeria 74 Turks and Caicos

48 Maldives 62 Puerto Rico 12 76 Poland 9.8

Macro Economics Report Page 16

Source: CIA World Factbook

Dr. M. Brenner conducted a study in 1979 on the "Influence of the Social

Not everyone suffers equally from unemployment. In a prospective study

Another cost for the unemployed is that the combination of

During a long period of unemployment, workers can lose their skills,

High unemployment can encourage xenophobia and protectionism as

High unemployment can also cause social problems such as crime; if

Macro Economics Report Page 18

Unemployment is argued to be "beneficial" to the people who are not

In the Shapiro-Stiglitz model of efficiency wages, workers are paid at a level

The inflation-fighting benefits to the entire economy arising from a presumed

Macro Economics Report Page 19

Before current levels of world trade were developed, unemployment was

As in the Marxist theory of unemployment, special interests may also benefit:

Optimal unemployment has also been defended as an environmental tool to

CONTROLLING OR REDUCING UNEMPLOYMENT:

Societies try a number of different measures to get as many people as