When the unemployment rate drops below the natural unemployment rate,

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The natural unemployment rate is the level of unemployment that is consistent with full employment, indicating that all individuals who are willing and able to work at the going wage rate are employed. When the unemployment rate drops below this level, it suggests that the labor market is becoming tight, and firms are having difficulty finding workers to fill open positions. As a result, wages may increase, and firms may start to compete more fiercely for labor, pushing up the cost of production. This, in turn, can lead to an increase in prices and inflationary pressures. One consequence of firms competing for labor is that they may raise wages and offer better benefits to employees to retain them, and as they raise their costs, they pass on this increase to consumers in the form of higher prices for goods and services. This is why when the unemployment rate drops below the natural unemployment rate, it signals that real GDP is rising above potential GDP as firms are producing more to meet the growing demand.

When the Unemployment Rate Drops Below the Natural Unemployment Rate