Question

Workers at a local mining company are paid $25.60 per hour, and they have incorporated a 3 percent annual raise in their contracts to account for expected inflation. Explain how unexpected inflation of 5 percent will affect the real wage and the unemployment rate. Of workers accurately predict the rate of inflation, is there a short-run trade-off between inflation and unemployment, as predicted by the Phillips curve

Answer 1

Answer:

Inflation simply explained is the increase in the prices of items over time. A higher inflation means higher rise in prices. In this case if the inflation rate is greater than the expected inflation rate (5% instead of 3%), the actual real wage will be less than $25.60.

The unemployment rate will decrease as workers have been relatively cheaper and the firms will also gain from the excess supply of cash due to unexpected higher inflation, and firms will higher more.

There will not be a trade off between inflation and unemployment if workers are able to perfectly adjust their inflation expectations.

Answer 2

Answer:

Since the inflation rate is higher than expected, the real wage will decrease by 2% (inflation rate - wage increase). This means that hiring workers will be cheaper. Since the price of labor will decrease, the quantity demanded of labor should increase.

The Phillips curve shows an inverse trade off in the short run between inflation rate and unemployment rate. A higher inflation rate will result in a lower unemployment rate, and that is exactly what should happen in this case.