Unit 2: Inflation & unemployment
Managerial Economics-II notes · PTU syllabus (BBAGE 201-18)
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Unit summary
Inflation and unemployment are the two great macroeconomic problems. This unit covers the meaning, types, theories, costs and measurement of inflation in India, policies to control it, the types of unemployment, Okun's law, the Phillips curve and stagflation.
After this unit you can
- Explain the types and theories of inflation
- Explain how inflation is measured in India and its costs
- Describe policies to control inflation
- Explain types of unemployment, Okun's law, the Phillips curve and stagflation
PTU syllabus topics
- Meaning
- types and theories of inflation
- cost of inflation and the sacrifice ratio
- measurement of inflation in India
- policies to control inflation
- meaning and types of unemployment
- Okun's Law
- the Phillips Curve
- stagflation
Cause
Too much spending chasing too few goods
Rising costs of inputs
Triggers
Higher income, credit, government spending
Wage hikes, oil prices, supply shocks
Control
Tight monetary and fiscal policy
Supply-side measures, productivity
Topic 1
Meaning and types of inflation
Inflation is a sustained rise in the general price level, reducing the purchasing power of money.
| Type | Meaning |
|---|---|
| Creeping | Mild, about 2–3% a year |
| Walking / trotting | Moderate, single digits |
| Galloping | Rapid, double digits |
| Hyperinflation | Extremely rapid, prices out of control |
| Demand-pull | Too much demand chasing too few goods |
| Cost-push | Rising costs of wages, raw materials, fuel |
Topic 2
Theories, costs and measurement
- Demand-pull theory: excess aggregate demand (from higher income, credit or government spending) pulls prices up.
- Cost-push theory: higher wages, oil prices or supply shocks push costs and prices up.
- Costs of inflation: falling real incomes, harm to savers and fixed-income groups, uncertainty, and an unfavourable balance of trade. The sacrifice ratio is the percentage of output lost for each 1% reduction in inflation.
- Measurement in India: the Consumer Price Index (CPI) — used by the RBI for its inflation target of 4% (±2%) — and the Wholesale Price Index (WPI).
Topic 3
Controlling inflation
Monetary measures
Raise repo rate, CRR, SLR; sell government securities
Fiscal measures
Cut government spending, raise taxes, reduce deficit
Supply measures
Raise production, imports, better distribution
Direct controls
Price controls, rationing
Topic 4
Unemployment
Unemployment exists when people willing and able to work at the current wage cannot find jobs.
| Type | Meaning |
|---|---|
| Frictional | Temporary, while changing jobs |
| Structural | Mismatch of skills or location with available jobs |
| Cyclical | Due to recessions |
| Seasonal | In off-seasons (agriculture, tourism) |
| Disguised | More people working than needed (common in Indian agriculture) |
Topic 5
Okun's law, the Phillips curve and stagflation
- Okun's law: for every 1% that unemployment rises above its natural rate, real GDP falls about 2% below its potential.
- Phillips curve: an inverse relationship between inflation and unemployment in the short run — lower unemployment comes with higher inflation. In the long run (Friedman–Phelps), the curve is vertical at the natural rate.
- Stagflation: high inflation together with high unemployment and stagnant output, as in the 1970s oil shocks — which the simple Phillips curve could not explain.
Key terms
- Inflation
- A sustained rise in the general price level
- Cost-push inflation
- Inflation caused by rising production costs
- CPI
- Consumer Price Index used to measure retail inflation
- Disguised unemployment
- More workers than needed, zero marginal productivity
- Stagflation
- High inflation with high unemployment
Quick revision
- Demand-pull vs cost-push.
- RBI targets CPI inflation of 4% ± 2%.
- Control: monetary, fiscal, supply-side, direct controls.
- Okun: 1% extra unemployment ≈ 2% output loss.
- Phillips curve: short-run trade-off; stagflation breaks it.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.Define inflation and give two causes.
- Q2.Differentiate between CPI and WPI.
- Q3.What is the sacrifice ratio?
- Q4.What is disguised unemployment?
- Q5.State Okun's law.
- Q6.What is stagflation?
Long-answer questions
- Q1.Explain the types and theories of inflation.
- Q2.Discuss the measures to control inflation in India.
- Q3.Explain the types of unemployment.
- Q4.Explain the Phillips curve and stagflation.
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