Question

Explain what the sacrifice ratio tells us about policies to reduce inflation.

Answer 1

Sacrifice Ratio measures the impact on increasing or declining inflation on the total output in an economy. It is usually derived from the Phillips Curve that represents inverse relationship between unemployment rate and inflation.

The sacrifice ratio shows a positive relationship between inflation and total output. This is because if inflation is declining, then it means that prices are falling. This will create disincentive for the firms to produce and invest. As a result, total output will decline. On the other hand, an increase in the inflation signifies rising prices, that will create incentives for the firms to expand output.

So, any policy that aims at reducing inflation has to deal with the problem of declining output in the economy. So, a balance need to be formed between achieving higher output growth and ensuring inflation is within control.