To demonstrate Principle 10, we created the country of Britania. In this country, the federal government found different statistics using national surveys.- Unemployment Rate: 15%
- Inflation Rate: 3%
As one can see, the unemployment rates are outrageous, while the inflation rates are about average. The federal government responds by pumping in more money to the economy in hope to reduce the unemployment rate. This is the general formula that Principle 10 follows:
- Because more money is circulating around the economy, consumers get higher income are more willing to spend, thus raising the demand level.
- As consumers spend, the producers must supply more goods in order to find the equilibrium
- In order to accomodate for extra production, firms must hire more workers, lowering the unemployment rate.
- However, as a response to the lowered unemployment rates, the increased circulation causes the value of the goods to rise, causing short-run inflation.
Because of government intervention, the unemployment rates were lowered to a much more reasonable rate at the cost of rising inflation:
- Unemployment Rate: 9%
- Inflation Rate: 7%
This concept can be explained simply by using real life examples. For example, the city of Murra has a bakery, steel factory, and fruit market. Because of the limited job opportunities, many people suffer from unemployment. To meet their needs, the government provides more funds to these firms. The increased funds lead to increased income for all workers, meaning that they are able to purchase more goods.
- Before government intervention, factory workers only made $10 an hour and could only afford one piece of bread and one apple a day.
- However, because their wages have increased to $15 an hour, they are able to purchase an extra piece of bread and an orange.
- The fruit market and the bakery must accomodate for the increased demand from workers by producing more fruit and bread.
- In order to accomplish this, they must hire more workers and increase the labor force.
- Because of the extra government spending, inflation occurs in the economy.
