Phillips curve

Question 1

What does the Phillips curve show us?

Answer 1

An aggregate supply relation between inflation, expected inflation and unemployment

Question 2

How do we derive the aggregate supply relation?

Answer 2

1. we start with the price setting equation - P = (1 + m)P
2. In equilibrium we have the wage that is set by wage setters: P = Pe (1 + m)Pe F(u,z)

Question 3

What does the price level depend on?

Answer 3

1. Expected price at level P
2. Unemployment at rate u
3. Mark-up m
4. Catchall variable

Question 4

What is the equation for this relation?

Answer 4

Pi = Pi(e) + (m + z) - ALPHA(u)
Inflation is = to the expected inflation plus the markup plus the catchall variable minus the alpha unemployment rate

Question 5

What happens to inflation when expected inflation increases?

Answer 5

It increases

Question 6

What leads to an increase in inflation?

Answer 6

An increase in the mark-up, or an increase in the factors that affect wage determination (an increase in z)

Question 7

what leads to a decrease in inflation?

Answer 7

An increase in the unemployment rate, as it is negatively related to the inflation rate

Question 8

What is the actual relation for this equation?

Answer 8

well for the inflation and expected inflation rate we need to add time indexes so the equation is now:
Pi(t) = P(e, t) + (m + z) - ALPHAu

Question 9

What is the wage spiral?

Answer 9

How a decrease in unemployment leads to the increase of inflation through the impact of changes in wages

Question 10

What are the steps in the wage spiral?

Answer 10

1. Low unemployment leads to higher nominal wages
2. Higher wages lead to firms increasing prices
3. Low unemployment leads to higher nominal wages
4. In response, workers ask for a higher wage
5. Higher wages lead to firms further increasing prices
   So the race between prices and wages results in steady wage and price inflation

Question 11

What happened to the relatiopnship between unemployment and the inflation rate in the US in the 70s

Answer 11

The relation disappeared

Question 12

What did this relationship disappear

Answer 12

1. An increase in the price of oil
2. Changes in the way wage setters formed expectations due to a change in the behaviour of the rate of inflation - The rate of inflation became constantly positive and persistant

Question 13

What is the NAIRU?

Answer 13

The non-accelerating inflation rate on unemployment is the rate that is required to keep inflation prices constant

Question 14

The Phillips curve and the natural rate of unemployment

Answer 14

Pi(t) - Pi(t-1) = -Alpha [Ut - Un)
NRU is the unemployment rate such that the actual inflation rate is = to the expected inflation rate

Question 15

What is the natural rate of unemployment?

Answer 15

The rate of employment that is needed in the labour market to be in equilibrium

Question 16

How do derive the NAIRU from the Phillips curve

Answer 16

πt− πt−1 = (m + z) − αut
0 = (m + z) − αut
un = m+ z
α

The natural rate of unemployment is the unemployment rate
such that the actual inflation rate is equal to the expected
inflation rate.