Stagflation exists when prices
a. and output rise.
b. rise and output falls.
c. fall and output rises.
d. and output fall.
The correct answer and explanation is :
The correct answer is:
b. rise and output falls.
Explanation:
Stagflation is an economic condition that is characterized by a combination of high inflation and high unemployment (or stagnation in output). It represents an unusual and unfavorable scenario for an economy because inflation and unemployment typically have an inverse relationship (as suggested by the Phillips Curve). In stagflation, both of these economic indicators worsen simultaneously, making it a complex problem for policymakers to address.
Here’s a breakdown of the two main components of stagflation:
- Rising Prices (Inflation): In a stagflation scenario, the general price level in the economy increases, meaning consumers experience higher costs for goods and services. This could happen due to supply-side shocks (e.g., an increase in oil prices, disruption in supply chains, or rising raw material costs), which push prices up across various sectors. As costs rise, producers often pass these increased costs onto consumers, which drives inflation.
- Falling Output (Economic Stagnation): Simultaneously, the economy experiences stagnation or a decline in output, leading to higher unemployment rates. When businesses face rising input costs and reduced consumer spending due to higher prices, they may cut back on production, leading to a slowdown in economic activity. This creates a situation where the economy is not growing or is even contracting, causing an increase in unemployment.
The classic example of stagflation occurred during the 1970s when a series of oil price shocks led to rising costs for many goods and services while simultaneously triggering a period of economic stagnation in many advanced economies, particularly in the United States.
Stagflation is problematic because the usual tools for combating inflation (raising interest rates) may worsen unemployment, while measures to reduce unemployment (such as increasing government spending) might worsen inflation. Therefore, addressing stagflation is particularly challenging for policymakers.