Unemployment and Inflation

Microeconomics is the section of economics that concerns single factors and the effects of
individual decisions. It is commonly known to be the study of individual decisions of a single
business entity. It consists of analyzing the price of a particular product, the capacity production
of a product, and how the price of each product in the market is affected by the forces of supply
and demand. It considers regulations, taxes, and analyzes markets in order to effectively set a
value for a specific good or service. The decisions made on a microeconomic level are very
pinpointed and precise. The outcome directly affects the supply and demand chain as well as
other forces that determine the price levels seen in the economy. For example, microeconomics
would access how a specific business could maximize its production so it could lower prices and
compete more fiercely with its competitors. In order to come up with these solutions,
microeconomics considers various variables such as the relationship of a firm with the market
and the appropriate price of a product to maximize profits. On the other hand, Macroeconomics
is a broader study that involves the economy as a whole, not just one particular company since it
assesses entire industries. For example, macroeconomics covers subjects such as an economys
GDP and how it is closely linked to unemployment rates, since they mutually influence one
another. Besides from GDP, topics such as interest rates, economic growth, and inflation are very
commonly studied in macroeconomics. Therefore, the main difference between microeconomics
and macroeconomics is the extent of their spectrums. By that I mean that microeconomics deals
with single markets or business entities whereas macroeconomics deals with entire economies
and industries. Although these two fields of economics are interdependent and different, they are
still complementary since decisions in macroeconomics have an impact on microeconomics. For
example, if an economy experiences inflation (macroeconomics) it would affect the price of raw
materials such as coal, sugar, and silver. As a result, companies will increase the prices
(microeconomics) of their end product to compensate for the increase in the raw material. This
clearly demonstrates that microeconomics and macroeconomics are closely intertwined; one
affects the other despite their differences.
The MACROECONOMY IN THE LONG RUN
Macroeconomics is the study of an economy in its largest sense by looking at the bigger pictures.
Aggregate expenditures refer to total expenses used on gross domestic product. These costs are
used by households, businesses, and governments to buy the entire gross domestic product
required by the domestic economy. These combined expenditures are an important in explaining
macroeconomic phenomena such as unemployment, inflation, GDP, and other related problems.
It does acknowledge the function of individual companies and only vaguely studies individual
industries. It is useful in helping determine the aggregate effect of certain policies on an
economy as a whole. The macroeconomic study of the aggregate market shows that at a specific
time all prices, including wages, are flexible and can theoretically reach equilibrium. In the long

term, the flexibility of the wages and their ability to adapt to economic circumstances allow them
to avoid surpluses and shortages.
UNEMPLOYMENT IN THE LONG RUN
Unemployment is a significant issue in todays modern societies, due to the current economic
concerns we witness all over the world. People who are employed by an entity, even if on
vacation or ill, are considered employed if they are remunerated for their work. On the other
hand, individuals who dont have a job and are actively searching for one are considered as
unemployed. Individuals who have been jobless for fewer than five weeks are classified in the
Short-term unemployment category. The other category is Long-term unemployment
which includes anyone who has been jobless for duration of 12 months or more. Although it isnt
an entirely accepted theory, many studies share a mutual opinion that unemployment occurs
since wages are not flexible enough to clear markets. According to this reasoning, a labor market
with a wide range of wage flexibility will not contain involuntary unemployment. This theory is
based on the belief that wages depend on the shortages or surpluses in a particular market only if
they extend over a long period of time. This means, wages will not be affected by shortages or
surplus, if these variations do not last long enough to impact salaries. The theory of sticky wages
and involuntary unemployment suggest that its this slow adjustment process that produces
surpluses and shortages in individual labor markets. Despite these theories, there exists an
accepted natural rate of unemployment at which upward and downward forces on wage inflation
are at equilibrium. At this natural pace, inflation is stage with no tendency to accelerate or
decline. However, this equilibrium is disturbed and interrupted by some variables. First, the
demographic factor, which includes the age and gender of a labor force, has a great effect on the
natural rate of unemployment. Secondly, government policies may influence the rate as well. For
example, the expansion of unemployment insurance can increase the natural rate whereas a tax
policy that increases the cost of investing or production has a negative effect on the
unemployment rate. As a matter of fact, there are a couple of ways to reduce the natural
unemployment.
MONEY, INFLATION, AND INTEREST RATES ON THE LONG RUN
In every economy, there is a complementary and closely intertwined relationship between the
amount of money in circulation, inflation rates and inflation. When a nation experiences a
surplus of money flow it causes inflation. When there is an excess of money in an economy, the
quality and value of the currency decreases. The goods and services in the market will be more
accessible to everyone, and business will have to adjust their prices according to the inflation.
Companies notice that people are spending a higher amount of money; consequently, they raise
the prices in order to re-establish the equilibrium present before the inflation. Basically, in a
country with high inflation, you need more money to buy the same product/service. To
understand the connection between money, inflation, and interest rate is it primordial to grasp the

difference between the nominal interest rate and the real interest rate. The nominal interest rate
refers to the interest rate proposed by your bank without any adjustment to inflation. For
example, in a savings account, the nominal interest rate will express how much money youll
gain over a particular time period. On the other hand, the real interest rate is the nominal rate of
interest minus inflation.
The Real Interest = The Nominal Interest Rate Rate of Inflation.
IF Money in circulation THEN Inflation Rate & Interest Rate Value
SHORT RUN ECONOMIC FLUCTUATIONS
Every economy in the world experiences an economic activity, which can be positive or
negative. If growth does not occur we witness economic stagnation which causes a recession.
Recession is a temporary period of economic decline during which trade and industrial activity
decrease, usually recognized by a decrease in GDP, household income, business profit, and a
clear rise in the unemployment rate. If a recession extends and starts deteriorating then a country
may enter a phase of depression; prolonged and severe recession. A Business cycle refers to any
fluctuations in production and economic activity over a couple of months or years even if these
economic fluctuations are irregular and unpredictable. Even if most macroeconomic variables,
that measure income/product, fluctuate together they still fluctuate by different amounts. In any
country, if the output start to decline, it is very likely that unemployment will react inversely by
rising accordingly. Most economist use the model of aggregate demand and aggregate to explain
changes in countrys business cycle. This model shows the quantity of goods, or services, a
household, firm, or government wants to buy at a specific price level. For example, a decrease in
the price level makes consumers feel wealthier which encourages them to spend more. This
increase in purchasing power means marker quantities of goods/services demanded. In the short
run, this supply curve is upward sloping because in the short run there is an increase in the
overall level of prices which causes a rise in the quantity of goods/service supplied. In other
terms, the decrease in the level of prices tends to reduce the quantity/services supplied by
business whereas an increase in the level price raises quantity of goods supplied. According to
the Stick-Wage Theory, nominal wages dont adjust quickly enough to short term a fluctuation
which means that at low price levels, employment is less profitable. It encourages firms to
reduce the quantity of goods supplied. Prices of some goods hardly adjust to the economic
conditions. In this situation, whenever there is an unexpected drop in price levels, some firms are
left with higher-than-desired prices that dont meet the market expectations. This depresses sales
and discourages companies to produce more.
RECESSION & POLICY GOALS

In order to fully comprehend the policy goals, it is primordial to completely embrace and
understand the causes of a recession and its consequences. A recession refers to an economic
situation in which a countrys GDP, or output, is experiencing a continual negative decline for at
least a period of six months. The deterioration in the economy is called an economic correction;
however, if the situation extends over a period longer than two years then its considered as a
depression. There are numerous factors that can endanger an economys health and contribute to
an economy's fall into a recession. Consumers purchasing interest and power are essential
variables in determining the condition of an economy. Generally, before a recession there is an
overproduction of goods which results in the supply demand surpassing the demand of products.
Consequently, companies have to readjust accordingly by increasing prices which discourages to
spend since their confidence in the economy diminishes. However, the utmost cause for
economic recession is inflation. The higher the inflation, the fewer amounts of goods/services the
people can buy with the same amount of money. Under these circumstances, consumers have the
tendency to reduce leisure costs, decrease overall spending and save more. Similarly, companies
attempt to limit their expenses to be able to offer lower prices. This budget restraint causes the
GDP to decline and leads to an inflationary environment. This triggers a domino effect,
companies fire workers to minimize costs which cause unemployment rates to increase causing
the purchasing power to drop.
INFLATION & UNEMPLOYMENT
The relationship between short term unemployment and inflation is an inverse correlation;
therefore, when inflation is high unemployment is low and when unemployment is high then
inflation is low. However, economist have noticed that this relationship only exists in the short
run, since during the long term, there seems to be no correlation or correlation between
unemployment and inflation. Classical economist supports the belief the natural rate of
unemployment refers to the equilibrium level of unemployment of the economy. This school of
thought is explained by the Philips curve. When the curve is vertical inflation is not related to
unemployment in the long run. Therefore, unemployment will not be affected by a variation in
inflation, whether positive or negative. On the other hand, this reasoning is invalid when
considering the curve from a short term point of view. The classical view states that the point
where the short term Philips curve crosses the long term is the estimated inflation. On the left of
that point, inflation is greater than predicted and the right represents a lower value than expected.
In other terms, unemployment under natural employment leads to inflation higher than expected
and unemployment higher than natural unemployment leads to inflation lower than expected.
However, there is an opposing theory that contradicts the classical view that inflation is a
problem of increasing money supply. The Keynesians focus on the institutional issues that
increase the price levels. This theory argues that organizations raise wages in order to satisfy
their workers. At the end of the month, they have to pay all their employees and the only profit
they can gain is from raising prices. This creates an increase in wages and prices which requires
an increase of money supply to keep up with the inflation. Therefore, the classical view believes

that money supply affects inflation whereas Keynesians look at it the other way around where
inflation is causing the change in money supply.
Economic Growth and Convergence Across Countries
The concept of convergence, which is also referred to as catch-up effect, is based on the
hypothesis that poor economies flourish, develop, and grow quicker than wealthier economies.
According to this belief, developing countries will overcome the difference separating them from
more developed economies, and at some point they will coverage in terms of per capita income.
It suggests that more developed a country is, the lower is maturing pace since once you reach a
certain point further growth is very limited. For this reason, poorer countries have the potential to
experience quick economic growth since they havent reached the point of stagnation yet. This
theory is only valid if technology is freely traded and available to the developing countries that
are attempting to catch-up since one of the main contributors to economic growth is technology.
Improved technology leads to increased production, which means more wages and more profits
for employees and investors respectively. Unavailable and expensive capital prevents poor
countries from experiencing catch-up growth, especially when that capital is scarce in those
countries. In order for convergence to occur, a country should experience a positive economic
growth. A positive economic growth indicates a wealthier economy and an increase in prosperity.
It increases production, which means increases profits for the production companies. Increased
production also means an increase in tax collection for the government and, reduced
unemployment levels, and better prospects for the economy.
CONCLUSION
The difference between classical and Keynesian economics resides in their disagreement
concerning the role of the government in the economy. On one side, the classical economists
believe that the market is impeccable and self-sustaining; therefore, no government intervention
is required. They preach the laissez faire doctrine and emphasize that the production,
consumption, and distribution of goods are exclusively based on economics laws and
principles. On the other hand, Keynesians state that the market is imperfect and not selfsustainable, for this reason, government should stimulate demand when economic growth is
lacking since consumer income encourages demand. They believe that at a natural equilibrium,
the economy experiences unemployment and negative growth. My opinion swings towards the
Keynesians belief. I believe that there are so many factors that influence the economy that its
highly improbable to keep a constant equilibrium on the long run. For this reason, I think
governmental stimuli are a good way to keep the economy going and on track especially during
an economic crisis. There is no harm is exploited our public sector with fiscal policies to boost
our economies.