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Lecture 6

Lecture 6 - Inflation and Unemployment

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ECON 105
Eldar Sehic

Inflation and Unemployment Effectiveness of Monetary Policy Suppose M ↑ s i M s(1)M s(2) M s(1) i1 2 (flat) M (dlat) i3(steep) M dsteep) Money i i1 I (flat) d Id(steep) Investment Id: investment demand Changing M is most effective in changing Y when M is steep (when money and bonds are not s d easily substituted) and when I isdflat (when firms are very sensitive to i) Inflation Rise in P Deflation: Fall in P Types of Inflation Demand Inflation: When AD moves right P AS P 2 P 1 AD 2 AD 1 Y 1 Y2 Y Supply Inflation: When AS moves left P AS2 AS 1 P 2 P 1 AD Y Y 2 1 Y Expectation Inflation: When people expect inflation and ask for higher wages (FP ↑) which moves AS left Total Inflation = Demand Inflation + Supply Inflation + Expectation Inflation Monetary Validation Suppose due to some positive shock economy is in an inflationary gap at high P LRAS AS2 AS 1 AD 2 AD 1 Y* Yhigh Y Natural reaction is for FP ↑ which moves AS left If central wants to validate the initial shock, it uses EMP, which moves AD right This can cause accelerating inflation Unemployment Able Population (AP) 1) Those willing to work are in Labour Force (LF) a. Those working are employed b. Those not working are unemployed (UN) 2) Those not willing to work are Not in Labour Force (NLF) Total not working (N) = NLF + UN Unemployment Rate (u) = UN/LF Participation Rate (PR) = LF/AP Drawbacks in Measurement of u: Underground Economy Underemployment (Hiring two people instead of one for the same amount of hours) Discouraged workers
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