Micro Economics – Eco 101C - #3

Instructor: Hira Mujahid

Project # 1
Group Leader: Haider Abbas – 23905
Group Members:
Mustafa Ahmed Munir – 24699
Unzila Sabir – 24634
Alveena Javed - 24855

Project Topic:
Society faces a short run tradeoff between
inflation and unemployment

Unemployment:
Unemployment is characterized as a circumstance where somebody of working age can't land a
position however might want to be in all day business. The normal rate of unemployment relies
upon different highlights of work advertise. Model incorporate, least wages laws, the market
intensity of association, the job of productivity compensation, and the viability of quest for new
employment.
While the meaning of unemployment is clear, financial specialists separate unemployment into
various classes. The two broadest classifications of unemployment are willful and automatic
unemployment. At the point when unemployment is intentional, it implies that a man has left his
activity enthusiastically looking for other business. When it is automatic, it implies that a man
has been let go or laid off and should now search for another activity. Burrowing further,
unemployment — both intentional and unintentional — is separated into three kinds.
Inflation:
Inflation is a quantitative measure of the rate at which the average price level of an economy of
selected goods and services increases over a period of time. Often expressed as a percentage,
inflation is regarded as a downfall in the general purchasing power of a nation's currency. As
prices rise, they start to affect the general living cost for the general public, and the appropriate
monetary authority of the country, like the state bank, then takes the necessary measures to keep
inflation within plausible limits and keep the country on track by initiating to run it smoothly.
Inflation is calculated in plenty of ways depending upon the types of goods and services
considered, and are the opposite of deflation which indicates a general decline occurring in
prices for goods and services when the inflation rate falls below 0 percent.
Relationship between inflation and unemployment:
The relationship between inflation rates and unemployment rates is inversely related.
Graphically, this indicates that the short-run Phillips curve is L-shaped.
A.W. Phillips published his observations about the inverse correlation between wage changes
and unemployment in Great Britain in 1958. This relationship proved to work for plenty of other
industrial countries as well.
From 1861 until the late 1960’s, the Phillips curve predicted rates of inflation and rates of
unemployment. However, from the 1970’s and 1980’s onward, rates of inflation and
unemployment differed from the Phillips curve’s prediction. The relationship between the two
variables became imbalanced over the passage of time.
Supply and Demand for Labor Correlating Unemployment
If we use wage inflation, or the rate of change in wages, as a proxy for inflation in
the economy, when unemployment is high, the number of people looking for work significantly
exceeds the number of jobs available. In other words, the supply of labor is greater than the
demand for it.
With so many workers available, there's little need for employers to "bid" for the services of
employees by paying them higher wages. In times of high unemployment, wages
typically remain stagnant, and wage inflation (or rising wages) is non-existent. In times of
low unemployment, the demand for labor (by employers) exceeds the supply. In such a tight
labor market, employers typically need to pay higher wages to attract employees, ultimately
leading to rising wage inflation.
Philips curve:
The Phillips curve relates the rate of inflation with the rate of unemployment. The Phillips curve
argues that unemployment and inflation are inversely related: as levels of unemployment
decrease, inflation increases. 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

This Philips curve shows that when 2% rate of unemployment decreases the 4% rate of inflation
increase. This shows the inverse relationship between inflation and unemployment.
UK Evidence – Unemployment versus Inflation

In UK, Inflation fell incredibly due to depression in early 2008. This resulted in a rise in
unemployment. Due to cost-push factors, Inflation increased in 2008-2012.

US Evidence – Inflation v Unemployment

In 1980s, US also experienced inflation and all the prices in the economy rose. However, there
was a depression later that resulted in falling output. The inflation fall from 14% to 4%, on the
other hand, unemployment rose from 6% to 11%. This is a brilliant example of trade off and
Philips curve evidence.
The Great Crash of 2008:
The financial crisis of 2008 is an example of this scenario. The US recession was considered the
worst after the Great Recession of 1930s.Although many actions were taken to face it. But one of
the short term actions was that the supply of money in the country was inflated, in order to
counter it, the prices of gasoline and fuel prices went high. The result of which was that the level
of unemployment came down and many jobs which were not there before were now created as
the inflation gave them high return on their services due to which they were able to get more
people to work.

Contradicting Views:
As to every theory there is contradiction. Same is the case with this one as in the 1970s the
inflation and unemployment both went high. As in 1973, the oil prices went high because of
trade sanctions by Middle East countries which produce oil. And after that inflation and
unemployment both went high.
The economists’ argue due to such evidences that there has to be another way to tackle
unemployment and it is not always the case that if inflation goes up unemployment comes down.

Relevance:
This theory has great significance with respect to modern world. Most of the time, the economic
policies are made on the basis of short run tradeoff between inflation and unemployment. In most
cases, in order to tackle the issue of increasing unemployment countries considers it best to
increase inflation in the economy.

Conclusion:
By analyzing the following evidences and examples, we hereby conclude that the tradeoff
between inflation and unemployment is inversely related. It is convenient for making economic
policies when the society faces such awful situations and it becomes inevitable. The Philips’
curve has been proved quite beneficial in handling the economic condition of the country. In few
cases, it is not only applicable in the short run but in the long run as well.