Holt 7525-9 S15_IT

Chapter 4 Inflation and Unemployment
The basic economic problem is scarcity. Human wants are unlimited. Resources are limited. The
basic goal in dealing with the problem of scarcity is to produce as much consumer satisfaction as
possible with the limited resources available.
Success or failure in achieving this basic goal depends not only on the efficiency or inefficiency of
particular markets and industries, but also on the performance of the overall economy. The
performance of the overall economy can vary significantly from year to year.
Three Macroeconomic Goals
Macroeconomics is the branch of economics that focuses on overall economic behavior. Any
society will have certain overall (macroeconomic) goals as it deals with the basic economic
problem of scarcity. Three macroeconomic goals that societies wish to achieve are:
1. Price level stability
2. Full employment
3. Economic growth
Achieving each of these three goals will contribute to the basic goal of producing as much
consumer satisfaction as possible with the limited resources available. These three goals, and
how they are measured, are the primary topics in this chapter and the next.
Inflation
In pursuing the goal of price level stability, the primary concern generally is to avoid inflation (or at
least to keep the inflation rate low).
Inflation – an increase in the price level.
The price level does not refer to the price of only one good or service. If the price of donuts
increases, that doesn’t mean that the price level will increase. The price level refers to the
weighted average of the prices of all goods and services.
Example 1: A late frost in Florida may cause an increase in the price of oranges. It is necessary
that the prices of individual goods be free to adjust to changes in demand and supply in order to
avoid shortages and surpluses. This is not inflation, but simply a price adjustment for one good. If
the prices of goods and services in general are rising, this is inflation.
The Price Level, Money, and Production
The price level in an economy depends on the relationship between the quantity of money spent
and the quantity of products purchased in the economy. If the quantity of money spent increases
relative to the quantity of products purchased, the price level will increase. If the quantity of
money spent decreases relative to the quantity of products purchased, the price level will
decrease.
Example 2: On Gilligan’s Island, the castaways produce what they can each day, and then the
day’s production is auctioned to the high bidders. Each of the seven castaways is allowed to
spend 10 units of money (Gills) on Days 1 through 4. On Days 5 through 7, each castaway is
allowed to spend 20 units of money.
The table on the next page shows, for each day, the quantity of money spent, the quantity of
products purchased, and the price level. The price level is determined by dividing the quantity of
money spent by the quantity of products purchased. If 70 Gills will buy 7 products, the price level
is 10.
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4 - 1 Inflation and Unemployment