Question

Macropoland, a country that is a natural gas and oil importer, has a natural rate of unemployment (at the full employment level of GDP) that is about 4.5%, and the long run average rate of inflation over time has been about 2%. However, during the period 1973-1974, the country experienced an inflation rate of about 15% while simultaneously experiencing unemployment of nearly 13%.

At the present time, Macropoland is experiencing very sluggish consumption and investment (a result of a fall in the housing market), and unemployment has again edged up to around 9%. Inflation is very low at 0.4%.

Macropoland has just hired you as their economic advisor. You have a big job ahead of you. Using your knowledge of aggregate demand and aggregate supply, can you explain what happened in these two time periods?

Develop a response that includes examples and evidence to support your ideas, and which clearly communicates the required message to your audience. Organize your response in a clear and logical manner as appropriate for the genre of writing. Use well-structured sentences, audience-appropriate language, and correct conventions of standard American English.

Answer 1

During the period 1973-1974, Macropoland experienced an inflation rate of about 15% while simultaneously experiencing unemployment of nearly 13%. When a country faces high inflation as well high unemployment rate, the country is said to be facing stagflation. High inflation was mainly because of steep hike in crude oil prices which meant that the country had to face very high prices for importing oil and gas. Unfortunately, petroleum products constituted a huge portion of the import basket. If the country chose to reduce the consumption of oil and gas it would lead to negative ripple effects in the economy, including in the automotive, agriculture, transportation sector of the economy.

Unfortunately, due to oil embargo in 1973-75 almost all the countries across the world faced stagflation.

Not only were there real shortages of grains, raw materials, and outputs of key basic industries in the economy, but there were artificial shortages of petroleum and petroleum products, and continued rounds of price increases that gave the appearance of shortages.

Thus inflation in its many manifestations was a key ingredient in the present recession. Real purchasing power was siphoned off by the oil producers.

At the present time, the country is experiencing very sluggish consumption and investment (a result of a fall in the housing market), and unemployment has again edged up to around 9%. Inflation is very low at 0.4%. We can say that the country is facing fall in aggregate demand as low inflation doesn't incentivize producers to increase production, which will lead higher employment due to increased business activity, and the economy would heat up. The government should use expansionary fiscal and monetary policy to increase aggregate demand and consequently higher employment level.