The Tradeoff Between Inflation And Unemployment (Part I)

Front 1

What did Phillips discover about %deltaW?

Back 1

%deltaW = g(growth rate of labor productivity) + a - bU

Front 2

What is ULC?

Back 2

cost of labor input per unit of output.
ULC = wage rate/ labor productivity

Front 3

Derive %deltaULC.

Back 3

%deltaULC = %deltaW - g

Front 4

What is the relationship between prices and ULC in normal times?

Back 4

1. Total costs are roughly proportional to labor costs.
2. Prices are roughly proportional to costs.
Conclusion: P directly propotional to ULC --> pi = %deltaULC

Front 5

Derive pi in terms of a, b and U.

Back 5

pi = %delta ULC = %deltaW - g = [g+a-bU) - g = a - bU = %deltaP.

Front 6

Origins of the Phillips Curve. Apply aggregate demand-aggregate supply analysis to a growing economy. What happens to the unemployment rate if AD grows faster? Or if it's slower?

Back 6

You can actually draw the graph of P vs Y to see this clearly. Faster growth of AD --> higher inflation and faster growth of real GDP, hence lower Unemployment. Slower growth of AD, lower inflation and slower growth of real GDP, hence higher U.

Front 7

Does the Phillips curve fit the data? Discuss with respect to 1954 - 1969 and 1970 - 1984.

Back 7

1954 - 1969 : Yes
1970 - 1984 : No

Front 8

Why doesn't the Phillips curve fit the data?

Back 8

pi not equal to %deltaULC because it is not true that total cost is directly proportional to labor cost given the spike in oil prices in 1970-1984 (supply shock).

%deltaW = g + a - bU shifts due to adverse supply shocks which raise U or favorable supply shocks which decrease U.

Front 9

What does the Phillips curve look like in normal times?

Back 9

Inflation against Unemployment : Negative exponential.

Front 10

What does the Phillips curve look like if AD fluctuates?

Back 10

U and pi should be negatively correlated.

Front 11

What does the Phillips curve look like if AS fluctuates?

Back 11

U and pi should be positively correlated.

Front 12

The Vertical Long-Run Phillips Curve:
1. What is the self-correcting mechanism?
2. How are points that deviate from the Long-Run Phillips Curve brought back to it?
3. Draw the curve and indicate where the recessionary and inflationary gaps are.

Back 12

1. When there is an inflationary gap, wages rise, AD shifts inwards, pi rises, GDP goes down and U rises.
Opposite happens when there is a recessionary gap.
2. By the self-correcting mechanism as previously described.
3. Inflationary gap is behind the vertical PC while the recessionary gap is in front of it.

Front 13

Why does expected inflation make the Phillips curve shift other than the energy cost?

Back 13

If people expect rate of inflation to increase, then they behave as though there's really more inflation. So pi = pi(e) + a - bU
pi(e) = expected rate of inflation
So the phillips curve actually shifts upwards.

Front 14

What is Lincoln's Law? What is its implication with regard to U?

Back 14

pi = pi(e) eventually
There is a natural rate of unemployment (full employment), U = a/b

Front 15

What is the tradeoff between inflation and unemployment in the long run?

Back 15

No tradeoff, because unemployment will be at its natural rate regardless of the rate of inflation.