Inflation and Unemployment

Inflation and unemployment are two main macroeconomic objectives for every economy. They have a huge impact on economic development. Inflation happens as there is a general rise in the amount of inflation in the economy. The percentage of the labour force that is unemployed is referred to as the unemployment rate (Mankiw, 2006). There is a tradeoff between inflation and unemployment in the short term. A increasing inflation rate reflects a rising trend in markets. Firms increase their productivity to gain more income. To meet the increased production, employers recruit more people, lowering the unemployment rate. However, this inverse relationship ceases to exist in the long run as the unemployment rate stays fixed even during instances of inflation (Mankiw, 2006). Maintaining inflation and unemployment at the right rates is fundamental towards economic growth. A high unemployment rate is bad for the state as it results in low consumer spending. The U.S. government tries to maintain unemployment below 6% (Amadeo, 2017).

The U.S. economy has seen inflation and unemployment have various effects on its economic growth. For example, during the 2009 recession, there was a high unemployment level as profits declined and businesses closed down. According to Amadeo (2017), to stimulate aggregate demand for goods and services, Barrack Obama's administration responded by cutting taxes and increasing spending. At the same time, the Federal Reserve increased money supply. These policies increased aggregate demand trough the multiplier. The simple law of demand states that an increase in demand causes the price level to go up holding other factors constant. Thus, there was a higher inflation rate in the periods following the recession. Data from the balance shows that from 2009, unemployment has declined steadily starting from 9.9% in 2009 to 4.7% in 2016. The inflation rate has also been on the downward trend amid fluctuations. The growth rate has been stable ranging between 1.6% and 2.6% in the period (Amadeo, 2017).

Part 2

Scenario 1

A reduction of tariff will increase the supply of coffee. Tariffs are taxes imposed on imports and therefore affect the supply side of the economy. The reduced tariff translates to a reduction in the cost of inputs as importers pay less to get raw materials into the country. Before the government intervention, the market is at equilibrium with the supply and demand curves S1 and S2 respectively. The initial equilibrium point is at (P1, Q1). The reduction in tariff results in an outward shift of the supply curve from S1 to S2. The equilibrium point moves to (P2, Q2). Therefore, the reduction in tariffs increases the equilibrium quantity while lowering the equilibrium price. As the cost of production goes down, firms are able to offer reduced prices and thus sell more.

P

S1 S2

P1

P2

D1

Q1 Q2

Q

Graph 1: A graph showing the effect of reduction of tariff on coffee imports

Scenario 2

The demand for coffee would increase. The health benefit would encourage consumers who do not like coffee to take it often. The finding affects change in consumer’s tastes and preferences, which is a determinant of demand. Initially, the market is at equilibrium with demand and supply curves D1 and S1 respectively with an equilibrium point (P1, D1). The change in preference towards coffee shifts the demand curve to the right from D1 to D2. The new equilibrium point is (P2, Q2). Thus, the discovery of health benefits in coffee would increase the quantity consumed and the prices would go up. The coffee would gain additional value and therefore fetch a higher price in the market.

P

S1

P2

P1

D1 D2

Q1 Q2

Q

Graph 2: A graph showing the effect of health benefit discovery in coffee

Scenario 3

The equilibrium quantity will increase from Q1 to Q2. On the quantity axis, the two scenarios shift the quantity in the same direction. However, it is difficult to conclude how the price reacts to the combination of the government policy and health benefit effects. The two scenarios shift prices in opposite directions and therefore the price can remain constant, as in the diagram below, increase or decrease depending on which effect is stronger.

S1 S2

P

P1

D1 D2

Q1 Q2

Q

Graph 3: A graph showing a combined effect of reduction in tariffs and discovery of health benefits in coffee.

References

Amadeo, K. (2017, April 19) Unemployment Rate by Year: Compare to Inflation and GDP. Retrieved from:https://www.thebalance.com/unemployment-rate-by-year-3305506

Mankiw, N. (2006). Principles of macroeconomics. Cengage Learning.