One factor that explains the short-run tradeoff between inflation and unemployment is labor contracts that fix wages for an extended period of time.

Question

Quizplus · Accepted Answer

When wages are fixed for an extended period of time through labor contracts, it becomes difficult for firms to adjust to changes in the market such as inflation or economic downturns leading to unemployment. Inflation reduces the real value of fixed wages which discourages employers from hiring new workers, leading to an increase in unemployment. Conversely, during times of low inflation or deflation, real wages increase without having to renegotiate labor contracts, encouraging firms to hire more workers, leading to a decrease in unemployment. Thus, labor contracts play a role in the short-run tradeoff between inflation and unemployment.

One Factor That Explains the Short-Run Tradeoff Between Inflation and Unemployment