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You are expected to evaluate/examine (AO3) the relationship between unemployment and inflation and other macroeconomic conflicts (SL+HL), and evaluate/examine (AO3) and draw (AO4) the Phillips curves and an AD/AS model showing the trade-off (HL)
Low Unemployment and High Inflation (AO3)
Low Unemployment and High Inflation (AO3)
Low unemployment means that households will have more money to spend, increasing aggregate demand.
When everyone is employed, it may lead to wage inflation: Workers realize their labor is scare and use this "power" to lobby for higher wages, which increases cost of production. This may decrease aggregate supply, causing what's called stagflation (stagnation + inflation: AS shifts to the left, and a new equilibrium is formed at a higher price level and lower real GDP).
The trade-off between inflation and unemployment can also be visualized using the Phillips curve, which is for HL students only further down this page.
Other Conflicts (AO3)
Other Conflicts (AO3)
High economic growth and low inflation: As an economy grows, the amount of spare capacity diminishes and the cost of production will increase. This will increase the general price level, causing inflation.
High economic growth and environmental sustainability: Increased levels of production and consumption may cause negative externalities.
High economic growth and equity in income distribution: Economic growth often creates a larger gap between the rich and the poor (everyone is better off than before, but some more than others).
More information about these 3 conflicts can be found in "Economic Growth".
The following section is for Higher Level students only.
Trade-Off Between Unemployment and Inflation (AO3, AO4) (HL)
Trade-Off Between Unemployment and Inflation (AO3, AO4) (HL)
The Phillips Curve is a diagram that can be used to illustrate the trade-off between unemployment and inflation. There are two versions:
Short-Run Phillips Curve (SRPC)
Long-Run Phillips Curve (LRPC)
The NRU is the natural rate of unemployment. There will always be some people unemployed, whether that is structural, frictional, or seasonal.
The SRPC extends below the x-axis because if the unemployment rate is beyond this point, deflation will start to occur as the unemployment will decrease spending, which decreases the general price level.
The LRPC is a vertical line because in the long run, everything will revert to the natural rate of unemployment (seasonal + frictional + structuraI).
As an HL student, you will also be expected to draw the effect of unemployment on inflation on AD/AS diagrams. Here, the effect of high unemployment is shown.
Because many become unemployed, consumption in the economy will decrease. This shifts AD to the left, which decreases the general price level of the economy.
This is why the SRPC goes beyond the x-axis: At a high enough unemployment rate, AD will have a leftwards shift.
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