Answer to Question #219448 in Microeconomics for enny

Question

Give five explanations for the trade-off between unemployment and inflation in the short and long run.

Answer 1

1. Relationship between inflation rates and unemployment is inverse. Graphically in the short run the Philip curve is L-shaped . As levels of unemployment decrease, inflation increases.

The Philip curve shows the inverse trade-off between rates of inflation and rates of unemployment. If unemployment is low, inflation will be low and if unemployment is low, inflation will be high.

2. As more workers are hired, unemployment decreases. The price level increases leading to increase in inflation.

In long run Philips curve is a vertical line at the natural rate of unemployment. Therefore inflation and unemployment are unrelated in the long run.

3. According to economists there can be no trade-off between inflation and unemployment in the long- run. Decrease in unemployment can lead to increase in inflation only in the short run. In the long run inflation and employment are unrelated.

4.Natural rate hypothesis or non accelerating inflation rate of unemployment theory predicts that inflation is stable only when unemployment is equal to the natural rate of unemployment.

5.Efforts to decrease unemployment below natural rates of unemployment will lead to inflation. This will change expectations of workers who will adjust their nominal wages to meet these expectations in the future. This leads to shifts in the shirt run Philips curve.