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Philips curve
A graph showing the short-run relationship between the unemployment rate and the inflation rate. The relationship is inverse.
If there is slow growth in the economy, then
there is high unemployment and low inflation
If there is fast growth in the economy, then
there is low unemployment and high inflation
The Philips curve shows only ______ in the inflation rate and unemployment rate
changes
There is _________ to higher inflation and lower unemployment
permanent trade-off (you can't just pick a combination of inflation rates and unemployment rates)
Why is there no permanent trade-off?
Because in the long-run, the economy will always return to the natural rate of unemployment.
In the long run, a higher price level.....
has no effect on real GDP. Real GDP is always at potential GDP in the long-run.
In the long-run, the Philips curve...
Is a vertical line at the natural rate of unemployment.
If there is no long-run trade-off, then why does the economy experience a short-run trade off?
Because of the differences between the expected inflation rate and the actual inflation rate, this could cause unemployment to rise or fall above or below the natural rate of unemployment.
How does higher than expected inflation affect the unemployment rate?
Wages are negotiated beforehand taking into account what the "expected" inflation rate is. If the inflation rate is higher than expected, then the real wage is lower and the firm will hire more people. Unemployment will decrease.
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