Inflation
Inflation is the rate at which the
general level of prices for goods and services is rising and, consequently,
the purchasing power of
currency is falling. Central banks attempt to limit inflation, and
avoid deflation, in
order to keep the economy running
smoothly.
Types of inflation
Demand pull inflation
This occurs when AD increases at a faster rate than AS.
Demand pull inflation will typically occur when the economy is growing faster
than the long run trend rate of growth. If
demand exceeds supply, firms will respond by pushing up prices. The
UK experienced demand pull inflation during the Lawson boom of the late
1980s. Fueled by rising house prices, high consumer confidence and tax cuts,
the economy was growing by 5% a year, but this caused supply bottlenecks and
firms responded by increasing prices.
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| This graph shows inflation and economic growth in the UK during the 1980s. High growth in 1987, 1988 of 4-5% caused an increase in the inflation rate. It was only when the economy went into recession in 1990 and 1991, that we saw a fall in the inflation rate |
Cost Push Inflation
This occurs when there is an increase in the cost of
production for firms causing aggregate supply to shift to the left. Cost push
inflation could be caused by rising energy and commodity prices
Example of Cost push inflation in the UK
In early
2008, the UK economy entered a deep recession(GDP fell 6%). However, at the
same time, Uk experienced a rise in inflation. This inflation was definitely
not due to demand side factors; it was due to cost push factors, such as rising
oil prices, rising taxes and rising import prices (as a result of depreciation
in the Pound) By 2013, cost push factors had mostly disappeared and
inflation had fallen back to its target of 2%.
Sometimes
cost push inflation is known as the ‘wrong type of inflation‘
because this inflation is associated with falling living standards. It is hard
for the Central Bank to deal with cost push inflation because they face both
inflation and falling output.
Hyperinflation
Hyperinflation is when
the prices skyrocket more than 50% -- a month. It is fortunately very rare. In
fact, most examples of hyperinflation have occurred when the government printed
money recklessly to pay for war. Examples of hyperinflation include Germany in
the 1920's.
Stagflation
Stagflation is just like its name says: when economic growth is
stagnant, but there still is price inflation. This
seems contradictory, if not impossible. Why would prices go up when there isn't
enough demand to stoke economic growth? It happened in the 1970s when the U.S.
went off the gold standard. Once the dollar's value was no longer tied to gold, the
number of dollars in circulation skyrocketed. This increase in the money supply was one of the causes of inflation. Stagflation
didn't end until then-Federal Reserve Chairman Paul Volcker raised the Feds funds rate to the double-digits and kept it there long
enough to dispel expectations of further inflation.
UNEMPLOYMENT
Unemployment is defined as a
situation where someone of working age is not able to get a job but would like
to be in full time employment..
Here are three primary categories of unemployment that are
typically discussed.
Structural unemployment
Structural Unemployment, one of the three types of
unemployment, is associated with the mismatch of jobs and workers due to the
lack of skills or simply the wrong area desired for work. Structural
unemployment depends on the social needs of the economy and dynamic changes in
the economy.
For instance,advances in technology and changes in market
conditions often turn many skills obsolete; this typically increases the
unemployment rate. For example, laborers who worked on cotton fields found
their jobs obsolete with Eli Whitney's patenting of the cotton gin. Similarly,
with the rise of computers, many jobs in manual book keeping have been replaced
by highly efficient software. Workers who find themselves in this situation
find that they need to acquire new skills in order to obtain a new job.
Frictional Unemployment
Frictional Unemployment is always present in the economy,
resulting from temporary transitions made by workers and employers or from
workers and employers having inconsistent or incomplete information. This type
of unemployment is closely related to structural unemployment due to its
dependence on the dynamics of the economy. It is caused because unemployed
workers may not always take the first job offer they receive because of the
wages and necessary skills. This type of unemployment is also caused by failing
firms, poor job performance, or obsolete skills. This may also be caused
by workers who will quit their jobs in order to move to different parts of the
country.
Frictional unemployment can be seen as a transaction cost of trying to find a
new job; it is the result of imperfect information on available jobs. For
instance, a case of frictional unemployment would be a college student quitting
their fast-food restaurant job to get ready to find a job in their field after
graduation. Unlike structural unemployment this process would not be long due
to skills the college graduate has to offer a potential firm.
Cyclical unemployment
Unemployment that is attributed to economic contraction is
called cyclical unemployment. The economy has the capacity to create jobs which
increases economic growth. Therefore, an expanding economy typically has lower
levels of unemployment. On the other hand, according to cyclical unemployment
an economy that is in a recession faces higher levels of unemployment. When
this happens there are more unemployed workers than job openings due to the
breakdown of the economy. This type of unemployment is heavily concentrated on
the activity in the economy.
Phillips Curve
The Phillips curve relates the rate of inflation with the
rate of unemployment
An economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship.
Short-run Phillips curve
According to the
Phillips curve, the lower an economy's rate of unemployment, the more rapidly
wages paid to labor increase in that economy.The relationship, however, is not linear.
Graphically, the short-run Phillips curve traces an L-shape when the
unemployment rate is on the x-axis and the inflation rate is on the y-axis.The Phillips curve
show the inverse trade-off between inflation and unemployment .As one increases
,the other must decrease .
The long-run Phillips curve is a
vertical line that illustrates that there is no permanent trade-off between inflation
and unemployment in the long run. However, the short-run Phillips curve is
roughly L-shaped to reflect the initial inverse relationship between the
two variables. As unemployment rates
increase, inflation decreases; as unemployment rates decrease, inflation
increases.
Consider the example shown in . When the unemployment rate is 2%, the corresponding inflation rate is 10%. As unemployment decreases to 1%, the inflation rate increases to 15%. On the other hand, when unemployment increases to 6%, the inflation rate drops to 2%.
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| The short-run Phillips curve shows the trade-off between inflation and unemployment. |
Long-run Phillips curve
According to economists, there can be no trade-off
between inflation and unemployment in the long run. Decreases in unemployment
can lead to increases in inflation, but only in the short run. In the long run,
inflation and unemployment are unrelated. Graphically, this means the Phillips
curve is vertical at the natural rate of unemployment, or the hypothetical
unemployment rate if aggregate production is in the long-run level. Attempts to
change unemployment rates only serve to move the economy up and down this
vertical line.here
Although the economy starts with an initially
low level of inflation at point A, attempts to decrease the unemployment rate
are futile and only increase inflation to point C. The unemployment rate cannot
fall below the natural rate of unemployment, or NAIRU, without increasing
inflation in the long run.
Natural Rate Hypothesis
The natural rate of unemployment theory, also known as the
non-accelerating inflation rate of unemployment (NAIRU) theory, was developed
by economists Milton Friedman and Edmund Phelps. According to NAIRU theory,
expansionary economic policies will create only temporary decreases in
unemployment as the economy will adjust to the natural rate. Moreover, when
unemployment is below the natural rate, inflation will accelerate. When
unemployment is above the natural rate, inflation will decelerate. When the
unemployment rate is equal to the natural rate, inflation is stable, or
non-accelerating.
