This section covers the following topics:

• Unemployment
• Basics of inflation
• The quantity and institutional theories of inflation
• The short and long-run Phillips curves

Section Summary

The unemployment rate is the number of people willing and able to work but without jobs divided by the total labor force. Total unemployment is made up of cyclical unemployment (which is due to the business cycle), structural unemployment (some people can’t find jobs because they have outdated skills and so forth) and frictional unemployment (made up of people looking for their first jobs or changing jobs).

Inflation is a sustained rise in the price level. It is measured using indices like the GDP deflator or the Consumer Price Index. Demand-pull inflation occurs when economy is beyond potential output, while cost-push inflation is triggered by sudden increases in input prices.

The quantity theory of inflation holds that inflation is based on the quantity of money available in the economy. Quantity theorists point to the equation of exchange, and assume that the velocity of money is constant and that the quantity of goods sold is independent of the money supply. In short, increases in the money supply lead to increases in price.

Subscribers of the institutional theory of money believe that workers negotiate higher wages, forcing firms to raise prices. The government can then (a) increase the money supply and inflation or (b) do nothing and accept lower growth rates. Some workers can always demand higher wages because of the insider/outsider model, in which insiders are so crucial to the firm’s success that they can constantly receive wage increases even when outsiders are unemployed.

The Phillips curves show the tradeoff between inflation and unemployment. The short-run Phillips curve is downward sloping. Changes in expected inflation shift this curve. The long-run Phillips curve is vertical, and expected inflation = actual inflation. The economy is at long-run equilibrium where these two curves... Sign up to continue reading Inflation, Unemployment and the Phillips Curves >

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