Philips Curve Nino Bazhunaishvili

A.Wiliam Philips

Wiliam Philips a New Zealand born economist , wrote a paper in 1958 titeled The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom from 1861 to 1957, and he found a consistant inverse relationship: when unemployment was hight, wage increased slowely; when unemployment was low, wage rose rapidly.

Philips Curve

The Philips curve represents the relative relationship between the rate of Inflation and The Unemployment rate.

Unemployment is considered low or high relative to the so-called natural rate of unemployment. Inflation is considered low or high relative to the expected rate of inflation.

Philips Curve

The Phillips curve must pass through that point on the graph at which actual inflation is equal to expected inflation, and at which the actual rate of unemployment is equal to the natural rate of unemployment.

Any shift in the natural rate of unemployment (and the natural rate of unemployment can shift) will shift the Phillips curve to the left or the right. Any shift in expected inflation (and expected inflation does shift) will shift the Phillips curve up or down.

The basic Phillips Curve idea – economic trade-offs

• In 1958 AW Phillips from whom the Phillips Curve takes its name plotted 95 years of data of UK wage inflation against unemployment. It seemed to suggest a short-run trade-off between unemployment and inflation. The theory behind this was fairly straightforward. Falling unemployment might cause rising inflation and a fall in inflation might only be possible by allowing unemployment to rise. If the Government wanted to reduce the unemployment rate, it could increase aggregate demand but, although this might temporarily increase employment, it could also have inflationary implications in labour and the product markets.

• The key to understanding this trade-off is to consider the possible inflationary effects in both labour and product markets arising from an increase in national income, output and employment

Explaining the Phillips Curve concept using AD-AS and the output gap

LRAS

Diagram shows the original short-run Phillips Curve and the trade-off between unemployment and inflation

NAIRU

New theories, such as rational expectations and the NAIRU (non-accelerating inflation rate of unemployment) arose to explain how stagflation could occur. The latter theory, also known as the "natural rate of unemployment", distinguished between the "short-term" Phillips curve and the "long-term" one. The short-term Phillips Curve looked like a normal Phillips Curve, but shifted in the long run as expectations changed. In the long run, only a single rate of unemployment (the NAIRU or "natural" rate) was consistent with a stable inflation rate. The long-run Phillips Curve was thus vertical, so there was no trade-off between inflation and unemploymen.

Philips Curve

A Shallow Philips Curve

A Steep Philips Curve

Expectations and modern view of PC

People won’t correctly anticipate the rate of inflation particularly if there is an abrubt change in the rate. Within the expectations framework it is the difference between the actual and expected inflation rate that will influence output and employment.

Philips Curve Formula

π=π-1+α(y-ye)

It is a measure of the price reaction to excess output,as follows:

y(e) is the equilibrium level of national income [which stands for employment, output, etc]y is the prevailing level of national income etc which may be above or below the equilibrium levela is a mathematical constant that determines the fit of data to a Phillips curveπ is the current price level and π-1 was the price level in the previous period.

Philips Cure Formula

If y exceeds y(e), that level of national income cannot be sustained without creating inflationary pressures, so that α(y-ye) will be positive and π will exceed π-1 Prices are rising .

If y(e) exceeds y, that level of national income is below the equilibrium level and here will be deflationary pressures created from unemployment, under-production and so on. And so α(y-ye) will be negative and π will be lower than π-1 Prices are falling

Resources:

http://in.answers.yahoo.com/question/index?qid=20091028041351AAqVCum http://tutor2u.net/economics/revision-notes/a2-macro-phillips-curve.html

http://books.google.de/books?id=yIbH4R77OtMC&pg=PA322&lpg=PA322&dq=expectations+and+modern+view+of+phillips+curve&source=bl&ots=Ph0DEYo8bl&sig=INkHf74j3K1KdUGMQWCVrJjmoZ8&hl=de&sa=X&ei=Pm-vT9jiIqX54QTD4YS9CQ&ved=0CHEQ6AEwBA#v=onepage&q=expectations

%20and%20modern%20view%20of%20phillips%20curve&f=false

http://tutor2u.net/economics/revision-notes/a2-macro-phillips-curve.html

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