Inflation, unemployment, growth - Economics IB Study Notes

Inflation is the sustained rise in the general price level of goods and services over time, measured by the Consumer Price Index (CPI) or Retail Price Index (RPI). Inflation erodes purchasing power—£100 today buys less than it did a year ago. The inflation rate formula is: (CPI₂ - CPI₁) / CPI₁ × 100.

Unemployment represents individuals actively seeking work but unable to find employment. The unemployment rate = (Number unemployed / Labour force) × 100. Types include: structural (skills mismatch), frictional (job transitions), cyclical (recession-related), and seasonal (time-dependent industries).

Economic growth measures the percentage increase in real GDP over time: Growth rate = [(Real GDP₂ - Real GDP₁) / Real GDP₁] × 100. Real GDP adjusts for inflation, unlike nominal GDP. Growth indicates rising living standards and productive capacity.

The Phillips Curve shows the inverse relationship between inflation and unemployment—lower unemployment often correlates with higher inflation due to wage pressures. However, stagflation (1970s phenomenon) proved this relationship can break down.

Natural Rate of Unemployment (NRU) is the equilibrium unemployment level when the labour market clears, comprising frictional and structural unemployment only. Full employment doesn't mean zero unemployment but unemployment at the NRU (typically 3-5%).

Key Formula: Real GDP = Nominal GDP / Price Index × 100

Understanding these interconnected concepts is essential—they form the macroeconomic objectives governments pursue through fiscal and monetary policy.

Think of inflation like water slowly filling a bathtub—prices gradually rise, and your money's purchasing power drains away. Demand-pull inflation occurs when aggregate demand exceeds supply (too much money chasing too few goods). During COVID-19 recovery (2021-2022), pent-up consumer demand collided with supply chain disruptions, causing global inflation to surge above 9% in the UK.

Cost-push inflation happens when production costs rise—like Russia's 2022 Ukraine invasion spiking energy prices, forcing businesses to pass costs to consumers. Venezuela experienced hyperinflation (1,000,000%+ in 2018) from excessive money printing, rendering currency worthless—citizens needed wheelbarrows of cash for bread.

Unemployment manifests differently across economies. Spain's youth unemployment hit 55% post-2008 crisis (structural—education didn't match job requirements). Seasonal unemployment affects UK tourism workers who face joblessness each winter. Cyclical unemployment spiked during 2008-09 recession when aggregate demand collapsed—UK unemployment reached 8.5%.

Economic growth transforms lives. China's 10% annual growth (1980-2010) lifted 800 million from poverty. Conversely, Japan's lost decade (1990s) saw near-zero growth, creating deflationary spirals and economic stagnation.

The trade-off appears when central banks raise interest rates to combat inflation—cooling demand but risking recession and unemployment. The Bank of England faced this dilemma in 2022-23, hiking rates to 5.25% to tackle 11% inflation, accepting slower growth as necessary medicine.

Real-world connection: Zimbabwe's 2008 hyperinflation reached 89.7 sextillion percent monthly—prices doubled every 24 hours, destroying the economy.