The short-run trade-off between inflation and unemployment

Meaning of a trade-off. Because resources are scarce and have other uses, getting more of one thing usually means accepting less of another; this is a trade-off, and what is given up is the opportunity cost of the choice. Governments face trade-offs between their own goals too, as when a policy that makes incomes more equal weakens the reward for hard work and so lowers efficiency.

The two evils.

• Inflation is a sustained, steep rise in prices; it lowers the real income and purchasing power of people on fixed or low incomes.
• Unemployment means people who want work cannot find it, as when job seekers grow faster than jobs do; it lowers production and income.

Society would like both to be low at once.

The trade-off stated. One of the ten principles of economics is that society faces a trade-off between inflation and unemployment in the short term: a policy that brings unemployment down tends to push inflation up, and a policy that brings inflation down tends to raise unemployment. A related principle is that prices rise when the government creates too much money.

Why it arises.

• Lower unemployment, higher prices. Suppose the government puts more money into the economy and spending rises. Spending on goods is demand backed by purchasing power. In a market where supply is unchanged and the number of firms is fixed, a rightward shift of demand raises both the equilibrium price and the quantity sold. To produce the larger quantity, firms need more factor services, including more workers. So more jobs come with higher prices.
• Lower inflation, more unemployment. If money and spending are cut back to curb rising prices, demand shifts to the left; with supply unchanged and a fixed number of firms, equilibrium price and quantity both fall. Firms then need fewer workers, so slower price rises come with fewer jobs.
• Example (our own): if a large rise in government spending lifts orders for garment units in Tiruppur, they take on more workers, but the same surge in spending also pushes up the prices of cloth, food and rent; if spending is then reined in to cool prices, orders fall and some of those workers lose their jobs.

Conclusion. In the short term, policymakers usually cannot push down inflation and unemployment together: a lower rate of one is bought with a higher rate of the other, and choosing between them is a trade-off like any other, with its own opportunity cost.