Why does a decrease in unemployment lead to more inflation?

Question

Why does a decrease in unemployment lead to increased inflation? And vice versa. Forgive me if my question sounds dumb; i haven't taken econ in a while and have forgotten some things. Just want to hear your thoughts. Thanks!

Answer 1

decrease in unemployment means an increase in employment... an increase in employment mean that newly employed would now demand more leading to increased aggregate demand... this increased aggregate demand means a rise in demand pull inflation...

also this can be proved by the Philips curve... according to that an increase in unemployment means a decrease in inflation and vice versa... its because both of them share an inverse relationship.

Answer 2

Actually, it doesn't seem to.

We have more unemployment right now, and more inflation.

There may be some silly economic theory that suggests that there is this linkage, but in the modern world inflation roars on while jobs decline.

Can you show it to be otherwise?

Answer 3

When the unemployment rates drop significantly that means companies are hiring.  As the pool of potential employees dwindles you have more competition for the available work force.  More competition translates into higher wages since companies only have wages to offer to entice workers. Eventually you could even be close to full employment, meaning there is a labor shortage and potential employers start enticing labor that is employed at other companies to leave there jobs in order to get the higher wages being offered. Eventually this additional labor cost will be reflected in prices for the good or services that the employees produce.  

Note that when I refer to full employment you need to understand there is always a small amount of unemployment to reflect people transitioning from one job to another, so full employment does not mean an unemployment figure of 0%.

A good rule of thumb is that whenever a factor of production is in short supply it puts upward pressure on inflation.  Factors of production would include labor force, energy, commodities, etc. In other words unemployment is only one thing that influences inflation.

Answer 4

More jobs means more people with disposable income.  More disposable income means more money in circulation so price inflation begins to occur.  

This is always necessitated though.  Say for instance, the decline in high paying silicon valley jobs  after the dot com bubble.  To be replaced by more low paying jobs.  Which was a net savings for companies.  So income levels also play a large factor in how much inflation occurs from added employment.