ESSAY: evaluate whether the Phillips curve accurately explains the relationship between inflation and unemployment

Question 1

Definitions of the Phillips curve?

Answer 1

Phillips curve- a Keynesian diagram/theory that shows the trade off between inflation and unemployment

Question 2

How the Phillips curve is accurate with diagram

Answer 2

-a country at near full capacity (between the perfect elastic and inelastic parts of the curve) will see a rise in inflation when they increase their GDP and therefore their employment
-when employment increases an economy should see an increase in inflation as there is more money in circulation due to more people earning and spending
-during high levels of unemployment ie a recession, as shown in the 08/09 recession there is very often deflation /disinflation and basically always no risk of inflation
DIAGRAM= Keynesian phillips curve

Question 3

How the Phillips curve isn’t accurate with diagram

Answer 3

-Neo classical reject the idea of the traditional Phillips curve and instead argue In the long term that unemployment is fixed at a natural rate
-any efforts to reduce unemployment will only be cyclical and employment will revert back to its natural rate in the long term
-explanation= in the short term when unemployment is reduced workers bid up their nominal wages due to job stability, as wage costs rise the price level rises too. when people realise their real wages haven’t actually increased some people decide not to work (classical unemployment) and employment is back to its natural rate at a higher level of inflation
DIAGRAM=perfectly inelastic long term curve with two short term Keynesian curves

Question 4

What does this depend on??

Answer 4

• time span- in the short run maybe the Keynesian Phillips curve shows the effect of inflation and unemployment but in the long run the neo classical curve shows there is a natural rate of unemployment and its hard to actually reduce employment in the long term
• NRU may be more applicable in a developed than developing, developing at lower capacity so schemes to increase employment may increased GDP without inflationary pressure