Thursday, 19 March 2009

Phillip Curve

Phillip Curve shows the relationship between level of unemployment and level of inflation. It is a trade-off between them, which means that if there is a rise in unemployment, therefore it would be a fall in inflation rates and vice versa.
When there is an increase in unemployment rates, more people now are not spending much as before. Therefore it could be a decline in the consumption, which is one factor, determined the aggregate demand. The rate of unemployment strongly depends on the aggregate demand. So a raise in unemployment rate would lead to a fall in aggregate demand and therefore, the rate of inflation will be reduced.

However, this model is not always true. It can’t explain the situation of the economy when there is a stagflation, which means that there is slower economic growth (or recession) combine with higher level of unemployment. So that new model has introduced base on the idea of Phillip Curve to explain it.Supposing the rate of inflation is now at 0, and therefore the rate of unemployment is at U. After time, the government realised that it is a high level of unemployment and they want to intervene to fix it. What they might do is to boost the demand for the market. After intervention, the unemployment rate is improved, it contracts from U to V. As there is a rise in demand, the inflation rate will increase as there is a rise in price level. Therefore prices get higher, and workers now required a higher real paid for their works.

However as there is a rise in their wages, workers now realised that their increase is just a nominal increase, therefore they might stop supply more labour and the output will return to its original. And finally, in the long run of Phillip Curve, there is a rise in inflation but a sustained in level of unemployment.

But.....
If inflation rises then exports become uncompetitive and so they fall. Exports are injections so AD falls which means unemployment raises.
If there is inflation then demand for Imports will rise and so leakages increase and so...unemployment rises.
If unemployment is low then exchange rates are high which makes imports competitive, exports not so...so unemployment raises.
So, really, inflation is high and unemployment is high; inflation is low and unemployment is low.
The exact opposite.
Or is this wrong...?
.... Absolutely true ...

1 comment:

chris sivewright said...

so - what is the answer to the problem?