Question

[ 10 points ] If the Fed increases inflation, show the impact on unemployment in both the long and short run?

Answer 1

Answer:

If fed increases inflation, the impact of price rise on unemployment rate in the economy can be best expressed by Phillips Curve.

Below is the graph showing impact of inflation on unemployment in the short run.

x SHORT RUN PHILLIPS CURVE H INFLATION RATE (%) H to UC UNEMPLOYMENTRATE (%)

In the short run , Phillips curve is downward sloping from left to right ,which indicates that ,as inflation increases, unemployment decreases.The reason is , during inflation, as AD increases, people tend to consume more, which leads to more production and more demand for labour . The result is ,fall in unemployment rate.

Phillips curve in long run

In the long run , there is no effect of inflation on unemployment rate.

See the graph below----

INFLATION RATE ( %.) LONG RUN PHILLIPS CURVE 1 110 UNEMPLOYMENT RATE UNEMPLOYMENT NATURAL RATE OF

In the long run, the Phillips curve is a vertical line at natural rate of unemployment.

Over the long run, when workers are fully aware of the loss of their purchasing power in the inflationary conditions, their willingness to supply labour diminishes, and the unemployment rate rises to the natural rate.