Relationship between inflation and unemployment

One of my Year 12 AS Economics students asks what is the relationship between inflation and unemployment. The first theory that springs to mind is the Phillips curve but this is generally not expected on the OCR AS economics course.

At AS I'd expect students to use a standard AS- AD diagram to show any link between inflation and unemployment. For instance,an increase in AD causes short run economic growth. Higher output requires more labour so unemployment falls. 

However given spare capacity in the upward sloping shape of the AS curve beyond Y1 (due to shortages and bottlenecks in key industries), the increase in AD results in a rise in the price level from P1 to P2, thus exerting inflationary pressure.

So an increase in aggregate demand results in inflation and reduce unemployment.  

However, does a fall in unemployment always coincide with inflation? No. Any increase in real GDP up to Y1 results in more output and less unemployment but with a constant price level - there is non-inflationary growth

So like so many things in economics, falling unemployment may or may not be associated with inflation depending upon assumptions eg the starting position and the price elasticity of aggregate supply.

The above analysis suggests that unemployment and inflation can be linked but the cause an increase in AD. any relationship between unemployment and inflation is best analysed using the Phillips curve - an A2 topic

Revision video: the current account

Here is a revision video of all the elements of the current account with minimal coverage of the capital and financial account. Watch in conjunction with the ONS The current account balance video

Revision video: Using AD-AS diagrams to answer extended questions

In this video I develop Revision video: using AD-AS diagrams to analyse economic performance to see how to use AD-AS diagrams to answer extended questions set by OCR in Macroeconomics F582.

OCR typically set three types of last question

·         Discuss whether a policy (SS) or policy instrument (R, $/£) can affect: a component of AD (C & I) | an economic indicator eg economic growth | an economic objective eg low and stable prices | economic performance eg GDP and inflation

·         Discuss whether a change in a factor influencing a component of AD can affect a performance indicator eg inflation

·         Discuss whether a change in an indicator of economic performance (economic growth, inflation) is beneficial (do benefits outweigh costs)

NB: R affects I; I affects both AD and AS | G on infrastructure and education affects both AD and AS

Evaluation: L3 assumes cet par – what if there is an unexpected event| is a variable eg R the most important | depends on starting position ie capacity | impacts vary between time periods 

Revision video: using AD-AS diagrams to analyse economic performance

This video explains the link between changes in AD and AS and economic performance using AD-AS diagrams. Key assumption: spare capacity

OCR set three types of last question in F582:

·         Discuss whether a policy (SS) or policy instrument (R, $/£) can affect: a component of AD (C & I) | an economic indicator eg economic growth | an economic objective eg low and stable prices | economic performance eg GDP and inflation

·         Discuss whether a change in a factor influencing a component of AD can affect a performance indicator eg inflation

·         Discuss whether a change in an indicator of economic performance (economic growth, inflation) is beneficial (do benefits outweigh costs)

NB: R affects I; I affects both AD and AS | G on infrastructure and education affects both AD and AS

Evaluation: L3 assumes cet par – what if there is an unexpected event| is a variable eg R the most important | depends on starting position ie capacity | impacts vary between time periods 

Real disposable income revision graphic

The level of real disposable income determines how much households can afford to spend and so affects consumption, hence AD

Labelling exchange rate diagrams

Here is a tip for remembering how to label the axis of exchange rate diagrams

Horizontal axis: measures quantity of currency traded eg number of € bought and sold

Vertical axis: measures the price of a currency ie how much of another currency eg $ one unit of domestic currency eg € can buy

Here is an example for Euro exchange rate diagram against the $

Revision video : analysis of a depreciation of sterling

Here is a revision video analysing the impact of a depreciation of sterling on AD and the current account.

The Marshall Lerner condition is only required for A2

Analyse the effect privatisation on economic growth [4]

Answers in economics exams are best written with short sharp clear sentences making appropriate user connectives. Typically you have just 2 lines to earn one mark.

Comment on whether an increase in the rate of interest reduces investment

Six mark OCR comment questions have 12 lines in the exam paper for an answer. Use short sharp concise sentences with appropriate connectives

Question source: OCR F5812 June 2013

Factors affecting C I G and X-M

Remember: the AD curve will shift if C I G or X-M change. C I G and X-M will change if any of the above factors change.