Question

Unemployment and Inflation

Two of the biggest issues in macroeconomics are inflation and unemployment. Policymakers would like to keep both of these measures low. Often, however, there is a tradeoff between the two. A strong economy that lowers unemployment can put upward pressure on prices. A weak economy that lowers inflation can increase unemployment.

We currently have the benefit of both very low unemployment and inflation. But things could change and it’s good to have policy plans in place before either of these problems gets too bad.

Imagine that you are in charge of macroeconomic policy. Answer these questions, being sure to explain your answers.

• What are some of the problems, difficulties, or hardships caused by unemployment?
• What are some of the problems, difficulties, or hardships caused by inflation?
• If you had to make a choice today between a policy that would head off increases in inflation or increases in unemployment, which one would you choose?

Answer 1

Answer:

A. Problems caused by unemployment:

• Increase in poverty due to loss of job
• Loss of income generation
• Govt borrowing would get increased as tax collection gets reduced due to unemployment
• Increase in govt expenditure to compensate unemployed
• Lower employment will cause reduction in GDP of nation
• Social problems like crimes and vandalism might get increased
• Reduction in average wages/ salary as there is excess supply of labour in market
• Reduced wages may create industrial dispute
• Reduced wages may lead to reduced purchasing power & reduction in standard of living
• Unable to meet financial obligation due to reduced wages & job loss which may create problems in mortgage industry
• Under utilization of human capital
• Reduced saving & investment

B. Problems caused by Inflation:

• Reduced purchasing power due to increase in price
• Increases cost of borrowing
• Reduced real rate of return
• Weakened currency makes import costlier
• Reduced aggregate demand
• Increase in menu cost and shoe leather costs
• Continuous increase in inflation increase unemployment as firms will face cost of production
• Increased business uncertainty and reduced competitiveness
• Increased taxes
• Too high inflation might cause hyper inflation
• Inefficient reallocation of resources
• Uncertainty of saving and investment

C. Inflation Vs Unemployment policy

First of all, inflation and unemployment are not related in log run, but in short run reduced unemployment will increase inflation, vice versa.

Though, I would better choose better unemployment over inflation, because if there is no inflation in economy, it will not give any benefit to society. But if there is no unemployment in economy it will give maximum benefits to all.

Controlling inflation also contracts the economy’s output and all other economic measures.

Every time inflation is not bad but it also good for economy, acceptable level of inflation will boost economy, but any type of unemployment is bad for economy.

Regards,

Lalit G Vaghela