Problem Set 5: The Phillips Curve and the Sacrifice Ratio Prof. Wyatt Brooks University of Notre Dame due December 9th, 2014 Section 1: AD-AS with the Phillips Curve Based on reading from Chapter 22 and Lecture 19. Suppose particularly favorable weather increases the productivity of farming temporarily. The aggregate expenditure determines the total amount that firms and households plan to spend on goods and services at each level of income. When looking at this in terms of the Philips curve, in the short run, there is a tradeoff between inflation and unemployment, so people's inflationary expectations can shift the Philips curve. The Phillips Curve shows that wages and prices adjust slowly to changes in AD due to imperfections in the labour market. The Phillips curve represents the relationship between the rate of inflation and the unemployment rate. However, a downward-sloping Phillips curve is a short-term relationship that may shift after a few years. The current Corona shock has been so unprecedented that it has distorted a lot of economic data, including the Phillips curve relationship. However, the labor market can be tight for certain skill sets even when unemployment is high. Phillips found a consistent inverse relationship: when unemployment was high, […] The government uses these two tools to monitor and influence the economy. What is the natural rate of unemployment? Assume: Initially, the economy is in equilibrium with stable prices and unemployment at NRU (U *) (Fig. Although he had precursors, A. W. H. Phillips’s study of wage inflation and unemployment in the United Kingdom from 1861 to 1957 is a milestone in the development of macroeconomics. If Money supply increases by 10%, with price level constant, real money supply (M/P) will increase. preparing the performance comparison of Phillips curve analysis, and Yuko Koyama, Fumiko ... of the equation provides the following relationship:4 ... (1+ )≈ if z is close to zero, to calculate the left-hand side of equation (1). e.g. This relationship was the foundation for the modified Phillips curve and is still valid and applicable for many developed countries. A Phillips curve shows the tradeoff between unemployment and inflation in an economy. The Phillips Curve. From a Keynesian viewpoint, the Phillips curve should slope down so that higher unemployment means lower inflation, and vice versa. 5 This relationship was referred to as the Phillips curve. The natural rate is … What is the Phillips Curve? But although the Phillips curve could not explain stagflation, a new relation between unemployment and inflation was discovered, namely the inverse relation of unemployment and changes in inflation. When unemployment is low relative to the natural rate of unemployment, inflation tends to be high and vice versa. The Phillips Curve is the graphical representation of the short-term relationship between unemployment and inflation Fiscal Policy Fiscal Policy refers to the budgetary policy of the government, which involves the government manipulating its level of spending and tax rates within the economy. One of the advantages of using Macrobond is that all my charts get updated automatically when new data is out, so no additional work there. In 1958, A. W. Phillips (1914-1975) published an important paper that found a significant negative relationship between the rate of increase of nominal wages and the percentage of the labour force unemployed during important periods in British economic history. a. 13.7). Suppose the Phillips Curve is given by [Πt is the inflation rate, EΠt is the expected inflation rate, and ut is the unemployment rate]: Πt = EΠt + 0.1 – 2ut Where EΠt = ΘΠt-1 Also, suppose Θ is initially equal to zero. A few months ago, I wrote a draft version of a blog post on the US Phillips curve. In his paper, Phillips described the supposed inverse relationship between unemployment levels and the rate of inflation. The equation is: AE = C + I + G + NX. The Phillips curve describes the inverse relationship between unemployment and inflation. However, my writing does not.