Revised Topic Paper

Inflation

Inflation refers to the general increase in the price of commodities and services provided by the market. Some scholars in economics believe that the rate of inflation and unemployment has the inverse relationship. The research paper will focus on analyzing the impact of inflation on unemployment. The research paper will borrow from the arguments of Phillips through his theory that resulted in an invention of Philips curve. The curve implies that when the inflation is high, the rate of unemployment is low or when the rate of unemployment is high inflation is low. Although this argument has been criticized by some economic scholars, it has been supported by some since the increase in inflation implies increased spending on the labor force. When the level of inflation is high businesses spend a lot of money on employing labor force to produce goods and offer services. When the economy shrinks, and most businesses are closed down due to poor market performance unemployment rise. The level of competition in markets by businesses decreases reducing unemployment is high since the demand for labor is low attracting low wages and hence low prices of goods and services in the market (Manki & Taylor, 2006).

There various types of inflation such as frictional unemployment, natural unemployment, cyclical unemployment or structural unemployment will be explored in detail in the research to identify how they relate to inflation as well as various views about them from different scholars. Each type of unemployment is caused by certain factors that are unique in nature. Phillips in his theory of explaining the connection between the rate of inflation and unemployment developed a rightward sloping graph that defined the relationship between inflation and unemployment as the inverse. This implies that whenever the prices of commodities and services in the market are high the rate of unemployment is low and the vice versa. This relationship is graphed in Phillips curve. The research paper will focus on analyzing the Philips curve in the second part by examining the role of monetary policies in controlling the level of inflation. Their effect to the supply of money in the economy will also be examined and how such effects relate to the level of unemployment in the economy. (Gottschalk, 2007). .

When aggregates demand for money demand is less and, prices for goods and services in the market decreases unemployment rises. Unemployment rates fluctuate towards natural rate, which is referred to as the rate of unemployment when there are no changes in monetary policies, and the economic output is at optimum levels. The natural unemployment rate includes structural frictional and cyclical unemployment. The paper will also examine Frictional unemployment, which refers to the rate of unemployment caused by the temporary loss of jobs resulting from the process of changing from one employment to another. Certain factors are pointed out as the main causes of Frictional unemployment, and the paper will examine such issues including high labor turnover, lack of employee motivation among other causes. Structural unemployment results from the mismatch of employee’s skills with what is needed by employers. The changing nature of technology may be one of the major causes of structural unemployment since it makes some skills which were previously required in an organization obsolete. Cyclical unemployment result from high levels of the labor force in the market more than what the labor supply can accommodate. It mostly occurs when a large number of graduates are released to the labor market than what the economy can absorb at that moment (Keynes, 2015).

The criticism directed towards Philips theory will also be examined in the paper to understand other theories that have been developed in response to his arguments. Some scholars have argued that the rate of inflation cannot affect the rate of unemployment in the long run. Philips theory is only applicable in the short run and not in long run. The principle argues that nominal quantities like prices have no effect on real variables like employment and output. When prices of goods and services are a high increase in a level of income is likely to follow. From this argument, Philips curve is vertical in long run meaning that the rate of unemployment will not be affected by the change in prices of commodities and services in the market. In the long run, unemployment rate is affected by natural inflation that is determined by changes in different variables such as minimum wages set by the government regulations (Keynes, 2015)..

Phelps and Friedman, arguments regarding expected inflation and how the theory of expectation relates to inflation would also be examined in the paper. The theory exemplifies how people behave regarding future expectations relying on information at hand. The theory of expectation is used in explaining how individual react depending on rational thinking. People are likely to anticipate future possibilities of inflation based on experience. Individuals predict future based on the information at hand. For instance, if the employees anticipate future possibilities of increased rate of inflation they will demand higher wages and salaries to ensure they remain in the same financial position before the inflation. Future predictions will tend to be close to market equilibrium. By demanding higher pay the short term gains made by reducing the level of unemployment is reversed to the natural rate of unemployment. This implies that the level of unemployment will always tend move towards natural or normal rate. The increase in the cost of production will always drive prices of commodities and services in the market. High costs of production increase pressure on reducing labor force as a major factor of production thus increasing unemployment (Gottschalk, 2007).

References

Mankiw, N. G., & Taylor, M. P. (2006). Economics. London: Thomson.

Gottschalk, J. (2007). Monetary policy and the German unemployment problem in macroeconomic models: Theory and evidence. Berlin: Springer.

Keynes, J. M. (2015). The General Theory of Employment, Interest, and Money.