Lecture 2

Labor Market
Prof. Dr. Qais Aslam
UCP, Lahore
 Topics to be covered
• Labor Market & Unemployment:
• Introduction to different Labor Market Indicators
• What are different types of unemployment rates
A Country’s standard of Living Depends on its
ability to Produce more goods and Services
• Difference of living standards around the world are staggering and
• Changes in living standards over time is also large
• This is attributed to Productivity
• Productivity - is the quantity of goods and services (wealth) that can
be produced (output) from each hour of work time with different set
of capital and labor inputs (resources)
• Growth rate of a country’s national productivity determines the
country’s national employment levels (GDP) and the country’s
national income levels (GDP)

3
A Country’s standard of Living Depends on its
ability to Produce more goods and Services
• Difference of living standards around the world are staggering and
• Changes in living standards over time is also large
• This is attributed to Productivity
• Productivity - is the quantity of goods and services (wealth) that can
be produced (output) from each hour of work time with different set
of capital and labor inputs (resources = factors of production)
• Growth rate of a country’s national productivity determines the
country’s national employment levels (GDP) and the country’s
national income levels (GDP)

4
 Labor Market
• Labor market is where labor skills are demanded (derived
Demand) by the firms and labor skills are supplied by the
households for an income
• Labor is the ability of a person to produce for an income
• Therefore labor market determines the Price (wage) of a
certain type of skills of labor through the interaction of
labor supply and labor demand
• Labor is not homogeneous (of the same kind) = there is
highly skilled, skilled, semi-skilled and unskilled plus lazy
labor
 Characteristics of Labor (N)
• Labor Is the capacity and capability of a human being to produce for an income
• Work done without an income is not labor
• Labor is attached to a human being and can only be delivered in person, others can do your
work but will deliver their own labor, not your labor
• Labor is perishable, an hour of labor not delivered can not be replaced
• Labor has a human trait has no legal mobility, only physical or economic mobility. Labor can be
hired but not bought, because slavery is banned
• Labor has a backward bending supply curve, at low wage supply of labor increases because
humans need more money for a lifestyle for their families and to sustain life. At very high wage
the supply of labor decreases, because labor becomes lazy and lethargic
• Demand of labor is because of its productivity (MPn). Higher the marginal productivity of labor,
higher the demand for labor, higher the wage. Lower the marginal productivity, lower the
demand of labor, lower the wage
• Labor is not homogeneous (of the same kind). There is highly skilled labor, skilled labor,
unskilled labor and lazy labor. Even in one working day the productivity of one person (Labor) is
different due to different physical, technological and emotional circumstances
Backward bending supply of labor curve
Labor has a backward bending supply curve, at low wage supply of labor increases because humans need more
money for a lifestyle for their families and to sustain life. At very high wage the supply of labor decreases,
because labor becomes lazy and lethargic

w∞

qsN

w1
 How Unemployment is measured
• Labor Bureau of Statistics every month measures unemployment in
a country
• Data on labor market would include: Employed, unemployed and
not in labor force
• Unemployment rates, types of unemployment, length of average
work week, duration of unemployment and the data comes from
general population survey
• Labor force (participation rate) is all the adult, able bodied, willing to
work for an income population in a country
• Unemployment rates are computed from the entire adult population
as well as for specific groups defined as race, gender, age etc.
 Employment & Unemployment
• Participation Rate (labor Force): are all the able bodied, adult population willing to work
for an income. Include employed, unemployed and not in labor force
• Participation Rate = X 100

• Employed: All part of labor force that are engaged in paid employment, work in their own
businesses or worked as unpaid workers in a family businesses.
• Both full time and part time workers are counted that includes those that are absent
because of a vacation, illness or bad weather
• Unemployment: Is the ratio of the number of people unemployed to the total number of
people in the labor force (not from total population) and include, that are not employed,
were available for work, and had tried to find employment during the previous four
weeks or those that are waiting to be recalled to a job from which they had been laid off

• Percentage unemployed = X 100 9

 Does Unemployment rate Measure what we want it to?
• It is easy to distinguish between a person with a full-time job and a person
with no job
• It is not easy to distinguish between a person who is unemployed and a
person who is not in the labor force
• Movements in and out of the labor force are very common
• More than one third of the unemployed are recent entrants in the labor force
and they include young workers looking for a job
• They also include older workers, now who left a job and are now looking for
work.
• Many unemployed (almost half) leave the labor force
• Because people move in and out of labor force, it becomes difficult to
interpret the difference between unemployed and those that left the labor
force (discouraged workers) and have given up looking for a paid job
Population in Pakistan 2017-2018 (Census 2017)
Population of Pakistan in 2020 220.8 Million
Households in Pakistan 32.2 Million
Male Population in Pakistan (51.2%) 106.4 Million
Female Population in Pakistan (48.7%) 101.3 Million
Transgender Population in Pakistan (0.1%) 0.1 Million
Rural Population in Pakistan (63.6%) 132.2 Million
Urban Population in Pakistan (36.4%) 75.8 Million
Population of The Punjab (53.0%) 110.0 Million
Population of Sindh (23.0%) 48.0 Million
Population of The KPK + FATA (17.0%) 35.5 Million
Population of The Baluchistan (6.0%) 12.3 Million
Population of The Islamabad (1.0%) 2.0 Million
Labor Force participation in Pakistan 2017-2018
Total Labor Force Participation Rate in Pakistan 2015 32.3%
Civilian Labor Force in Pakistan (45% of the working age population 61.0 Million
Employed (92.0%) 53.0Million
Unemployed (8.0%) 8.0 Million
Working Age Population (65% of the population) 135.0 Million
Working Age Population – Rural (63.4% of the working age population) 85.6 Million
Working Age Population – Urban (36.6% of the working age population) 49.4 Million
Labor Force – Rural (31% of the working age population & 69% of the 42.0 Million
labor force of Pakistan )
Labor Force – Urban (14% of the working age population & 31% of the 19.0 Million
labor force of Pakistan )
Unemployed - Rural 2.0 Million
Unemployed - Urban 1.5 Million
Different kinds of Unemployment
• Natural Rate of Unemployment = unemployment at
full employment
(a) Frictional Unemployment
(b) Structural unemployment
• Cyclic Unemployment
• Hidden (Disguised) Unemployment
• Depressed Unemployed (out of labor force)
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 Natural Rate of Unemployment
• Natural Rate of Unemployment exists at full employment and includes: (total
of 6% permissible)
(a) Frictional Unemployment – the portion of unemployed who leave one job
to look for another both horizontally ( leaving job because of job
environment or migration purposes and looking for same paid job
elsewhere) and vertically ( leaving one job for a better pay or grade job
elsewhere – this increases GDP levels) (3%)
(b) Structural Unemployment – are unemployed due to changes in the
structure and technological changes of the economy and introduction of
new technologies (3%)
• Okun’s Law: 1% increase in unemployment over Natural Rate causes GDP
to fall by 2%
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 Other forms of Unemployment
• Cyclic Unemployment – due to the recession and depression in the
economy (down sizing of labor force)
• Hidden (Disguised) Unemployment – where the MP (Marginal
Productivity) of labor employed is zero or near zero (lazy labor) = m
Major problem of Pakistan
• Depressed Unemployed – who have stopped looking for work actively
because they think that jobs are only given on “safarish” (nepotism) and
do not consider their own work habits. They are out of the labor force
• Those not in labor force are neither employed nor unemployed and
include full time students, homemakers, children below 18 years,
mentally and physically disabled and retirees
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Unequal Burden of Unemployment is on:
1.Less educated and less skilled and lazy labor are
more unemployed than skilled, educated and hard
working people
2.Younger people who have less mobility than older
people are more unemployed
3.Race and Ethnicity: Migrants are more unemployed
than local people
4.Gender Biases: Women and transgender are more
unemployed than men
 Classical Macroeconomics
Equilibrium Output & Employment
• Classical Revolution
• Classical Macroeconomics emphasized the importance of Real factors in determining wealth of
nation about state control (money has no role except as medium of exchange)
• Government had no role in economic activity
• Stressed the optimizing tendencies of the free market and absence of government intervention
= classical economists distrusted the government and stressed the need of government
regulations (except those necessary to see that the market remains committed for preempted
intervention to have free market of individual and national interest when the market was left
unfettered (to protect both side against fraud)
• Classical analysis was primarily a real analysis
• Money had no role in economic activity except as medium of exchange = the growth of an
economy was the result of increased stock of factors of existing stock) production & advances in
techniques of production (value addition to the existing wealth)
 Employment in Classical Macroeconomics

• The assumption of the Classical economists about its labor analysis is that :
1. Market works well
2. Firms & individual workers optimize
3. They have perfect information
4. There are no barriers to the adjustment of money wages
and
5. The market clears at market price (nothing sells above the
market price and demand)
6. Government has no role except to regulate the market
7. Money has no role except as medium of exchange
 Production function & Marginal Product of labor

• In making hiring decisions, a firm must consider how size of its workforce
affects the amount of output that would be produced
• A firm’s decision to hire any additional unit of labor would be on the Labor’s
Marginal productivity
• Marginal productivity of Labor (MPn) is the increase in the amount of output
produced by an additional unit of labor
• As the number of workers are increased, the marginal productivity of labor
(MPN) declines (Diminishing marginal product)
• Or as the quantity of inputs increase, the production function gets flatter,
reflecting the property of diminishing marginal product
• The Value of Marginal Product of any input (labor) is the marginal product of
that input multiplied by the market price of the output
 The Value of Marginal
The Value of Product of Labor
Marginal
Product of
(MPN): depends upon
Labor (MPN) the number of workers.
The curve slopes
downwards because of
diminishing marginal
product. This is also the
Market
firms labor demand
wage curve because labor is
demanded on its
marginal productivity
The Value of
Marginal
Product of
Labor (MPN) or
Demand Curve
of labor
Profit maximizing quantity of output quantity of
output
Market wage (Real Wage) is determined by the qsN and qdN

w∞

qsN
Real Wage w/p

w1

qdN =
MPn
 What causes labor Demand curve to shift
• Labor Demand curve reflects the value of the marginal product of labor
• The shift of the Labor Demand curve is because of:
1. Output Prices: MPN of X good increases Prices of Firms Output. When the
output prices change, the value of marginal product changes & the labor
demand curve shifts. Increase would shift the curve rightwards, decrease
would shift the curve leftwards
2. Technology Changes: Technology changes reduce labor demand, and increase
labor marginal productivity. Increase would shift the curve rightwards,
decrease would shift the curve leftwards
3. Supply of other factors of production: The quantity of one factor of
production can change the quantity of labor demanded. More capital would
decrease inputs of labor and vice versa. Increase would shift the curve
rightwards, decrease would shift the curve leftwards (capital-labor ratio)
 Production function in the classical
Economics
(Short-run function)
• Inputs: Inputs are resources used in the production of
goods and services = Factors of Production = Land + Labor
+ Capital + Entrepreneur (organization)
• Y=𝑓 (, 𝑁)
• Where K = Capital; N = Labor inputs; Q is quantity of
output and bar over shows that Capital is constant (does
not change) in the short run model
• F is the function of
 Aggregate Labor Demand
• Labor is demanded because it produces goods & services which are demanded
to be consumed through the market = derived demand of labor (& other
factors) by firms that produce commodities
• Under perfect competition firms chose their output levels so as to maximize
their respective profits (MC = MR) when MR = Market Price (P)
• MC = MR ……..(1)
• In the short run output is varied solely by changing labor inputs (MC), therefore
choice of level of output = quantity of labor inputs (are one and same decision),
where costs (wages) are only variable costs and all other factors are fixed costs
• MC = money wage divided by number of units of output produced by additional
units of labor (N) inputs (Marginal inputs = MPNi). MPNi is derived from the
production function of each firm (i), assumed to be identical for each firm
• MCi = ……..(2)
 Fig. 1 Production Function & MPN Diminishing Returns Negative returns
(a) Production Function E F

Output Constant Returns ∆y =5

Y G
D
∆N =1
Y=𝑓 (Ќ, 𝑁)
C ∆y =10

B
∆N =1
A
0
1 2 3 4 5 6 n
B Employment
MPN Diminishing Returns
Constant Returns C

D
Negative returns
E
A F
0
1 2 3 4 5 6 n
(b) Marginal Productivity of Labor Employment MPN
 Explanation to Fig 1. – Production
Function & Marginal Productivity of
Labor (MPN)
• On line A, 0 units of N are hired and total output (Y) is 0
• On Line B, 1 unit of N is hired and total output is 10 units, the change in output (Y) given
by a change in labor (N) is 10. or MPN of 1 worker is 10, since output increased by 10
• On line C, 2 workers (N) are hired and total output (Y) is 20 units, the MPN of 2 workers
is 10 each (or the same as 1 worker) since output increased by 10 when labor increased
by 1 additional unit. This is the area of constant returns to scale.
• On line D, 3 workers are hired and total output (Y) is 28 units, the MPN of 3 workers is
10 workers is 8 units each or less than when 2 workers were hired. Output increases at
a diminishing rate or the area is diminishing returns to scale
• On line E, 4 workers are hired and (Y) is 33 units. MPN is 5.
• In line F, 5 workers are hired and Y is 34; MPN is 1
• On line G, 6 workers are hired and Y is 32; MPN is -2, there is negative returns to scale &
firms will not hire with decreased output (Y).
• Optimum is determined where AP = MP
 MCi = ……. (2)
• Condition for short run profit maximization under pure competitive market (perfect
competition) is:
• P = MCi, ……… (3)
• Where P = Market Price, MC= Marginal costs; i = particular small firm
• Therefore substituting MC with labor inputs wages () we get
• P = …….(4)
• Or = …….(5)
• In order to maximize profits, The firm i would hire labor inputs up to the point where the
additional (marginal) output obtained by hiring one more (marginal) worker (MPN) = to
the real wage () paid to hire that worker
• In other words
• labor is demanded because of its Marginal productivity (MPN) and
the labor demand curve is down ward sloping due to the law of
diminishing returns
• If the MPN is more than the real wage () , the payment to the worker (N) in real
terms is less than the real product produced than profits will increase by hiring
an addition unit of labor.
• If the real wage is more than MPN than the payment to workers will be more
than the real product produced and profits will decrease by hiring an additional
unit of labor, which means that costs increase over the product price (revenue)
the firm will reduce labor in order to increase profits.
• Thus the profit maximization quantity of Labor (N) demanded by a firm at each
level of real wage () is given by the quantity of labor inputs where real wage () =
MPN (Marginal productivity of Labor)
• = …….(5)
• Or = f() (-)…..(6)
• Labor demand ) is an inverse (-)function of real wage ()
Where in the aggregate as with individual firms,
• an increase in the real wage lowers labor demand
 Aggregate Labor Supply ()
• Labor services are supplied by individual workers in the economy (house
holds).
• Classical economists assumed that the individual attempts to maximize utility
(their satisfaction levels or standard of living). And,
• The level of utility depends positively on both real income (), which gives the
individual command over goods & services and leisure (comfort zone).
• There is a trade-off between two goals, because, income is increased by work,
which reduces available leisure time .
• Labor supply curve () is positively sloping curve and gives the labor supplied at
each value of money wage (w), because higher the money wage, higher the
real wage. Equi-proportional increase or decrease in money wage and price
levels will leave the quantity of labor supplied unchanged
• = MPN or w = MPN X P
• P is the inflation rate or the capacity of w to buy goods and services
 Two features of Classical Labor Supply Theory:

1. Wage variable is the real wage ()

• Labor supply (N) is determined by the real wage, not by nominal (money) wage
• Labor (worker) receives utility (satisfaction) from consumption of goods &
services, and in making work-leisure decisions the individual is concerned with
the command over goods & services received from income for a unit of labor
• At point A, incomes are less, therefore utility is less, although leisure is more
• At point c, income is more, utility is more, but leisure is least
• As real wage increases (or decreases), leisure decreases (or increases), and
hours of work increase (or decrease)
• Significance: Since () is measured on the vertical axis on the labor supply curve
(N), if either the money wage, or prices or both change, the number of hours
worked are determined by moving along the labor supply curve
 Real Income for 24 hours work (a). Income-Leisure Trade-off
( =4)=96 Fig. 2 Income-Leisure Trade-off & Labor Supply Curve
C

( =3) = 72 U1
B
( =2)= 48 U2
A 24 Leisure Hours
U3

15 16 18 N
Real Wage
(b). Labor Supply Curve
4
C
B
3
A
2

6 8 9 Hours of work per day

2. Labor Supply Curve (N) is positively sloped, more labor is assumed to be
supplied at higher real wage rates.
• Higher Real wage rates means a higher price for leisure in terms of forgone
income and worker will chose less leisure and vice versa
• This effect is the same as substitution effect in theory of consumer demand
• At higher income workers may be more desirable relative to further increment
in income
• With successive increases in real income, a point may be reached where
workers chose to supply less labor as real wage increases and therefore
consume more leisure
• At this point of very high real wage income effect outweighs the substitution
effect
• Labor supply curve at very high wage rate assumes a negative slope and bend
backward towards the vertical axis (backward bending supply curve)
• In normal wage rates, the aggregate supply curve of labor does have a positive
 What causes Labor supply Curve to shift
• Labor supply curve shifts whenever people change the amount they want to
work at a given wage
• Labor Supply curve shifts to the right when supply increases and shifts to the left
when supply decreases, because of:
1. Changes in Tastes & attitudes towards work-leisure trade off: Change in tastes
or attitude towards work, today with small family size more mothers choose to
work
2. Changes in Alternate Opportunities: Supply of labor in any labor market
depends upon the opportunities available in other labor markets. If wage in
one market rises, labor would shift from low wage market to higher wage
market and vice versa
3. Immigration & Migration: Movement of workers from region to region or
country to country is another important source of shift in labor supply.
Immigration increases skilled workers in a country while migration is brain
drain and shifts labor supply to another country
 Equilibrium Output & Employment
• Aggregate Production function
• Y = f(, N)
• Labor Demand Schedule
• = f()
• Labor Supply Schedule
• = f()
• Equilibrium condition for the labor market is when:
• =
• Which determines output, employment and the real wage () in the
classical system as endogenous variables, or determined within the
model
 Fig. 3. Classical output & Employment Theory
(a) Labor Market Equilibrium
𝑠
Real Wage () 𝑁 𝑠
𝑁

𝑾
( ) A
𝑷 𝟎

MPN =

𝑵𝟎
A (b) Output Determination
𝒀𝟎
Y = f(, N)

Output

𝑵𝟎
 Explanation of Fig. 3
Classical output & Employment Theory

• Part (a) depicts Labor Market Equilibrium at real wage at

equilibrium point A.
• In the Aggregate Labor supply = Labor demand at point A. Or
• = and equilibrium employment is .
• Part (b) depicts Aggregate Output Determination
• Substitution for equilibrium employment into production function
in part (b) determines aggregate output at point A
 Factors determining output &
Employment in the Classical Model
• All factors determining output in the classical model are variables affecting
the supply side of the market for output or the amount firms chose to
produce. In other words,
• In the classical model, the level of output and employment are determined
solely by supply factors
Factors that Do Not Affect Output in the classical Model:
• Price do not affect any of the variables (real wage, employment levels or
real output in the system
Factors that Affect Output in the classical Model:
• If new technology is introduced, MPN will increase, demand of labor will
increase, and would shift to the right, equilibrium employment changes,
output will increase. Aggregate supply curve shifts to the right and real
output will increase from y1 to y2
 Conclusion
• Classical Model is a supply-determined output and employment
model
• Classical Aggregate Supply curve is vertical because of the
assumptions of the labor market
Explicit Assumptions:
• Labor and product market can be characterized by the auction
market
• Labor & output are assumed to be traded in markets that are
continuously in equilibrium and in which participants make
decisions on announced real wage rates and product prices
 Business cycles,
Unemployment & Inflation
Lecture 19 & 20
Dr. Qais Aslam
Schools of Economics
1. 1776 – Adam Smith (Classical School of Economics)
= Micro Economics
2. 1950 – Karl Marx (Marxist School of Economics)
3. 1936 – J. M. Keynes (Keynesian School of
Economics) = (Macro Economics)
4. Modern Schools of Economics
• Neo-Classical School
• Monetarists (Milton Friedman)
• Neo-Keynesians
• Neo Marxists
• Neo-Islamists School
Business Cycles
• In 1929-1930 the Microeconomic Indicators of the
economies of the leading Industrial nations at that
time (8) was working perfectly fine
• But there was a general collapse of these economies.
Widespread unemployment, low production and
bankruptcies of businesses
• In 1936 Keynes published his book in order to explain
the causes of the Great Depression of 1929-1930
• “Capitalism is an excellent engine of economic
growth, but it is not self-regulatory” Keynes.
• There are inbuilt crisis in capitalism
 MC

P AC2 normal profit AC =MR) AR = MR

AC3 super normal

Profit (AC < MR)

Q
 According to Keynes
• the firms in the classical model produce at normal
profits where AC=MC (Least Costs)at point E where
MC = MR
• But firms do not exist only to make normal profits, but
to make super normal profits.
• For this they have to be efficient and to have least
costs below point E.
• This is not possible because (a) 3 factors of production
are constant in the short run and (b) because classical
school assumes full employment levels (Static State)
 Static State
• In static state when all the factors of production are fully
employed, people have incomes, they can save, but can not
invest because there are no new resources left to invest.
• At full employment levels S > I and therefore economy will
decline
• Also in order to become efficient, the firms will down size or
reduce labor costs. “They kill the Goose that lays the golden
egg”. Keynes
• With less labor input at aggregate levels, the aggregate
income and employment, expenditure and demand would fall
while the aggregate production would increase, therefore real
Output (aggregate supply) would be greater than real
Aggregate demand on national level
• There would be a downward trend of the economy and the
business Cycles
Employment & Unemployment

• Participation Rate (labor Force): are all the able bodied, adult
population willing to work for an income
• Employed: All part of labor force that are engaged in paid
employment
• Unemployment: Is the ratio of the number of people
unemployed to the total number of people in the labor force
• percentage unemployed = X 100

45
Natural Unemployment
• Natural Unemployment exists at full employment and includes: (total of 6%
permissible)
(a) Frictional Unemployment – the portion of unemployed who leave one job to
look for another both horizontally ( leaving job because of job environment or
migration purposes and looking for same paid job elsewhere) and vertically
( leaving one job for a better pay or grade job elsewhere – this increases GDP
levels) (3%)
(b) Structural Unemployment – are unemployed due to changes in the structure
and technological of the economy and introduction of new technologies (3%)
• Okun’s Law: 1% increase in unemployment over Natural Rate causes GDP to
fall by 2%

46
Different kinds of Unemployment
• Natural Unemployment
(a) Frictional Unemployment
(b) structural
• Cyclic Unemployment
• Hidden (Disguised) Unemployment
• Depressed Unemployed

47
Other forms of Unemployment
• Cyclic Unemployment – due to the recession and
depression in the economy (down sizing of labor force)
• Hidden (Disguised) Unemployment – where the MP
(Marginal Productivity) of labor employed is zero or near
zero (lazy labor)
• Depressed Unemployed – who have stopped looking for
work actively because they think that jobs are only given
on “safarish” (nepotism) and do not consider their own
work habits. They are out of the labor force

48
 Unequal Burden of
Unemployment is on:

1. Less educated and less skilled and lazy labor are more unemployed
2. Younger people who have less mobility than older people are more
unemployed
3. Race and Ethnicity: Migrants are more unemployed than local people
4. Gender Biases: Women and transgender are more unemployed than
men
Inflation (General Price Rise)
• Inflation is too much money chasing too few goods
in the economy or Demand pull Inflation or when
supply of goods and services is less than Demand
Or
• The percentage change in Price levels is Inflation
rate
• Inflation is bad for the demand side and good in
short run for the supply side
Philips Curve is A graph that shows the negative
relationship between inflation rate and
unemployment rate 50
Types of Inflation
• Demand Pull inflation – that is instigated by an increase in aggregate
demand
• Cost-push Inflation (supply side inflation) – which is caused by an
increase in costs of production
• Stagflation – Occurs when output is falling increasing unemployment, and
at the same time overall price levels are rising
• Sustained Inflation – occurs when the overall price levels continue to rise
over some fairly long period of time
• Core Inflation = when there is rise in cost of energy and food
• Hyperinflation – a 100% or more increase in prices a year (very very bad)
51
Measurement of Inflation
• CPI (Consumer Price Index) = 100 X

• GDP Deflator = = 100 X

 Causes of Inflation
Increase in Input Prices of land (Rent), labor (Wages),
capital and energy (Interest), Organizations
(Profits)cause cost push Inflation
Printing of notes increases money supply more than
money demand and therefore raise over all prices of
goods and services and resources in the
economy ,which is Demand Pull Inflation
Inflation reduces consumer surplus (Demand)
Inflation increase costs of production therefore
reduces producers surplus (Supply)
Therefore inflation decreases growth and society’s
welfare
53
 Taxes
Taxes increases prices and brings down the
aggregate demand curve thus reducing the
employment, income and growth (GDP) levels,
Therefore taxes should be reduced and tax net
widened for more revenue to the Government

54
 Bank borrowing
• Bank borrowing by the Government
increases the cost of loans (interest rates)
for businessmen in the money market and
decreases the money supply in the
economy, thus reducing the much needed
by private sector finances for investment as
well as making them more expensive

55
Cconsumer Price Index (CPI)
• CPI – is a price index computed each
month using a bundle that is meant to
represent the ‘market basket’ purchases
monthly by the typical urban consumer
• The quantities of each good in the bundle
that are used for the weightages are based
upon extensive surveys of consumers

56
GDP Deflator
• GDP deflator is a price measure, measuring how overall
price level changes along with changes in real output
(GDP)
• Firstly, fixed wastage procedure and 1 year as base year is
used to calculate the changes in prices in subsequent
years
• Secondly, the deflator uses 1 and 2 as the base year
when computing the percentage change between year 2
and 3 and so on
• The series of changes computed in this way is taken to be
the series of percentage changes in the GDP deflator:
inflation rate of the overall price levels
57
Difference between GDP deflator and CPI

• CPI covers only consumer goods and services

• GDP deflator covers all goods and services produced
in the economy

58