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Macroeconomics. Price level - Essay Example

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In the short-term view, inflation and unemployment are inversely proportional to each other. That means when unemployment is high, price level keeps low and when inflation goes high, unemployment takes a down turn. The problem with this phenomenon is that the government and the regulators of an economy would ideally want to keep both the unemployment level and inflation at as low as level possible…
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Macroeconomics. Price level
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Download file to see previous pages Economists have noted that in long run, inflation and unemployment becomes increasingly unrelated to each other. That means a change in the unemployment seems to have little or no effect on the inflation and vice versa.
Inflation is also inversely proportional to the total consumer spending. As inflation goes up consumers are wary of spending and hold their purchases as dearly as possible. This is due to the fact that when prices rise there is also a hike in the expected price levels in the future that has an adverse effect on the consumer spending. When prices increase the consumer spending power comes down and disposable incomes are significantly lower.
When unemployment is low and there is an increase in price level, wages will rise in response to higher prices. This is because in low unemployment situation, employees can successfully demand full compensation for the higher prices. This has spiralling effect on both the wages and general input costs along with the rate of inflation. All these factors tend to leapfrog each other under low unemployment.
When unemployment is moderate, however, the employees will not be compensated in full and will have to settle for less, and so the wage costs do not rise as fast as prices when unemployment is high. ...
This will stop the rise of the prices and rate of increase in inflation.
Under full unemployment, the wage costs will be sufficiently low to hold the prices down and unless the regulatory authorities step in the market will go into a deflationary mode.
In between the full and low rate of unemployment there is a certain level that's just high enough that costs and prices rise at the same level, so that inflation remains a stable level.

This unique rate of unemployment is called the non-accelerating-inflation rate of unemployment or NAIRU in short.
Economists note that in developed economies such as Australia, the tendency of the rate of unemployment automatically has a tendency to reach the NAIRU rate of employment. Whenever there is inflationary pressure, the unemployment in the long term adjusts itself towards NAIRU rendering the short term Phillips curve invalid.
The below figure shows that "an extra one percentage point of unemployment pushes the inflation rate down by about 0.4 percentage points in the following year--more in some years, less than others."

(DeLong, 2002).
Expectation of a price rise' & its impact on consumption spending:
When inflation is on the rise and prices of commodities increases, it raises the expectation of the price level also. Initially higher inflation expectations can have an emotional effect because when consumers expect a generalized rise in prices across essential goods and services, then it makes them accelerate their spending to prevent paying higher prices later, providing a near-term increase in consumption. However provided the interest rates are not changed, the consumptions comes down as people adjust their spending to match their dispensable income until they ...Download file to see next pagesRead More
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