A.Wiliam Philips Wiliam Philips a NewZealand born economist ,wrote a paper in 1958titeled The Relationbetween Unemploymentand the Rate of Changeof Money Wage Rates inthe United Kingdom from1861 to 1957, and he founda consistant inverserelationship: whenunemployment was hight,wage increased slowely;when unemployment waslow, 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 passthrough that point on the graphat which actual inflation isequal to expected inflation, andat which the actual rate ofunemployment is equal to thenatural rate of unemployment. Any shift in the natural rateof unemployment (and thenatural rate of unemploymentcan shift) will shift the Phillipscurve to the left or the right.Any shift in expected inflation(and expected inflation doesshift) will shift the Phillips curveup 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 Curveconcept using AD-AS and the output gapLRAS Diagram shows the original short- run Phillips Curve and the trade-off between unemployment and inflation
NAIRU New theories, such asrational expectations and the NAIRU (non-accelerating inflation rate ofunemployment) arose to explain howstagflation 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 likea normal Phillips Curve, but shifted in thelong run as expectations changed. In thelong run, only a single rate ofunemployment (the NAIRU or "natural"rate) was consistent with a stable inflationrate. The long-run Phillips Curve was thusvertical, so there was no trade-offbetween inflation and unemploymen.
Philips Curve A Steep Philips CurveA Shallow Philips Curve
Expectations and modern view of PC People won’t correctlyanticipate the rate of inflationparticularly if there is an abrubtchange in the rate. Within theexpectations framework it is thedifference between the actualand expected inflation rate thatwill influence output andemployment.
Philips Curve Formula π=π-1+α(y-ye)It is a measure of the price reaction to excess output,asfollows:y(e) is the equilibrium level of national income [which standsfor employment, output, etc]y is the prevailing level of national income etc which may beabove or below the equilibrium levela is a mathematical constant that determines the fit of data toa Phillips curveπ is the current price level andπ-1 was the price level in the previous period.
Philips Cure FormulaIf y exceeds y(e), that level of national income cannot be sustainedwithout creating inflationary pressures, so that α(y-ye) will be positiveand π will exceed π-1 Prices are rising .If y(e) exceeds y, that level of national income is below the equilibriumlevel and here will be deflationary pressures created fromunemployment, under-production and so on. And so α(y-ye) will benegative and π will be lower than π-1 Prices are falling