(a) Explain whether there is a relationship between inflation and unemployment. Should government interfere and reduce inflation and unemployment? Provide real life examples.
(b) Using your home country as a case study outline and analyse inflation, unemployment and growth trends. Identify what range of the aggregate supply curve your country is operating in.
(c) Explain how monetary policy can influence an economy, including the exchange rate and employment levels.
i. Relation between inflation and unemployment:
Inflation stands for the rise in prices of various goods and commodities due to various factors such as increased in money supply, rising demand for goods and decreasing supply of good. This way inflations results in increase price level of goods making them dearer. Unemployment means the decrease in opportunities to earn money at the existing wage rate. This way unemployment results in declining jobs and decreasing wage rates (Atkinson & Miller, 1998).
The relation between inflation and unemployment as per the Philip curve is negative. That is with the rise in unemployment there is substantial fall in inflation and vice versa. This means that when people are offered jobs, they get disposable income in their hands for regular requirements. With the promotions the disposable income raises leading to more expenditure. However there may exist diminishing marginal returns to utility as the person may be earning good income earlier. The result is that people have more money in their hands and they spend extravagantly. The outcome is price hikes leading to inflation. With more employment opportunities and more disposable income available, people tend to spend more leading to inflationary effects that comes into action. This way rise in demand at present supply level leads to rise in prices causing inflation (Atkinson et al., 1998).
On the other hand if their exist less disposable income with the people due to low wage rate and increased unemployment, the prices of goods will also fall down. That is decrease in demand at present supply level will result in price decline. This way unemployment leads to decreasing money movement in the market. Savings are less and people spend mostly on necessities. Result is decline in demand and therefore the inflationary affects also face a setback (Begg & Ward, 2003).
Government interference stands for controlling business activities. That is government makes efforts through directions and regulations to control the free market conditions, business participation and regular business activities to control economic conditions of the country. The main motive is to work for the welfare of the people. The government interference is however argued to be restricted as they may cause various problems to the economy and businesses (Atkinson & Miller, 1998).
Thus the government interference should be restricted up to some extent. That is, instead of taking controls over the market, the government expenditures should be made for the public welfare processes. This includes building roads, hospitals, schools and colleges etc. With expenditures on the public utilities the government can give support to the normal living of all the citizens in the country (Butkeviciene et al., 2008).
iii. Need of government interference:
Government should interfere and reduce inflation and unemployment because of the following reasons.
A. Interference for reducing inflation:
Thus government should make efforts to keep a control over the pricing of essential goods. Moreover the minimum rates for the necessities will be fixed so that the businesses cannot take advantage of stock piling and lesser supply. Finally the quality assurance is fixed so that every product sold in market meets the food related guidelines and requirements (Dornsbusch, 2002).
B. Interference for reducing unemployment:
Thus government should invest in projects which promise to generate employment opportunities for number of people. Also the unemployed should be guided towards the job by government offices. In some countries unemployment allowance is also given so that the unemployed could at least meet their necessary requirements for living. Government should interfere and reduce inflation and unemployment because of the following reasons (Lash & Urry, 1994).
It has been proved at various times that the government intervention is a disguised blessings for the economy and its citizens. During the first economic slowdown in year 1929, the economies faced a set back and the governments were finding ways to bring market stimuli through application of new financial projects. The British government took the step of making rail lines so that the money movement can be started. This resulted in bringing employment opportunities for various people and hence government interference helped in bringing back the economy from complete stagflation phase (Layton & Robinson, 2014).
Various other examples of government interference helping us in the present day world include the followings.
i. Unemployment rate in Australia:
The unemployment rate has declined in Australia in December 2014 to 6.10 percent as against 6.20 in November 2014. However the overall unemployment rate is much higher as against 4 percent in February 2008. As per the data retrieved from the Australian Bureau of Statics, the following graph of Australian unemployment rate and the recent trend can be shown.
(IECONOMICS, 2015)
From the above diagram, we can clearly analyses that the unemployment rate is on an average of 6 percent. This trend of rise in unemployment has been observed since 2008, when the economic slowdown affected the economies around the world.
ii. Inflation rate in Australia:
The inflation rate has been rising but at a diminishing rate, year on year basis, in Australia in the recent years. The rate of inflation on January 2014 was 2.7 as against 1.2 on December 2012. This shows the trend of economy improvements in the country. This trend has continued to grow as the inflation rate showed consistent rise until July 2014 by reaching to 3 but again a fall has been recorded which brought it back to 2.3 in October 2014.This can be shown as below.
(IECONOMICS, 2015)
iii. Growth trends:
The growth trends includes the imports, exports, currency rates, GDP, unemployment rate and various other factors that depicts the financial position of the country and its economic growth. The growth trend in Australia as on September 2014 is discussed as follows.
This way an overall average growth trend is observed till date. The growth rate has improved from -0.5 in January 2011 to 1.2 in March 2014. However a steep fall has been observed later which brought it down to 0.25 until the start of October 2014 (IECONOMICS, 2015). This information can be displayed as below.
(IECONOMICS, 2015)
This way the overall features of Australian economy can be concluded as follows.
(IECONOMICS, 2015)
iv. Relation between inflation, unemployment and growth:
Inflation, unemployment and growth are all interconnected with each other. Inflation results in rising prices on the one side but on the other side signals the presence of good employment opportunities in the market. It confirms that people have extra disposable income which is supporting the inflationary effects in the market. This way inflation is a sign of economic growth and prosperity. However the reverse of inflation that is deflation is a sign of economic slowdown. The prices of goods and services decline when their demand declines. The demand for goods decline when people do not have extra disposable income. This mostly happens when there is no job or decline in pay scale. This way deflation shows that the economy is contracting and the unemployment level is rising which is causing the reverse of inflation.
The best method to achieve high level benefit for the country is through achieving a definite level of inflation in the economy. In Australia there is a target of achieving 3% inflation based on year on year basis. The government through its yearly policies decides on market stimuli methods so that the economy can be supported by boosting the investment and hence helping movement of money in the market. Various projects and plan are developed overtime to enhance the employment opportunities and achieve a definite level of inflation in the market. This way an estimate growth is expected to be achieved over time.
v. Aggregate supply curve of Australia:
Aggregate supply curve consists of Gross Domestic Product or GDP related information at various price levels. The Aggregate supply for Australia consists of the following features.
An increase of GDP has been recorded in year 2013 at 1561$ billion as against 1532$ billion in year 2012. However the annual growth rate is consistent at 2.7 in year 2014 and 2013. The GDP growth rate however has decline to 0.3 in year 2014 as against 0.5 in year 2013. This information can be displayed as below.
(IECONOMICS, 2015)
In addition the Gross national product is rising at 379020 AUD millions. On the other hand, the Australian Gross Fixed capital formation is falling at 103088 AUD million. The Money supply is rising at 310804 AUD million. At present the aggregate supply curve that is operating in the country is stated as below.
(IECONOMICS, 2015)
vi. Range of supply curve Australia is operating:
A. Short Run Aggregate Supply curve:
The aggregate supply curve stands for the volume of goods and services that are actually produced in an economy at the specific price levels. The aggregate supply curve shows contraction of supply when the GDP falls and expansion when the GDP rises. This can be depicted as below.
At present the Australian Economy is operating at the low level expansion of aggregate supply. This is because of adverse effects of the global slowdown that the economy even after various economic boosts and government policies is not able to improve its present economic conditions and achieve sustainable economic growth.
B. Long Run Aggregate Supply Curve:
The long run aggregate supply curve changes when there is a natural growth of output that affects the supply. The various factors that affect change in the long run aggregate supply curve include increased productivity, improvement in efficient, enhanced output, increase in stock etc. The shift in the Long run Aggregate supply curve takes places as follows.
This way an increase in long run supply curve results in increase in Real National Income and vice versa.
(Perloff, 2001)
i. Monetary Policy and its influence on economy:
The monetary policy actually consists of government policy and influence towards the movement and use of funds by the various financial organizations. The financial organizations are banks and other agencies that offer credit to the people at a specified rate. Through monetary the interest rates that has been charged on the loan applier is fixed. Thus efforts are made to give a fair deal and terms of taking loan that is offered to the public. On the other hand, the investors who deposit their money in the banks are also offered interest so that they get minimal return on their investment. A percentage difference is set between the interest charged from loan applicants and the interest disbursed to the investors so that the banks can earn profits and manage their administrative expenditures accordingly (Marrewijk, 2007).
This way an effort is made to control the supply of money in the market. That is with the excess supply of money the disposable income with the public increases and that will result increasing expenditures and leading to inflation. On the other hand if the supply of money decreases the demand for goods declines and thus declines the inflation making the goods available at low prices (Marrewijk, 2007).
ii. Monetary Policy and exchange rate:
The exchange rate is actually the international market rate of currency which is fixed by the market forces. At this price the currency is exchanged in the foreign market. The monetary policy affects the exchange rate. Actually the monetary policy can reduce interest rates and this results in making easy available of capital in the market. Thus the domestic financial and capital assets including bonds, real estates and stock becomes less attractive. This will certainly affect the rate of returns on foreign investment. The final outcome will be that the foreign investors will sell out their share and will not demand for that particular currency for future investment. This way the exchange rate of the currency will fall due to the interest declining steps taken through the monetary policy. The domestic investors also will start looking toward international boundaries for future investment and thus will decline the investment in the country. Overall the demand for the currency will fall which will adversely affect the currency exchange rate. On the other hand when the interest rate raises the domestic financial and capital assets become dearer thereby increasing the value of investments of foreign investors. Thus they can demand more currency for investment which will result in increasing foreign exchange price of that country (Mahadevan, 2004).
The outcome of the faulty monetary policy on the foreign exchange rate can be identified as follows.
(Layton & Robinson, 2014)
iii. Monetary Policy and employment levels:
Employment levels stands for the numbers of deserving candidates getting jobs. The employment level is affected by the monetary policy as well. With the fall in the interest rates the availability of funds to the public will increase. This will result in increasing investment in the economy that will automatically produce more employment opportunities as the factors of production will be deployed for the production purpose including labor. Thus the people who participate in the production process will get employment and earn good income. People will save less and invest more to create new business opportunities. On the other hand if the interest rates increase than the funds available at loan will get dearer. There will be lesser entrepreneurial spirit and investment that can be observed in the economy. People will save more in the banks as the returns from investment are higher and safe than investing them in capital market. There will no investment or business set up leading to no employment opportunities and increasing unemployment levels (Atkinson et al., 1998).
The outcome of faulty monetary policy on employment will be as follows.
(Dornsbusch, 2002)
This way the monetary policy is the backbone of every economy. A faulty monetary policy can lead to huge loss to the economy. On the other hand, the correct monetary policy can help in achieving various high level gains and profits to the economy. Therefore there is a need to develop a monetary policy that could benefit the nation and its citizens as well.
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