Chapter 35. The Short-Run Trade-off between Inflation and Unemployment.
Summary
TLDRThis video explores the short-term trade-off between inflation and unemployment, drawing from Gregory Mankiw's 'Principles of Economics'. It discusses the Phillips Curve, illustrating the negative correlation between unemployment and inflation rates in the short run. The video explains that while policy interventions can influence these variables temporarily, in the long run, factors like market power and efficiency wages determine unemployment, and monetary policy cannot alter the natural rate of unemployment. It also covers the impact of supply shocks, like the OPEC oil crisis, and the importance of expectations in shaping the Phillips Curve.
Takeaways
- 📚 The video discusses the short-run trade-off between inflation and unemployment based on 'Principles of Economics' by Gregory Mankiw.
- 🔍 Unemployment is influenced by the labor market, minimum wage laws, and job search effectiveness, while inflation is affected by money supply growth.
- 🔄 In the long run, unemployment and inflation rates are not related, according to experiments based on U.S. data.
- 🛠 Policymakers, such as the government and central banks, can use fiscal or monetary policy to influence unemployment and price levels in the short run.
- 🔑 The short-run correlation between unemployment and inflation is negative, implying that reducing unemployment can lead to higher inflation.
- 🎯 Central banks aim to stabilize the purchasing power of money, which may result in higher unemployment as a trade-off for lower inflation.
- 📈 The Phillips Curve illustrates the relationship between the rate of unemployment and the rate of change of money wages, with an inverse relationship observed historically.
- 📊 Aggregate supply and demand analysis shows that an increase in demand can lead to higher prices and output, affecting the Phillips Curve.
- 🌐 Shifts in the Phillips Curve are influenced by expectations, with changes in the slope over time reflecting variability in these expectations.
- 🔮 Milton Friedman's work suggests that in the long run, there is no relationship between inflation and unemployment, leading to a vertical long-run Phillips Curve.
- 🌟 The natural rate of unemployment is the rate towards which the economy gravitates in the long run and is influenced by factors such as market power of unions and efficiency wages.
- 🛑 Supply shocks, such as those caused by OPEC restricting oil supply, can shift the Phillips Curve, leading to higher unemployment and inflation rates in the short run.
Q & A
What is the main topic of the video?
-The main topic of the video is the short-run trade-off between inflation and unemployment, as discussed in Gregory Mankiw's 'Principles of Economics'.
What is the relationship between unemployment and labor market factors?
-Unemployment is influenced by factors in the labor market, including minimum wage laws and the effectiveness of job search.
How does the inflation rate depend on money supply?
-The inflation rate is dependent on the growth in money supply, as demonstrated by experiments based on real data from the United States.
What is the conclusion about the long-term relationship between unemployment and inflation?
-In the long run, unemployment and inflation are not related, according to the experiments and data analysis.
Who are the policy makers referred to in the script?
-The policy makers referred to are the government, which can implement fiscal policy, and the central bank, which can implement monetary policy.
What is the short-term correlation between unemployment and inflation according to the video?
-In the short run, there is a negative correlation between unemployment and inflation, meaning that when one decreases, the other tends to increase.
What did A.W. Phillips discover in his paper about the UK economy?
-A.W. Phillips discovered an inverse relationship between employment and the rate of change of money wages in the UK economy from 1861 to 1957.
What is the basic idea behind the Phillips curve representation in the video?
-The basic idea is that higher output leads to greater employment and a lower unemployment rate, but this can result in a higher price level due to increased consumption.
What is the role of expectations in the Phillips curve?
-Expectations play a crucial role as they can cause variability in the slope of the Phillips curve over time, reflecting how quickly people adjust their expectations of inflation.
What is the natural rate of unemployment and why is it important?
-The natural rate of unemployment is the rate toward which the economy gravitates in the long run. It is important because it represents the basic or natural value of unemployment that will be maintained in the long run, and it cannot be influenced by monetary policy.
How can supply shocks affect the Phillips curve?
-Supply shocks, such as the OPEC oil crisis, can shift the Phillips curve to the right, indicating that for the same level of inflation, there will be a higher level of unemployment.
What is the conclusion about the trade-off between inflation and unemployment in the long run?
-In the long run, the trade-off suggests that there is a cost of higher unemployment for lower inflation, but ultimately, the unemployment rate will return to its natural rate regardless of the inflation rate.
How do rational expectations affect the Phillips curve?
-Rational expectations affect the Phillips curve by adjusting how quickly people update their expectations of inflation, which can either shift the curve or leave it unchanged depending on whether they believe a change in inflation is temporary or permanent.
Outlines
📚 Introduction to the Short-Run Trade-Off between Inflation and Unemployment
This paragraph introduces the concept of the short-run trade-off between inflation and unemployment, drawing from Gregory Mankiw's 'Principles of Economics'. It explains how unemployment is influenced by labor market conditions, minimum wage laws, and job search effectiveness, while inflation is tied to money supply growth. The script notes that in the long run, these variables are not related, but in the short run, they exhibit a negative correlation. The role of policy makers, either through fiscal or monetary policy, is highlighted in influencing these variables. The paragraph also references the Phillips curve, which historically showed an inverse relationship between employment and the rate of change of money wages, and discusses the impact of aggregate demand on prices and output.
🔍 The Long-Run Phillips Curve and the Concept of Natural Unemployment
The second paragraph delves into the long-run implications of the Phillips curve and introduces the concept of the natural rate of unemployment. It discusses how in the long run, monetary policy cannot influence this natural rate, and that real changes are necessary to affect it. The paragraph also touches on the dichotomy of classical economics, which posits that money growth does not affect real variables in the long run. The role of expectations in the Phillips curve is explored, emphasizing how changes in expected inflation can shift the curve and affect the trade-off between inflation and unemployment. The impact of supply shocks, such as those caused by OPEC's oil restrictions, is also examined, showing how they can shift the aggregate supply and Phillips curve, leading to higher unemployment and inflation.
🛠 The Role of Expectations and Supply Shocks in Inflation Dynamics
The final paragraph focuses on the role of expectations and supply shocks in the dynamics of inflation. It explains how people's beliefs about the permanence of inflation can affect the Phillips curve, with temporary inflation not altering the curve, but a new area of inflation leading to a shift. The paragraph discusses the impact of the Organization of the Petroleum Exporting Countries (OPEC) as a significant example of a supply shock that can shift the Phillips curve to the right, resulting in higher unemployment at the same level of inflation. The concept of rational expectations is introduced, suggesting that the speed at which people adjust their inflation expectations can influence economic outcomes. The paragraph concludes by emphasizing the trade-off between inflation and unemployment in the short run and the inevitability of returning to the natural rate of unemployment in the long run.
Mindmap
Keywords
💡Inflation
💡Unemployment
💡Phillips Curve
💡Aggregate Supply and Demand
💡Policy Makers
💡Money Supply
💡Natural Rate of Unemployment
💡Expected Inflation
💡Supply Shocks
💡Rational Expectations
Highlights
The video discusses the short-run trade-off between inflation and unemployment based on Gregory Mankiw's 'Principles of Economics'.
Unemployment is influenced by the labor market, minimum wage laws, and job search effectiveness.
Inflation rate is determined by growth in money supply and is not related to unemployment in the long run.
Policy makers can use fiscal or monetary policy to influence unemployment and price levels in the short run.
Central banks aim to stabilize the purchasing power of money, which may lead to higher unemployment.
Phillips curve demonstrates an inverse relationship between employment and the rate of change of money wages.
Samuelson and Solow's analysis of the USA supports the Phillips curve concept.
Larger output leads to greater employment and potentially a higher price level due to increased consumption.
Aggregate supply and demand representation shows the impact of demand increase on price levels and output.
The Phillips curve shifts due to changes in expectations about inflation.
Classical economics suggests that money growth does not affect real variables in the long run.
Friedman's data analysis found no long-run relationship between unemployment and inflation.
The natural rate of unemployment is related to long-run factors such as market power and efficiency wages.
Monetary policy cannot influence the natural rate of unemployment in the long run.
Supply shocks, like those from OPEC, can shift the Phillips curve to the right, increasing unemployment at the same inflation rate.
Expected inflation affects the sensitivity of the unemployment rate based on the gap between actual and expected inflation.
In the long run, the actual inflation equals expected inflation, leading to unemployment returning to its natural rate.
Rational expectations theory suggests that how quickly people adjust their inflation expectations affects economic outcomes.
The video concludes that reducing inflation may come at the cost of higher unemployment.
Transcripts
hi welcome on to this video we're going
to develop now charter 35 the short run
trade-off between inflation and
unemployment
this is a book of gregory monkey
principles of economics
so we we already know that unemployment
definitely depends on labor market
on all the minimum wage laws and even
the effectiveness of
job search from the other side we know
that the inflation rate depends on
growth
in money supply and actually
after several experiments
and those experiments based on real data
basically from united states
the the conclusion is that in the long
run these two variables
unemployment and inflation rate they are
not
related so we know that the policy
makers they can
expand engagement who are the policy
makers we are talking about the
government
it means fiscal fiscal policy or we are
talking about
the central bank then monetary policy
then uh at this point we can um
the unemployment will decrease and then
the price level will increase
so what we are going to have a look here
it's like in the la in the
in the short run unemployment and
inflation they are correlated
negatively okay so then
from one side we know that the central
bank the objective for
most of the central bank to keep the
powerful acquisition of all people
stable then they the
aim is to reduce inflation or to keep at
least stable
but then the cost could be
higher unemployment then
after after a paper
written by phillips an economist
the relationship between employment and
rate of
change of money wages in the united
kingdom
during 1861 1957
uh they discovered or he discovered that
there is a relationship
inverse between these two variables then
other prominent economists sam also and
solo
made these analysis for usa and then
the idea is basic is simple yet we have
larger
output means that greater employment
and then naturally lower rate of
unemployment
and due to the success of consumption
the concept for
the consequence could be higher price
level
then we have this uh this representation
of the aggregate supply
and aggregate demand and then
in this one we have an increase for
example for this data we have an
increase in the aggregate
demand so we have the now the
equilibrium is the price that is 106.
this 106 is the index of the cpi the
consumer
consumer price index we know that over
100
is an increase compared with the word
base year
basically we made a comparison year by
year
and then we have here higher level
prices by higher level of
output then if we want to represent that
in the philips curve
it relates inflation in the y-axis and
unemployment rate in the x-axis
we have here when the inflation is
equivalent to two percent
we have higher level of unemployment and
for an output of
5 or 15 000 then we can achieve
higher output but the cost should be
uh definitely higher inflation
shifts in the philips curve then
it started to have the idea of the role
of expectation
why because well basically first
something to we need to have clear is
that
if there is actually a variability
in the slope over time in this phillips
curve
well it appears in these uh in these
expectations
so actually what we learned
from classical economies is the demonic
growth
it doesn't have a it doesn't it doesn't
have any change in variables
uh in real variables it has more
more uh more
effect actually in uh in the nominal
ones
this is the basic idea so for this
reason this phillips curve
it it has a relevance in the short
run then uh we know that the
unemployment rate at least in the long
run
in the long run actually is changed by
market power of unions or even the role
of efficiency wages
then uh actually for this reason
friedman
said and actually after several data
discover no relationship the long run
between these two variables
then we have the core phillips is
vertical
and then it's a valid situation or is a
confirmation for the dichotomic of a
classical
that money growth doesn't change
anything in viable
and real variables at least in the long
run so here we have inflation and the
unemployment rate
and then we are going to be talking
about the natural rate of unemployment
which is definitely related with the
with the future with the long run and
the aggregate supply
with the natural level of output
then uh then here
basically what we have here when we have
uh the situation
of the in the long run we have an
increase
in the aggregate demand um
in this situation well the only
situation that we are going to generate
is an increase in the price level
not any change in other in other
variables at least in the long run
then here when we talk about natural
well
this is unemployment rate toward which
the economy gravitates in the long run
it's like the basic
or the or the natural value
the the unemployment will be kept
uh in the in the long run and it is
really important to
uh take into consideration that monetary
policy
cannot influence natural rate of
unemployment
just like real changes really could
change this variable
and then when we make a comparison
between theory and evidence
well actually we we have a look that
uh that basically the the facts
are really related what we have in the
theory
uh at the end this logic of the
aggregate supply it applies to the long
run
remember that when we talk about
aggregate supply in the long run it's
vertical
because the prices can adjust uh
in the long run the basic for example
the theory of the sticky wages
maybe the loan in the short run you
cannot just wages but in the long run
they are easily uh adjusted and then
those variables are more affected by
expected inflation
here is the the question that we're
going to face with the unemployment rate
we have a natural rate of employment
unemployment and then minus a this
should go
this a factor is going to be the
sensitivity
of of the unemployment rate
based on the gap between actual
inflation
and inspected inflation the expected
inflation is given
is higher than uh actual inflation so we
have a
naturally lower um lower unemployment
in the long run the actual inflation is
equal to
expected inflation because um everybody
knows we should be
effectively like value so unemployment
rate equal to the natural rate of
unemployment
so then when there is an expected
inflation that changes
it shifts the curve it depends to the
right
or to the to the to the left
but in the short run which is really
important and the most relevant during
20th
century is the trade-off between these
two variables
then for example here when we have the
representation of the long run
phillips curve and then we have here the
short run
basically when we face a change from
this
curve the the the one down to this one
we can express in the short run a change
from a to b
so higher inflation lower level
of unemployment but if anything changes
at the end of the day we're going to
have dana c
point then we're going just to have the
same level
of of of inflation
but higher level of unemployment
so then basically um the situation here
is just like the
unemployment will return to natural rate
regardless
the rate of inflation so just in the in
the short run policy makers
can take or use this tool to change
but in the long run more real variables
should be necessary
so then uh in this situation the the
supply shocks
can definitely make some changes into
the philips curve can
shift this curve to the right actually
the
one of the most important the one the
one of the
most important um example is
organization of petroleum
of exporting countries the opec
well actually they restricted the amount
of crude oil they pump it
and actually it increased the price
level
it shifts aggregate supply and philips
curve
so here we have an example we have here
an expanding inflation rate
in the y-axis unemployment rate in the
x-axis
and then we have the level of the
aggregate demand in the the right side
and here we have the in the in the left
side is not the monetary
and supply is more the aggregate and on
on demand and okay supply and here we
have this shock of supply which was a
decrease
in the supply of oil so it generates
naturally a decrease
in the total output and an increase in
the price level
and as a consequence we have here a
shift to the right
for the phillips curve it means the same
level
of the same level of inflation
higher level of unemployment associated
with this situation disregard is why
that i didn't cancel them out so
actually this is the two important facts
that we need to take into account
if people believe that it is temporary
expected inflation will not change the
philips curve however
if people believe that this is a new
area of inflation philips curve
will change so what is the cause of
reduction inflation
basically the answer more unemployment
is just like the basic conclusion of
this chapter
so then here we have the situation and
when we have
uh these naturally we have from
a uh in the short run we are going to
move to b
so then show our inflation by higher
level of unemployment
but in the long run we're going to face
then
lower uh lower limit employment but the
same level of
inflation so this is the cost more
unemployment that you need to you need
to face
so then uh this rational expectation
explained uh depends on how quickly
people adjust their expectation of
inflation if they change from the things
uh
that federal reserve says on the economy
says about the
cannot economy in general then is going
to be
any effort or is going to be any change
into the real economy
okay so that's basic is like more about
it's not
not a lot of questions not a a lot of
maths
just like have an idea that the core
philips where it comes from
and some some interesting idea
about what happening between the
trade-off
inflation and employment thank you so
much
see you next video bye-bye
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