Question

Please explain the trade off between inflation and unemployment. Should we worry about inflation? How important is to control the level of unemployment in one economy?

Answer 1

There is a negative relationship between inflation and unemployment in the short run. If the unemployment rate is low, firms compete with each other to hire more workers. This competition drives up the worker's wages. This increases the production cost for firms. To maintain profitability, firms transfer the burden of increased cost to consumers through higher prices. This causes inflation. Again, if there is high inflation in the economy, people will spend more money to buy goods. This will spur economic activity and firms will hire more labor. Unemployment rate will decrease. This explains the short-run trade off between inflation and unemployment.

A single digit moderate inflation, generally ranging from 3-5%, is considered to be healthy for the economy. There is no need to worry about this level of inflation. However, if inflation increases to double digits, it can have serious repurcussions on the economy. Real commodities become scarce and money loses its value. This leads to further chaos and uncertainty.

Unemployment is one indicator that is directly felt by individuals. Higher level of unemployment not only decreases economic output, but also aggregate consumption, savings and investment. If unemployment increases by a massive rate, the economy can be trapped in a recession and everyone in the economy might suffer. thus, it is very important to control the level of unemployment in one economy.