NAME: MURIGI KAMAU

REG NO: K24/5216/2024

KENYATTA UNIVERSITY

UNIT: EET 101

UNIT TITLE: MACROECONOMICS THEORY 1

INSTRUCTOR: DR SAM MBURU

DEPARTMENT: MACROECONOMICS THEORY

 TOPIC: TYPES, CAUSES, EFFECTS TO THE ECONOMY AND SOLUTIONS TO INFLATION AND
UNEMPLOYMENT.

INTRODUCTION

Inflation and unemployment are two critical macroeconomic issues that significantly affect stability
and growth. While inflation refers to the general increase in prices over time, unemployment
represents the portion of the labour force that is without work but actively seeking employment.
Understanding their types, causes, effects, and possible solutions is essential for developing effective
economic policies.

INFLATION.

TYPES OF INFLATION.

➢ Demand-Pull Inflation- Occurs when demand for goods and services exceeds supply, causing
prices to rise.

➢ Cost-Push Inflation- Results from increased production costs, such as higher wages and raw
material costs, leading to price hikes.

➢ Hyperinflation- Extreme inflation where price rise uncontrollably in a short period ,often due
to excessive money printing.

➢ Stagflation- A combination of high inflation and stagnant economic growth, which is

challenging to address.

➢ Built-In Inflation- When businesses and workers anticipate future inflation, leading to a cycle
of rising wages and prices.

CAUSES OF INFLATION

✓ Excessive Demand- When consumers, businesses, and the government increase their
spending, demand outstrips supply, leading to higher prices.

✓ Rising Production Costs- Higher costs of wages, raw materials and energy push prices up and
businesses pass these costs to consumers.

✓ Excessive Money Supply- When central banks print too much money or lower interest rates
excessively, more money chases the same amount of goods, leading to inflation.

✓ Supply Chain Disruptions- Natural disasters, wars or logistical failures can reduce the
availability of goods, increasing their prices.

✓ Government Policies- Large government deficits excessive public spending and tax cuts can
inject too much money into the economy, fueling inflation.

✓ Weak Exchange Rate- A depreciating currency makes imported goods more expensive,
leading to imported inflation.

✓ Inflation Expectations- When people expect future inflation, they demand higher wages, and
businesses preemptively raise prices, creating a self-fulfilling cycle.
 EFFECTS OF INFLATION ON THE ECONOMY

• Reduced Purchasing Power- As prices rise, consumers can afford fewer goods and services
with the same amount of money, leading to lower living standards.

• Uncertainty in Business Planning- High inflation makes it difficult for businesses to plan
long-term investments and expansion due to unpredictable costs.

• Increased Interest Rates- Central banks often raise interest rates to curb inflation, making
borrowing more expensive and reducing economic growth.

• Erosion of Savings- Inflation reduces the real value of money saved in banks, discouraging
savings and investments.

• Income Redistribution- Fixed income earners suffer as their purchasing power declines,
while debtors benefit since they repay loans with devalued money.

• Weaker Currency and Reduced Competitiveness- Persistent inflation can weaken a country’s
currency in international markets, making exports more expensive and reducing global
competitiveness.

• Social and Political Instability-Rising inflation can lead to protests, labour strikes and
dissatisfaction with government policies.

SOLUTIONS TO INFLATION

o Monetary Policy Adjustments- Central banks can increase interest rates to reduce borrowing
and control money supply. This discourages excessive spending and slows down inflation.

o Fiscal Policy Measures- Governments can reduce excessive public spending and increase
taxes to reduce disposable income and curb demand-driven inflation.

o Supply-Side Policies- Encouraging production efficiency through investment in

infrastructure, reducing production costs, and promoting competition to stabilize prices.

o Exchange Rate Policies-Strengthening the local currency through controlled foreign exchange
interventions to stabilize imported inflation.

o Investment in Technology and Innovation- Encouraging technological advancements to

increase production efficiency and lower costs.

UNEMPLOYMENT

TYPES OF UNEMPLOYMENT

▪ Frictional Unemployment- Short-term unemployment due to job transitions.

▪ Structural Unemployment- Arises when workers’ skills do not match available jobs.

▪ Cyclical Unemployment- Occurs during economic downturns when demand for goods and
services decreases.

▪ Seasonal Unemployment- Jobs affected by seasonal demand, such as tourism and

agriculture.
 ▪ Technological Unemployment- When automation and technology replace human labour.

CAUSES OF UNEMPLOYMENT

❖ Economic Recessions and Downturns- When businesses experience reduced demand during
contractions, they lay off workers, increasing unemployment.

❖ Structural Changes in the Economy- Changes in industries, such as the decline of

manufacturing or the rise of digital services, can leave workers without relevant skills.

❖ Technological Advancements-Automation and artificial intelligence replace human labour in

industries like manufacturing, banking and retail.

❖ Outsourcing and Offshoring- Companies move jobs to countries with lower labour costs,
leading to domestic job losses.

❖ Lack of Education and Skills- A mismatch between the skills workers have and the skills
required in the job market results in structural unemployment.

❖ Rapid Population Growth- More people enter the workforce than there are available jobs,
leading to a higher unemployment rate.

❖ Higher labour costs and strict Labour Laws-Employers may be reluctant to hire if wages,
taxes or employment regulations make it costly to maintain a workforce.

EFFECTS OF UNEMPLOYMENT

I. Lower Income and Living Standards- Higher unemployment reduces household incomes,
limiting access to necessities such as foods, healthcare, and education.

II. Reduced Consumer Spending- Unemployed individuals have less money to spend, leading to
decreased demand for goods and services, which slows economic growth.

III. Loss of Government Revenue- Fewer employed individuals mean lower tax collections,
reducing the government’s ability to fund public services.

IV. Increased Government Expenditure on Welfare- High unemployment forces government to

spend more on unemployment benefits and social support programs, straining public
finances.

V. Brain Drain and Talent Loss- Skilled workers may migrate to countries with better job
opportunities, leading to a loss of talent and reduced innovation in the economy.

VI. Higher Crime Rates and Social Unrest- Long term unemployment can lead to increased
crime, social instability and a rise in mental health issues among affected individuals.

VII. Decreased Productivity and Economic Growth- When a large portion of the labour force is
unemployed, the country operates below its economic potential, reducing overall output and
growth.

SOLUTIONS TO UNEMPLOYMENT

✓ Government Job Creation Programs- Public infrastructure projects, investments in green

energy and other government-driven initiatives can create employment opportunities.

✓ Education and Skills Development- Investment in vocational training and educational reform
to align skills with labour market needs, reducing structural unemployment.
 ✓ Encouraging Entrepreneurship- Providing financial incentives, startup capital, and training
for individuals to start their own businesses and become self-employed.

✓ Lowering Interest Rates- Central banks reduce interest rates to encourage businesses to
borrow and expand, leading to job creation.

✓ Tax incentives for Employers- Offering tax breaks to businesses that hire more workers or
invest in workforce training programs.

✓ Encouraging Foreign Direct Investment- Attracting multinational companies to invest in local

industries and create more jobs.

CONCLUSION.

Inflation and unemployment are interrelated macroeconomic challenges that require careful policy
interventions. While inflation can erode purchasing power and cause economic instability,
unemployment reduces income and productivity. A balanced approach involving monetary, fiscal,
and structural policies can help maintain economic stability and growth.