The Relation between Inflation and Unemployment in the Gambia: Analysis of the Philips Curve
A Phillips curve shows the tradeoff between unemployment and inflation in an In other words, there may be a tradeoff between inflation and unemployment when . Since lens is made up of two spherical mirrors, both of its sides are positive. "object image height and distance relationship", where the image was larger. The relationship between inflation rates and unemployment rates is inverse. .. image. Aggregate Supply Shock: In this example of a negative supply shock. The negative association between unemployment and inflation is known as the existed an equilibrium relationship between unemployment rate and inflation.
The competitiveness of a country may be seriously affected. Factors affecting the inflation 1. Increase in Money Supply: Inflation is caused by an increase in the supply of money which leads to increase in aggregate demand.
The higher the growth rate of the nominal money supply, the higher is the rate of inflation. Increase in Disposable Income: When the disposable income of the people increases, it raises their demand for goods and services.
Disposable income may increase with the rise in national income or reduction in taxes or reduction in the saving of the people. Increase in Public Expenditure: Government activities have been expanding much with the result that government expenditure has also been increasing at a phenomenal rate, thereby raising aggregate demand for goods and services 4.
Increase in Consumer Spending: The demand for goods and services increases when consumer expenditure increases.
Consumers may spend more due to conspicuous consumption or demonstration effect. Cheap monetary policy or the policy of credit expansion also leads to increase in the money supply which raises the demand for goods and services in the economy 6. In order to meet its mounting expenses, the government resorts to deficit financing by borrowing from the public and even by printing more notes. Repayment of Public Debt: Whenever the government repays its past internal debt to the public, it leads to increase in the money supply with the public.
The existence of black money in all countries due to corruption, tax evasion etc. Shortage of Factors of Production: One of the important causes affecting the supplies of goods is the shortage of such factors as labour, raw materials, power supply, capital, etc.
When the country produces more goods for export than for domestic consumption, this creates shortages of goods in the domestic market. This leads to inflation in the economy. Unemployment is a situation in which a person or an individual wants to work at existing or prevailing wage rate but he did not get it. India is a developing economy mainly based on agriculture but the percentage share of agriculture is declining after independence.
Now the dependency is also increasing on others sectors also like service sector and industrial sector. The main causes of unemployment in India are the poor economic condition, corruption and population. Economists general classify unemployment into three types according to the causal factors, namely, frictional unemployment, cyclical unemployment results from business recessions and depressions and structural unemployment mismatch between requirements of the employers and the type of unemployed.
Seasonal and disguised unemployment Disguised unemployment refers to zero or very low productivity level and is most prevalent in Indian agriculture sector are prevalent in India. Unemployment has both economic and social implications for a country like India. Occurrence of unemployment results in the loss of output, loss in revenue of the government and in consequence disastrous effect on developmental works.
Inflation and Unemployment (With Diagram)
Unemployment is negatively related to the growth rate of the economy. It states that there is trade off between real GNP and Unemployment. Unemployment also means loss of self-respect, poverty and frustration. It can even lead to social unrest in the country.
The manufacturing sector in India, which provides the bulk of employment to the skilled and semi-skilled labour force, is growing at abysmally low rates of between 2 and 5 per cent.
Graphically, this means the short- run Phillips curve is L-shaped This is because: This is because if they ask for higher wages, employers can turn round and say there are 3 million unemployed people willing to work at lower wages.
Therefore, wage inflation is likely to be muted during the period of rising unemployment. This will reduce cost push inflation and demand pull inflation.
Therefore, firms are seeing an increase in spare capacity and increase in volume goods not sold. In a recession, there will be greater price competition. Therefore, the lower output will definitely reduce demand pull inflation in the economy.
Therefore, when a country makes progress and its production expands, the employment opportunity grows.
The Phillips curve in the Keynesian perspective (article) | Khan Academy
But there seems to be no definite relationship between unemployment and inflation in India. The Phillips curve shifted. The US economy experienced this pattern in the deep recession from to and again in back-to-back recessions from to Many nations around the world saw similar increases in unemployment and inflation.
This pattern became known as stagflation—an unhealthy combination of high unemployment and high inflation. Perhaps most important, stagflation was a phenomenon that could not be explained by traditional Keynesian economics.
Economists have concluded that two factors cause the Phillips curve to shift. The first is supply shocks, like the oil crisis of the mids, which first brought stagflation into our vocabulary. In other words, there may be a tradeoff between inflation and unemployment when people expect no inflation, but when they realize inflation is occurring, the tradeoff disappears.
Both factors—supply shocks and changes in inflationary expectations—cause the aggregate supply curve, and thus the Phillips curve, to shift. In short, a downward-sloping Phillips curve should be interpreted as valid for short-run periods of several years, but over longer periods—when aggregate supply shifts—the downward-sloping Phillips curve can shift so that unemployment and inflation are both higher—as happened in the s and early s—or both lower—as happened in the early s or first decade of the s.
Keynesian policy for fighting unemployment and inflation Keynesian macroeconomics argues that the solution to a recession is expansionary fiscal policy, such as tax cuts to stimulate consumption and investment or direct increases in government spending that would shift the aggregate demand curve to the right.
Assume we have flexible money wages. However, this does not mean that there is no unemployment. Let us assume that, for a given structure of the labour market, unemployment is uf as in Fig.
The Phillips curve in the Keynesian perspective
Because there is excess demand for labour, two things may happen. First, that the level of unemployment at this real wage is less than uf. Second, that because of the excess demand the money wage will rise. With an excess demand for labour a wider range of skills would be demanded and the employer would be willing to substitute available skills for unavailable ones. It is also likely that capital would move to areas where labour is available, thus reducing the cost of labour mobility, and information may also spread more quickly.
We shall thus assume that there is an indirect relationship between the excess demand for labour and unemployment.
Given the excess demand for labour, money wages will rise, until the equilibrium wage rate is reached. Let us also assume that the rate at which money wages rise depends on the excess demand for labour; the greater the pressure in the labour market the faster is the rate of change of money wages.
We thus have two relationships: Combining these two we get a relationship between unemployment and inflation. This relationship is shown in Fig. The full-employment is represented by uf, where there is no tendency for money wages to change, even though there is some unemployment which is known as natural rate of unemployment. Any level of unemployment less than uf implies that money wages will rise, because there is an excess demand for labour, and the rate at which they will rise depends on the excess demand for labour.
At any unemployment greater than uf there is an excess supply of labour and money wages are likely to fall, at a rate depending on the size of the excess supply.
The relationship shown in Fig. Phillips who first discovered the empirical relationship between the change in wages and employment in the U. So far we have been discussing the relationship between the change in wages and unemployment. To relate the above discussion to an analysis of inflation we have to postulate some relationship between a change in money wages and a change in prices.
There have been various ways in which this has been done, such as, mark up theories of pricing or marginal productivity theory of wage determination. For our purpose it does not matter what is the exact relationship between the change in money wages and a change in prices. Let us assume that there is a positive relationship between the two. We can then translate Fig. Assume that the government wishes to maintain unemployment at u, less than uf. This is a more complex development of the first theme discussed above in terms of the comparative static model but it does not incorporate the second theme—expectations and adjustment to them.
Expectations and the Phillips Curve: To discuss expectations in the analysis of the Phillips Curve, and to sketch briefly some of the recent developments in this field we start with the labour market again. The real wage depends on two factors, the money wage and the price level. When there is inflation both the money wage and the price level are changing and both are expected to change to some extent.
An individual selling his labour receives a money wage offer and he has to assess what is the real wage represented by this offer. To do this he has to think what the price level could be over the period for which he offered the money wage. The actual real wage is W0 divided by whatever the price level is expected.
We thus have a possibility that the actual real wage may be greater or smaller than the real wage expected by the suppliers of labour on which they base their decision about how much labour to supply.
We shall be interested in the rate of change of the variables and thus. We is the expected change of percentage in real wages. Equation 1 states that, the expected percentage change in real wages is equal to the expected percentage change in money wages minus the expected change in the price level. Now, assume that the expected change in money wages is equal to the actual change-in money wages which is equal to the rate of inflation—the percentage change in prices.Inflation and Deflation - Unemployment and Inflation (3/3) - Principles of Macroeconomics
We are also assuming that there is an ongoing inflation in which prices and money wages change at the same rate. Equation 2 says that the expected change in the real wage depends on the difference between the actual rate of inflation and the expected rate of inflation. If the actual rate of inflation is greater than the expected rate, the expected real wage is increasing; if the actual inflation is equal to expected inflation, the expected real wage remains unchanged; and if the actual rate of inflation is less than the expected rate, the expected real wage is falling.
The supply curve shows the relationship between the quantity of labour supplied and the real wage. However, what is now important for the supply of labour is not the current real wage, but the expected real wage.
Only if the expected change in the real wage is zero, is the current real wage the correct variable for the supply of labour. This is shown by the middle supply curve of labour where the expected rate of inflation is equal to the actual rate of inflation. Again, from equation 2this is the supply curve for which the expected rate of inflation is greater than the actual rate. Consider now that an initial equilibrium in which the actual inflation rate is equal to the expected inflation rate and assume that both are zero no inflation.
The equilibrium in the labour market is at A where real wage is W0 and employment is L0. Associated with this full-employment there is some level of unemployment uf, which is called the natural rate of unemployment. Assume that, now prices start rising, but at this level expectations about changes in the price level remain unchanged. Thus, the expected change in the price level is less than the actual change in the price level. The supply curve of labour moves to the right where real wage falls but the quantity of labour supplied rises to L1 and unemployment falls.
The greater is the rise in prices, the larger is the difference between the actual change in prices and the expected change in prices.
The Phillips Curve (Explained With Diagram)
The shift of the supply curve to the right is greater, employment is larger and unemployment is smaller. Let us translate this into a Phillips curve. When the rate of change in prices is zero—and everyone expects it to continue to be zero—equilibrium in the labour market in Fig. L0 with unemployment at uf in Fig.
Labour market equilibrium in Fig.