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When unemployment falls below its equilibrium level, firms' human resources departments increase nominal wages to attract and retain employees. This raises the firms' costs, prompting their marketing departments to increase prices to protect the target profit margin. The resulting rise in both wages and prices reflects the conflicting claims on output between workers and owners, initiating an inflationary process.

Inflationary Consequence of Low Unemployment

An economy is operating with an unemployment rate significantly below its long-run equilibrium. Arrange the following events into the logical sequence that describes the resulting inflationary pressure.

Based on the provided scenario, explain the economic mechanism that connects the country's low unemployment rate to the accelerating increase in the general price level. Your explanation should address the motivations and actions of both firms and workers.

Analyzing an Economic Boom

During an economic boom, unemployment often falls to a very low level. Explain the process by which this situation can lead to a sustained increase in the general price level. In your answer, describe the motivations and actions of both firms and workers and how their interactions contribute to this outcome.

Explaining the Link Between Low Unemployment and Inflation

In an economy experiencing a very low rate of unemployment, businesses find it increasingly difficult to hire new staff and retain their current employees. If these businesses respond by increasing the nominal wages they offer, what is the most likely subsequent chain of events?

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