Business Analytics - Assignment Example

Business Analytics Assignment 1 by Course: Tutor: University Department Date Due Introduction This paper intends to analyze the proposition that there exists a correlation between the rate of inflation and the level of unemployment in an economy. The first section will study the wage inflation rate plotted against unemployment rate then proceed to give the price inflation plotted against unemployment rate. Analysis of the Philips curve in both short-run and long run will be conducted. Statistical analysis of Consumer Price Indices and unemployment rate in UK will be studied. The relevant data for the analysis is sourced from Office for National Statistics. Part of the analysis will include correlation, scatter plot, and hypothesis testing. Lastly, the paper will present significance of the statistical analysis. The Philips Curve Phillips curve relates inflation to unemployment. According to the curve, inflation and unemployment have inverse stable relationship (Cashell, 2004). It means that wages tend to rise rapidly in response to lower rate of unemployment. A. W Philips developed a research paper that plotted unemployment rate against the rate of change of money wages. Data that was utilized by the researcher was for the United Kingdom from 1861 to 1931, which effectively yielded a curve of wage inflation – unemployment trade-off (Arnold, 2013). This curve is evident in figure 1. It is important to note that low unemployment is accompanied with excess demand, which causes demand-pull on wages (Jain, 2006). On the opposite side, high unemployment is followed by a diminishing wage. Figure 1: Original Philips Curve In later years, a wage inflation rate was substituted with the price inflation rate plotted against unemployment rates. The result was an inverse relationship between price inflation and unemployment as shown in figure 2. Figure 2: Philips Curve In a study by Mankiw (2011), there is no stable short run Phillips curve. It means that each short run Phillips curve indicates some level of expected inflation rate. Short run Phillips curve intersects the vertical long run Philips curve at the expected rate of inflation. In the short run, expectations remain unchanged. However, as expectations change, the outcome will be a shift in the short run Phillips curve. The long run situation is that price expectations are updated and wage negotiations takes into consideration the new information. Consequently, a given rate of unemployment is transformed to higher inflation rate. In summary, inflation is fully unanticipated in the short run hence there is a trade-off between inflation and unemployment. Conversely, inflation is fully anticipated in the long run thus unemployment remains at its natural rate. Statistical Analysis: A case study of United Kingdom In order to address the relationship between price inflation and the level of unemployment in United Kingdom, it is pertinent to analyze the data on table 1 obtained from Office for National Statistics. The data is on the rate of inflation and level of unemployment for the period starting 1988 to 2014. Office for National Statistics holds a view that consumer price inflation is utilized by the government in setting a target for inflation. Besides, CPI plays a vital role in uprating pensions, wages and benefits and gaining an understanding of impact of inflation on budgets of families. Consumer price index as well as the unemployment rate facilitates formulation of favorable economic policies (The World Bank Group, 2015). Table 1: CPI and Unemployment rate 1988 - 2014   CDID CDID CPI All Items Index: Estimated pre-97 2005=100 LFS: ILO Unemployment rate: UK: All: Aged 16-64: %: SA D7BT LF2Q seasonal adjustment seasonal adjustment NSA SA base period base period - - price price CURR CURR index period index period 2005 - Date 1988 63.5 8.6 1989 66.8 7.2 1990 71.5 7.2 1991 76.8 8.9 1992 80.1 10.1 1993 82.1 10.5 1994 83.8 9.6 1995 86 8.7 1996 88.1 8.2 1997 89.7 7 1998 91.1 6.3 1999 92.3 6 2000 93.1 5.6 2001 94.2 5.1 2002 95.4 5.2 2003 96.7 5.1 2004 98 4.8 2005 100 4.9 2006 102.3 5.5 2007 104.7 5.4 2008 108.5 5.8 2009 110.8 7.8 2010 114.5 8 2011 119.6 8.3 2012 123 8.2 2013 126.1 7.8 2014 128 6.3 Source: Office for National Statistics (2015) Scatter diagram of the data The first step is to draw a scatter diagram of inflation rate against unemployment rate using the data obtained from Office for National Statistics. Figure 3: Scatter diagram of inflation index verses unemployment rate According to the diagram, inflation rate and unemployment are negatively related. The strength of this negative relationship will be investigated in subsequent section using correlation analysis. Correlation analysis In order to establish whether there exists a correlation between rate of inflation and the level of unemployment, correlation analysis will be conducted using the data above. Correlation serves the purpose of measuring the strength of linear relationship between two variables. The result of correlation analysis conducted using excel is tabulated below. Excel correlation output: It is apparent from the outcome above that inflation and unemployment rates have a correlation of -0.2584. This shows that the two variables have a weak negative linear relationship. Excel covariance output The covariance between CPI and unemployment rate is -7.2764. This displays inverse relationship between the variables. Hypothesis test Further hypothesis test can be conducted to confirm whether there is evidence of a linear relationship between inflation index and unemployment rate. The hypothesis test is as follows: i. Null and alternate hypothesis: ii. Test statistic: iii. Significance level is . The critical values for the two-tailed test are and . We will reject the and accept the if . If , we will fail to reject the null hypothesis. iv. Value of test statistic: v. Since , we fail to reject null hypothesis. This demonstrates that there is no sufficient evidence to confirm a linear relationship between inflation index and unemployment rate at the 5% level of significance. Significance of the findings This research is significant in the sense that it informs a research of the unlikely of stagflation. In the same vein, episodes of high unemployment combined with low inflation were likely to occur. Similarly low unemployment conjoined with high inflation was likely to happen as confirmed by the scatter diagram, covariance, and correlation analysis. Moreover, it is possible for policy makers to arrive at a desired combination of unemployment and inflation by manipulating aggregate demand. Conclusion This research confirmed existence of a correlation between the rate of inflation and the level of unemployment. The level of correlation is weak and negative. This was further confirmed by a negative value of covariance i.e. -7.2764. Furthermore, the research revealed that an economy can face periods of high unemployment – low inflation and low unemployment – high inflation. Reference List Arnold, RA 2013, Economics, Mason, OH, Cengage Learning. Cashell, BW 2004, Inflation and Unemployment: What is the connection? Washington DC, Congressional Research Service. Jain TR 2006, Macroeconomics Management, New Delhi, V.K Publications. Mankiw, G 2011, Principles of Economics. Mason, OH, Cengage Learning. Office for National Statistics 2015, Consumer Price Indices, viewed 19 April 2015, www.ons.gov.uk/ons/datasets-and-tables/data- selector.html?cdid=D7BT&dataset=mm23&table-id=1.1. Office for National Statistics 2015, Unemployment rate, viewed 19 April 2015, http://www.ons.gov.uk/ons/taxonomy/index.html?nscl=Unemployment+Rates. The World Bank Group 2015, Consumer Price Indices, viewed 19 April 2015, http://data.worldbank.org/country/united-kingdom. Read More