A manager needs to monitor inflation within the economy because high inflation can lead to a recession and profit squeezes. In order to keep your business running smoothly and generating profits you must keep a close eye on inflation. Understanding how prices on goods and services as well as how the federal reserve tries to handle inflation in there own way leads to a succesful manager and business.
The Phillips Curve shows an inverse correlation between () and () 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:
Even if there are no short run trade off between inflation and unemployment there is a long-term cost to high inflation. With high volatility in inflation rates it makes banks and business persons weary about making long term decisions which results in slower rates of growth. This makes the federal reserve try and keep inflation low. There is in fact no long-term trade off between inflation and unemployment.
prices of inputs and outputs
It’s easier to pass on costs increases when the following is true:
Long term contracts should include price-adjusted clauses that will benefit both parties. This will reduce the risk that entails in these long term contracts for both sides. Adjustment clauses should also be carefully drafted to again make sure both parties benefit regardless of what will happen in the economy. This takes a lot of work but if done right it will ensure both parties benefiting and nobody losing a signifigant amount.
Contradictory to consumer beleif the consumer price index is a good measure of inflation in the fact that if it rises from 3 percent to 5 percent, inflation may not be 5 percent, but inflation did most likely rise 2 percent. This lets companies look at the CPI and learn enough from it to get a visual of the big picture happening in the economy. For business-analysis, business created weighted averages are ususally a better idea than using the CPI.
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:
Explan 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.
An increase in prices and fall in the purchasing value of money.
All goods and services that are typically bought by urban consumers.
Goods sold by manufacturers or wholesalers that are finished goods (not services).
The relationship between unemployment and the rate of inflation.
The relationship between the output being produced with the given resources and the potential output that can be produced if capacity was fully used.
stagflation is when the economy has slow groth, high unemployment, and rising prices.
Describe the characteristics of the following events briefly.
The author writes the Phillips Curve broke down in the 1970s. In the 1970’s we experienced stagflation where there was higher unemployment and higher higher inflation. This led to the philips curve being criticized because economists argued that there was no trade off between unemployment and inflation in the long run. This is still debated amongst economist where some believe the phillips curve has relevance and some do not.