Unemployment and Inflation

Question 1

What is structural unemployment?

Answer 1

Unemployment as a result of a mismatch between firms needs and what workers offer, even when job are availible

Question 2

What is cyclical unemployment?

Answer 2

A decrease in economy-wide demand for goods and services can generate cyclical unemployment - it is where the unemployment rate is about the structural/equilibrium unemployment rate

Question 3

Define zero inflation?

Answer 3

The price level is constant over time (some prices may be falling but others are rising to offset)

Question 4

Define inflation?

Answer 4

Price level is growing over time

Question 5

Define deflation?

Answer 5

Price level is falling over time

Question 6

Define rising inflation?

Answer 6

The rate of inflation is itself growing over time

Question 7

Define disinflation?

Answer 7

The rate of inflation is falling over time

Question 8

Why is inflation bad?

Answer 8

1. Borrowers with nominal debts benefit from unexpected inflation
2. Lenders with nominal assets will lose out from unexpected inflation
3. If inflation is unpredictable then lending may not occur due to uncertainty
4. Misallocation of resources in short run
5. Menus costs

Question 9

What is the fisher equation?

Answer 9

Real interest rate = nominal interest rate - inflation rate

Question 10

Why is deflation bad?

Answer 10

1. Unexpected deflation benefits lenders at the expense of borrowers
2. Nominal wages are sticky downwards, so falling prices of goods and services can increase real marginal cost of production and generate unemployment

Question 11

Why is a low but positive inflation ideal?

Answer 11

Increases the range of real interest rates that can be implemented by the central bank
Helps relative price and wage adjustments when wages are sticky downwards in nominal terms

Question 12

What are 3 causes of inflation?

Answer 12

1. Increase in market power of firms (lower competition
2. Employees’ bargaining power increases (stronger unions)
3. Increase in aggregate demand

Question 13

How does an increase in the market power of firms result in inflation?

Answer 13

Firms demand becomes more steep, so marginal cost increases for all levels of marginal cost

Question 14

How does an increase in employees’ bargaining power result in inflation?

Answer 14

Higher wages required for all combos of effort and employment, so wage increase for all levels of employment, so prices must increase

Question 15

How does an increase in aggregate demand result in inflation?

Answer 15

Higher employment as a result of higher AD means higher wages for all levels of effort, so price level increases

Question 16

What is the bargaining gap?

Answer 16

Difference between the actual salary that companies want to pay to attract and retain workers and the real wage that allows the to maximize profits while still being competitive

Question 17

When employment is above equilibrium, what will the bargaining gap and inflation be?

Answer 17

Positive

Question 18

What does the Phillips curve show?

Answer 18

The relationship between inflation and unemployment

Question 19

Why does the Phillips curve shift?

Answer 19

If a new level of inflation become normal or expected the Phillips curve will reset/shift

Question 20

How do inflation expectations cause inflation, explain using the Phillips curve?

Answer 20

Past inflation is used by workers to inform future expectations of inflation. If workers expect that that there will be high inflation in the future then they will raise their wage demands (to maintain standard of living), so the bargaining gap opens up and inflation rises, as it is now expected the Phillips curve shifts up, so that equilibrium unemployment generates higher inflation

Question 21

What does an increase in input prices do to the Phillips curve/inflation?

Answer 21

An increase in input costs increases the optimal prices for each level of wages, causing equilibrium employment to fall, which results in high inflation and low output. If high AD is maintained, then inflation will be high, and inflation expectations will rise, hence shifting the Phillips curve upwards

Question 22

Using the Phillips Curve, if there is decrease in unemployment, what will happen to inflation?

Answer 22

Increase

Question 23

What does the long-run phillips curve look like? (mention axis)

Answer 23

Y = inflation rate
X = unemployment rate
LRPC = vertical line at natural rate of unemployment

Question 24

What does the short-run phillips curve look like? (mention axis)

Answer 24

Y = inflation rate
X = unemployment rate
SRPC = downward sloping L

Question 25

Why does the short run phillips curve not hold in the long run?

Answer 25

Workers and consumers can adapt their expectations about future inflation rates based on current inflation and unemployment rates