The Phillips curve

Question 1

What is the Phillips curve

Answer 1

An economic model that shows the possible inverse non-linear relationship between unemployment rate and rate of inflation

Question 2

High unemployment

Answer 2

Inflationary pressures tend to be weak (low inflation)

Question 3

A fall in unemployment

Answer 3

This may not lead to an increased inflation as spare capacity and resources are being used efficiently. However, eventually it will lead to wage and price pressures increasing. The result can be increased wage inflation, which leads to a faster rice in consumer prices, hence the inverse relationship.

Question 4

What happens when inflation is too high?

Answer 4

At this point the trade off between jobs and prices is unfavourable so a nations central bank will start to raise interest rates.

Question 5

Challenges of the Phillips curve

Answer 5

It came under scrutiny in the 1970’s as countries experienced high inflation and unemployment at the same time (stagflation).

Question 6

Expectations-Augmented Phillips Curve (EAPC)

Answer 6

A Phillips Curve that considers the effect of expectations. E.g. if people expect high inflation, then inflation will be higher for a given rate of unemployment.

Question 7

What causes the Phillips curve to shift or flatten?

Answer 7

-Supply side policies
-Labour market reform
-International trade

Question 8

Supply side policies

Answer 8

Aimed at improving productive capacity of an economy e.g. education and training. This can lead to a lower structural unemployment and a flatter curve

Question 9

Labour market reform

Answer 9

Can improve work incentives and improve labour mobility which can increase competition in the labour market and bring down unemployment without increasing inflation

Question 10

International trade

Answer 10

If increased overseas trade leads to greater contestability and lower prices, this can lead to a lower inflation rate and flatter curve