There are different types of unemployment. Such as frictional unemployment, which is workers that are temporarily between jobs, to voluntary unemployed, who are workers choosing to remain unemployed. The table below illustrates the different types of unemployment.
The table suggests possible solution to the unemployment. Unemployment brings along a cost. The opportunity cost of each unemployed person is what they could have contributed to the economy. Along with this is that when one is unemployed one also stops paying taxes, and starts receiving benefits, this then causes the government to loose money over an unemployed person. Money that could have been used for something else. But unemployment brings along another cost that is not only facts and numbers. But also those who have been unemployed for longer will be less motivated to get a job, also the youth that is unemployed will join this group of people that are going to be socially excluded. After all the work place is more than only working, it is also an interaction between people. Unemployment depresses incomes and thereby deprives the government of both direct and indirect tax revenue.
From this comes the next definition, inflation. Inflation refers to the continual increase in prices. The value of money refers to the amount of goods or services one unit of a currency can buy. Inflation expresses that the value of money is falling because the prices keep rising. To inflation there are benefits and disadvantages. The benefits can be things such as that people are earning more and this pay more taxes, this is beneficial for the government. Firms are able to increase prices and profits before they have to pay out the higher wages. But on the down side you will be receiving more money but the money you receive will be worth less. You will not be able to buy as much. Another thing will be that local goods will be more expensive and imports will be encouraged, whilst exports will be lower.
Just like unemployment there are different types of inflation. They differ because of their causes. There is the cost push inflation, this occurs when a firm passed on an increase in production costs to the consumer. The inflationary effect of increased costs can be results of increased wages, and increased import price, increased indirect taxation. But the biggest cost of all is the uncertainty. This means you can’t control demand. Consumer uncertainty leads to a higher propensity to save. Uncertainty will also withhold investors from investing. If they don’t invest economic growth will be challenging. One last thing will be the difference between rich and poor. The rich will have the luxury and power to negotiate income. Throughout times of inflation savers are worse off than borrowers. There are other causes of demand but they are not relevant to the essay, this because it would deviate too much from the question.
The relation between inflation and unemployment can be defined best by the work of an economist called Bill Philips. He was the first to suggest that there was most defiantly a relation between unemployment and money wages. He based his findings on figures for unemployment and money wages between 1861 and 1957, almost a time period of a 100 years. His work suggested that there was a trade-off between unemployment and inflation (as measured by changes in money wages.). This relationship is illustrated in the Phillips curve:
The curve illustrates that when unemployment is low, inflation is high and vice versa. This being an inverse relationship. Workers will be in a strong position to ask for a wage rise is unemployment is low. Where as when the unemployment is high those workers will compete for each job and wages are held down. It also shows that money wages are sticking downwards. Once the curve passes below the horizontal axis the line flattens out since even workers then will resist a pay cut, this explains the sticking downwards, workers will not take pay cuts as well as pay rises. The monetarists reacted upon this as they said that there maybe a short run trade off relationship between the two, there was no long-term relationship. The man that said this then developed the expectations augmented Philips curve to explain this difference. This led him to conclude that governments could not reduce unemployment by increasing demand.
When in the 1960’s to 1980’s both unemployment and inflation increased there rose doubt on this theory. Keynesians explained that is was due to the unanticipated external inflationary shock caused by the imperfections. The monetarists claimed that there would always be a natural level of unemployment. This is illustrated by the Long-run Phillips Curve (NAIRU). No government policy could work on the this level of unemployment. In fact any policy would make it worse. A certain level of unemployment is needed to keep the economy stable.
The following refers to the graph on page 3. Unemployment is at NAIRU, and the rate of inflation is stable at 4% par annum. This will be the expected rate of inflation, wage settlements will be linked to this so real wage rates will be constant. Now if the government tries to reduce the level of unemployment to U1 by increasing aggregate demand. The effect will be an increase in prices and production will become more profitable because many costs will not change immediately, because wages for example are normally only adjusted annually.
The graph below is the Expectations-augmented Phillips Curve:
So to conclude in what way there may be a trade-off between inflation and unemployment it is because of the job opportunities and the wages. Unemployment is effected by inflation because of the wages, and inflation is effected because of the costs of unemployment. Then looking at the part asking if it possible for a country to have high levels of inflation and unemployment at the same time, the trade-off would say no, but it is possible if the point where the SRPC crosses the NAIRU is high enough.
Word count::1309
Consulted Literature:
Sixth edition
G F Stanlake and S J grant
Pages: 371-381, 418-430
The table was taken from on 24-09-‘02
3 Graph taken from Introductory Economics page 427.
Excluding tables and bibliography
