Answer to Question #238462 in Macroeconomics for Jin

Question

How the Phillips Curve model (and associated diagram) could be modified to take account of shifts in the relationship over time?

Answer 1

Philips curve model was given by A. W. Philips. Philips curve shows the relationship between inflation and unemployment. High inflation in the economy means lower unemployment and lower inflation means higher unemployment rate in an economy. It is used to guide macro economic policy in an economy.

 

Original Philips curve shows the graphical relationship between the inflation rate and unemployment. It is modified and shows that over the time period in the long run it shows that there is no relationship between unemployment and inflation.

Any change in the Aggregate demand and aggregate supply will have impact on the Philips curve.

Short Run Philips curve 

In the above diagram short run Philips curve shows that E point t Inflation rate is r and unemployment rate is U. When AD change then Movement in Philips curve occurs along the Philips curve and when Aggregate supply curve changes then Philips curve shifts over the time.

Movement from point E to A shows that AD increase that leads to increase in price level and inflation and decrease in unemployment rate. When prices increase then self correcting adjustments will happen and wage will increase that leads to shift aggregate supply to left side means decreases for the new equilibrium and Philips curve shifts to the Right side.

When opposite happens to the above situation Philips curve shifts to the left side. When AD decreases Price level decreases and inflation decreases and unemployment increase. By self correcting mechanism AS will shift o the right side means increase and Philips curve shifts to the left side.

 

In long Run Philips curve has been modified and it says there is no relationship between inflation rate and unemployment rate. As shown in the below diagram Long run Philips curve is vertical line that means at natural level of unemployment rate inflation does not effect unemployment in an economy and it does not accelerate inflation in the economy.