IB Economics 3.3.5 Relative Costs of Unemployment Versus Inflation Notes

1. Both unemployment and inflation create significant problems for an economy, but their impacts differ in severity and nature because they hit different groups through different mechanisms.
2. Understanding which cost does more damage helps policymakers make better decisions when they face trade-offs between the two, because a policy that eases one problem often worsens the other.

Costs of unemployment

1. Lost output: unemployed workers produce nothing, so the economy operates inside its production possibilities curve and real GDP is lower than it could be, meaning goods and services that could have existed are permanently forgone.
2. Reduced tax revenue: people out of work earn less, so they pay less income tax and spend less, which shrinks consumption tax receipts and weakens the government's ability to fund public services.
3. Higher welfare spending: as more people become unemployed the government must pay more in unemployment benefits and social support, so a falling tax take and a rising benefits bill together strain the budget and can push it into deficit.
4. Deskilling and long-term unemployment: the longer someone is out of work the more their job-specific skills erode and the further they fall behind industry developments, so re-employment gets harder and short-term joblessness can harden into structural unemployment.
5. Poverty, inequality and social costs: lost income pushes affected households toward poverty and widens inequality, and the associated stress is linked to worse physical and mental health and higher crime, which impose further costs on society.