1 Unemployment and Inflation Tradeoff You go home after stud

1. Unemployment and Inflation Tradeoff

You go home after studying macro and explain the relationship between unemployment and inflation to your grandma. She laments –“sounds like a choice between two evils?” Why would she say this? Assuming she is right, which one would you rather have and why? This should not be a one phrase answer; please, discuss.

2. The Open Economy: American Spending and the Value of the Dollar

This discussion question comes straight out of the textbook. Suppose that Americans decided to spend a smaller fraction of their incomes. What would be the effect on Savings, investments, interest rates, the real exchange rate (of the Dollar), and the trade balance?

Solution

1) There is always a trade off between inflation and unemployment . When we try to decrease unemployment by public spending or private setting up of firms , the Aggregate expenditure in the economy rises . Also more employment leads to more AD and more prduction . This causes money supply to rise . So there is inflation . So when unemployment decreases , inflation increases . There is inverse relation between the two .

Nothing is good for the economy in extreme situation . A low level of inflation is good for the economy since it promotes economic growth . But when there is no inflation at all there will be high unemployment . So a balance of both is necessary .