A manager needs to monitor: The issues that can arise from high inflation rates and volatile inflation rates The inflation data, because it shows varying rates of change for different goods The Fed’s worries because they constitute the primary driver of monetary policy today If their company’s costs increase much faster than their product prizes
The Phillips Curve shows an inverse correlation between inflation rate and unemployment rate using data from 1861 - 1958. It implies the Fed could achieve low unemployment at the cost of high inflation.
The Phillips Curve broke down in the 1970s when Lyndon Johnson inaugurate Great Society social programs while the Fed kept interest rates low.
So is there a tradeoff between inflation and unemployment? Milton Friedman and Edmund Phelps says:
There is no long-term tradeoff between inflation and unemployment that policymakers can exploit to reduce unemployment. The Federal Reserve now has a stable policy: Keep inflation low *There is a long-term cost to high inflation
prices of inputs and outputs
It’s easier to pass on costs increases when the following is true:
Long-term contracts should often include price-adjustment clauses Adjustment clauses should be carefully drafted to insure that both parties benefit over the widest possible eventualities Inflation adjustments are commonly found in long-term resource contracts. Inflation adjustment clauses should be written with the actual government data release specified explicitly
The Consumer Price Index is not perfectly accurate, but it does a good job of showing changes in the inflation rate. For business-analysis purposes, custom-created weighted averages are usually more appropriate. Companies that need an idea of what the Federal Reserve is thinking can look at changes in the CPI and learn enough to understand the big picture. No average CPI would accurately reflect changes in production costs.
A business for whom raw materials constitute a major cost should hedge against the risk of sharp increases in the price of raw materials by:
Explain each of the following terms in your own words. The author explains the terms in the textbook. If necessary, you may also Google the term on the Web. Good resources include:
Explain the terms in your own words briefly.
Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country.
The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
The Producer Price Index (PPI) is a family of indexes that measures the average change over time in selling prices received by domestic producers of goods and services. PPIs measure price change from the perspective of the seller.
The Phillips curve is an economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship. The theory claims that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment.
Capacity utilization rate measures the percentage of an organization’s potential output that is actually being realized. The capacity utilization rate of a company or a national economy may be measured in order to provide insight into how well it is reaching its potential.
Stagflation is a period when slow economic growth and joblessness coincide with rising inflation, which means that all three macroeconomic indicators are going in the wrong direction.
Describe the characteristics of the following events briefly.
The author writes the Phillips Curve broke down in the 1970s. Elaborate. In the 1970s, there seemed to be a breakdown in the Phillips curve as we experienced stagflation - higher unemployment and higher inflation. The Phillips Curve was criticized by monetarist economists who argued there was no tradeoff between unemployment and inflation in the long run. However, some feel that the Phillips Curve has still some relevance and policymakers still need to consider the potential tradeoff between unemployment and inflation. The Phillips Curve broke down with seemingly no stable or inverse relationship. It was possible to have several inflation rates associated with a single unemployment rate.